Tuesday, 25 October 2011

Demand for a product increases when the prices of its complements decrease

Demand for a product increases when the prices of its complements decrease.
This quote comes from Strategy Letter V (Joel on software). It's useful for selling products.
Every product in the marketplace has substitutes and complements. 
A substitute is another product you might buy if the first product is too expensive. 
Chicken is a substitute for beef. 
If you're a chicken farmer and the price of beef goes up, 
the people will want more chicken, and you will sell more.
When computers become cheaper, more people buy them, and they all need operating systems, 
so demand for operating systems goes up, which means the price of operating systems can go up.
Smart companies try to commoditize their products' complements.
When IBM designed the PC architecture, they used off-the-shelf parts instead of custom parts, 
and they carefully documented the interfaces between the parts in the (revolutionary) IBM-PC Technical Reference Manual. 
Why? So that other manufacturers could join the party. As long as you match the interface, you can be used in PCs. 
IBM's goal was to commoditize the add-in market, which is a complement of the PC market, and they did this quite successfully. 
Within a short time scrillions of companies sprung up offering memory cards, hard drives, graphics cards, printers, etc. 
Cheap add-ins meant more demand for PCs.
When IBM licensed the operating system PC-DOS from Microsoft, Microsoft was very careful not to sell an exclusive license. 
This made it possible for Microsoft to license the same thing to Compaq 
and the other hundreds of OEMs who had legally cloned the IBM PC using IBM's own documentation. 
Microsoft's goal was to commoditize the PC market. Very soon the PC itself was basically a commodity, with ever decreasing prices, 
consistently increasing power, and fierce margins that make it extremely hard to make a profit. The low prices, of course, increase demand.
 Increased demand for PCs meant increased demand for their complement, MS-DOS. 
All else being equal, the greater the demand for a product, the more money it makes for you. 
And that's why Bill Gates can buy Sweden and you can't.

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