While competition between ﬁrms producing substitutes is well understood, less is known about rivalry between complementors. We study the interaction between ﬁrms in markets with one-way essential complements. One good is essential to the use of the other but not vice versa, as arises with an operating system and applications. Our interest is in the division of surplus between the two goods and the related incentive for ﬁrms to create complements to an essential good. Formally, we study a two-good model where consumers value A alone, but can only enjoy B if they also purchase A. When one ﬁrm sells A and another sells B, the ﬁrm that sells B earns a majority of the value it creates. However, if the A ﬁrm were to buy the B ﬁrm, it would optimally charge zero for B, provided marginal costs are zero and the average value of B is small relative to A. Hence, absent strong antitrust or intellectual property protections, the A ﬁrm can leverage its monopoly into B costlessly by producing a competing version of B and giving it away. For example, Microsoft provided Internet Explorer as a free substitute for Netscape; in our model, this maximizes Microsoft’s joint monopoly proﬁts. Furthermore, Microsoft has no incentive to raise prices, even if all browser competition exits. This may seem surprising since it runs counter to the traditional gains from price discrimination and versioning. We also show that a essential monopolist has no incentive to degrade rival complementary products, which suggests that a monopoly internet service provider will oﬀer net neutrality. There are other means for the essential A monopolist to capture surplus from B. We consider the incentive to add a surcharge (or subsidy) to the price of B, or to act as a Stackelberg leader. We ﬁnd a small gain from pricing ﬁrst, but much greater proﬁts from adding a surcharge to the price of B. The potential for A to capture B’s surplus highlights the challenges facing a ﬁrm whose product depends on an essential good.
Chen, Keith M. and Nalebuff, Barry, "One-Way Essential Complements" (2006). Cowles Foundation Discussion Papers. 1881.