Laws of Tech: Commoditize Your Complement

Key takeaway

• For entrepreneurs: commoditizing the complements to a company’s core products enables focus on dominating a specific layer of a product stack while ensuring that adjacent layers—those that are complementary to the core product—become highly competitive and commoditized. This strategy not only helps in maintaining a lean and efficient company structure but also in capturing a larger share of the market and consumer surplus.
• For investors: the strategic advantage of focusing on commoditizing the complements to a company's core products. This strategy not only secures a dominant market position by making the complementary products or services more competitive and less profitable for others but also enhances the demand and profitability of the company's primary offerings.

Summary

The article "Laws of Tech: Commoditize Your Complement" by Gwern, published on April 23, 2024, explores a strategic pattern in technology economics known as "commoditizing your complement." This concept, initially identified by Joel Spolsky in 2002, involves companies aiming to dominate a particular layer of a product stack while fostering intense competition in adjacent layers. By doing so, they create a quasi-monopoly for themselves and drive down the prices of complementary products to marginal costs. This strategy increases overall demand for the final product and allows the company controlling the chokepoint to capture the majority of the consumer surplus[1].

Insights

• Commoditizing complements is an alternative to vertical integration, where a company focuses on securing a dominant position in one layer of a product while ensuring that other layers remain highly competitive and commoditized.
• This approach allows a company to remain relatively small and lean, avoiding the risks associated with vertical integration, such as overextension and being outcompeted at every level.
• The strategy can be implemented incrementally and strategically, often through investments in intellectual property or other areas that foster competition in the complement layers.
• It maintains the appearance of competition in the market while ensuring that extreme competition is confined to layers where the company itself is not at risk.
• Examples of this strategy include IBM's commoditization of add-on manufacturers, Microsoft's commoditization of PC hardware, and various tech companies' contributions to open-source software to prevent competitors from gaining a foothold in their layer of the stack[1].

Implications

• Companies that successfully commoditize their complements can divert a larger share of consumer surplus to themselves, effectively increasing their profitability.
• The strategy can lead to lower prices for consumers in the commoditized layers, which can increase demand for the final product.
• It can prevent the emergence of competing monopolists by making it difficult for them to earn significant profits in the adjacent layers, thus hindering their ability to vertically integrate.
• The approach can lead to a concentration of market power and control in the hands of the company that successfully commoditizes its complements, potentially raising antitrust concerns.
• For consumers and other market participants, understanding this strategy is crucial for recognizing the dynamics of market control and the distribution of value within technology ecosystems[1].

Long-form breakdown