created: 17 March 2018; modified: 14 Jun 2018; status: finished; confidence: highly likely; importance: 5
Joel Spolsky in 2002 identified a major pattern in technology business & economics: the pattern ofcommoditizing your complement, an alternative to vertical integration, where companies seek to secure a chokepoint or quasi-monopoly in products composed of many necessary & sufficient layers by dominating one layer while fostering so much competition in another layer above or below its layer that no competing monopolist can emerge, prices are driven down to marginal costs elsewhere in the stack, total price drops & increases demand, and the majority of the consumer surplus of the final product can be diverted to the quasi-monopolist. A classic example is the commodification of PC hardware by the Microsoft OS monopoly, to the detriment of IBM & benefit of MS. This pattern explains many otherwise odd or apparently self-sabotaging ventures by large tech companies into apparently irrelevant fields, such as the high rate of releasing open-source contributions by many Internet companies or the intrusion of advertising companies into smartphone manufacturing & web browser development & statistical software & fiber-optic networks & municipal WiFi & radio spectrum auctions & DNS (Google): they are pre-emptive attempts to commodify another company elsewhere in the stack, or defenses against it being done to them.
Smart companies try to commoditize their products’ complements
Former MS product manager Joel Spolsky’s 20021
Strategy Letter V: The Economics of Open Source (./; HN) discusses a pattern he sees in technology companies and software in particular (emphasis in original, most links added):
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.
A complement is a product that you usually buy together with another product. Gas and cars are complements. Computer hardware is a classic complement of computer operating systems. And babysitters are a complement of dinner at fine restaurants. In a small town, when the local five star restaurant has a two-for-one Valentine’s day special, the local babysitters double their rates. (Actually, the nine-year-olds get roped into early service.)
All else being equal, demand for a product increases when the prices of its complements decrease.
…In general, a company’s strategic interest is going to be to get the price of their complements as low as possible. The lowest theoretically sustainable price would be thecommodity price- the price that arises when you have a bunch of competitors offering indistinguishable goods. So:
Smart companies try to commoditize their products’ complements.
If you can do this, demand for your product will increase and you will be able to charge more and make more.
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.
Spolsky provides 8 examples (IBM commoditizing the add-on manufacturers, MS commoditizing IBM+PC manufacturers, IBM/Transmeta/Sun/HP funding FLOSS/Linux, Netscape open-sourcing Navigator, Sun developing Java & the JVM):
Understanding this strategy actually goes a long, long way in explaining why many commercial companies are making big contributions to open source. Let’s go over these.
- Headline: IBM Spends Millions to Develop Open Source Software.
- Myth: They’re doing this because Lou Gerstner read the GNU Manifesto and decided he doesn’t actually like capitalism.
Reality: They’re doing this because IBM is becoming an IT consulting company. IT consulting is a complement of enterprise software. Thus IBM needs to commoditize enterprise software, and the best way to do this is by supporting open source. Lo and behold, their consulting division is winning big with this strategy. …
- Headline: Netscape Open Sources Their Web Browser.
- Myth: They’re doing this to get free source code contributions from people in cybercafes in New Zealand.
Reality: They’re doing this to commoditize the web browser. This has been Netscape’s strategy from day one. Have a look at the very first Netscape press release: the browser isfreeware. Netscape gave away the browser so they could make money on servers. Browsers and servers are classic complements. The cheaper the browsers, the more servers you sell. This was never as true as it was in October 1994. …
- Headline: Transmeta Hires Linus, Pays Him To Hack on Linux.
- Myth: They just did it to get publicity. Would you have heard of Transmeta otherwise?
Reality: Transmeta is a CPU company. The natural complement of a CPU is an operating system. Transmeta wants OSs to be a commodity.
- Headline: Sun and HP Pay Ximian To Hack on Gnome.
- Myth: Sun and HP are supporting free software because they like Bazaars, not Cathedrals.
Reality: Sun and HP are hardware companies. They make boxen. In order to make money on the desktop, they need for windowing systems, which are a complement of desktop computers, to be a commodity. Why don’t they take the money they’re paying Ximian and use it to develop a proprietary windowing system? They tried this (Sun had NeWS and HP had New Wave), but these are really hardware companies at heart with pretty crude software skills, and they need windowing systems to be a cheap commodity, not a proprietary advantage which they have to pay for. So they hired the nice guys at Ximian to do this for the same reason that Sun bought Star Office and open sourced it: to commoditize software and make more money on hardware.
The bytecode idea is not new - programmers have always tried to make their code run on as many machines as possible. (That’s how you commoditize your complement). For years Microsoft had its own p-code compiler and portable windowing layer which let Excel run on Mac, Windows, and OS/2, and on Motorola, Intel, Alpha, MIPS and PowerPC chips. Quark [QuarkXPress?] has a layer which runs Macintosh code on Windows. The C programming language is best described as a hardware-independent assembler language. It’s not a new idea to software developers.
If you can run your software anywhere, that makes hardware more of a commodity. As hardware prices go down, the market expands, driving more demand for software (and leaving customers with extra money to spend on software which can now be more expensive.)
Sun’s enthusiasm for WORA is, um, strange, because Sun is a hardware company. Making hardware a commodity is the last thing they want to do. Oooooooooooooooooooooops! Sun is the loose cannon of the computer industry. Unable to see past their raging fear and loathing of Microsoft, they adopt strategies based on anger rather than self-interest. Sun’s two strategies are (a) make software a commodity by promoting and developing free software (Star Office, Linux, Apache, Gnome, etc), and (b) make hardware a commodity by promoting Java, with its bytecode architecture and WORA. OK, Sun, pop quiz: when the music stops, where are you going to sit down? Without proprietary advantages in hardware or software, you’re going to have to take the commodity price, which barely covers the cost of cheap factories in Guadalajara, not your cushy offices in Silicon Valley.2
A way I would express it as: Any product is the joint outcome of a large number of individual components, each of which layers is necessary but not sufficient to the final valuable use of the entire stack put together; a smartphone is not much good without a power-efficient sensitive radio, but the radio is not much good without a good OS on top of it, and a good OS is not much good either without great apps like web browsers (and is a web browser all that useful if there aren’t useful websites to use in it, and where are the languages & compilers for all this coming from anyway…?). Many products are formed by a stack of two-sided markets.
The end product of a Symbian, iOS, or Android smartphone is without a doubt fantastically valuable to the user, but what is the fair division of the revenue among the countless people, technologies, manufacturers who created each of the many critically-important layers in the full tech stack? Certainly contemporary intellectual property law (eg
software patents) does not provide a socially-efficient distribution like the Shapley value to all the participants! There are constraints in that the final product cannot cost more than the value to the user (otherwise consumers simply wouldn’t buy it, and if the consumer surplus isn’t at least considerably above zero, no one would bother to learn about it) and the companies in the commoditized layers can’t be forced down to below marginal costs (otherwise they would go bankrupt & exit the market), but these are weak, and do not give any good hints as to who will capture the majority of the value: the chip fab manufacturers? the chip designers? the device manufacturers? the OS developers? the userland application developers? the ISPs? the website owners?
Vertical integration can be an effective way of resolving the intractable market dispute with top-down dictatorships, but can require lax anti-monopoly regulations, high capital investment, massive corporation overextension & empire-building, and risks being outcompeted at every level by nimbler competitors; this makes it difficult for any up-and-coming company to implement, and often ineffective. Commoditizing the complements, in contrast, permits a company to remain (relatively) small & lean, can often be accomplished with small strategic investments in releasing intellectual property or other investments, can be done incrementally focusing on specific layers without the
Big Bang orientation of vertical integration and permitting
defeat in detail, retains the general facade of competition, and ensures the extreme competition remains confined to other layers of the stack where the complement can benefit from the cost reductions but is not at any risk.
In practice, the division winds up being due to power plays and market dynamics, and who can most effectively erect a moat while sabotaging competitors, exploiting tactics like lawsuits & software patent trolling, proprietary APIs, cross-business subsidies, kickbacks, DRM, deliberate incompatibility or
embrace and extend, FUD, operating at a loss indefinitely, etc. (
There’s An App For That is why you buy an iPhone - but it’s Apple with the $930b market cap & not the app developers.)
Done correctly, this is effective at perpetuating incumbents’ long-term control of markets & justifies their enormous valuations - by definition, the competitors elsewhere in the stack, who might develop a chokepoint, are too numerous, fragmented, and low-margin to invest substantially into threatening R&D3 or long-term strategic initiatives, and any upstart startups can be relatively easily bought out or suppressed (eg Instagram or WhatsApp). Nor does this require convoluted explanations like
they are pretending to not be monopolists or fully general unfalsifiable claims like
it’s good PR for why big companies like Google steadily fund so many apparently oddball projects like new open source TCP/IP protocol replacements, which are neither directly profitable nor well-known nor impressively charitable - but do have clear explanations in terms of business objectives like
driving more mobile web browsing (thus allowing Google to show them more ads, because the complement, mobile web browsing, has become cheaper/easier). As ucaetano puts it:
Another way that I like to express that iscreate a desert of profitability around you. I once had a strategy professor define the Google business model somewhat like that, whereGoogle tries to make every other business around it free or irrelevant…A desert of profitability shifts consumers to you, and keeps competitors away.
A list of examples I think reflect this dynamic to some extent:
- IBM’s 1956 consent decree settling a 1952 antitrust lawsuit: IBM was required to sell as well as lease its devices; more importantly, its business services arm was spun off and IBM had to license software/patents/manuals/training to competitors. Previously, IBM (like many other hardware manufacturers) included all necessary software with its hardware for
free, particularly for the OS/360, strangling any independent software market; the decree and the eventual
unbundlingis credited with sparking a vibrant (and highly profitable) market for IBM mainframe software. (It is also credited with putting the fear of God into IBM & protecting smaller companies like Microsoft; in an ironic repetition, Microsoft’s own antitrust travails in the 1990s are credited for causing it to back off its classic ruthless tactics and enable Google’s own rise to dominance4.)
- credit card companies/small businesses: interchange fees in particular (part of why the credit card industry is one of the highest-profit margin ones after academic publishing, itself a suspicious example)
- Lisp machines vs x86/SPARC/Sun
- Netscape vs Windows (in Robert Metcalfe’s infamous expression, cross-platform web browsers & the Internet would reduce Windows to a
poorly debugged set of device drivers); MS’s initial response was to… license IE free for all users, not just noncommercial users like Netscape, killing a major revenue stream for Netscape early on5
FLOSS: Red Hat, Google etc
- XEmacs represented an early example of a company trying to improve a FLOSS version of a genre of software previously typically sold commercially (text editors) in order to support sales of more niche tooling (their C++ IDE)
- GNU and compiler/interpreter companies: GCC; commercial C++ implementations would themselves be cannibalized by GCC, and IDEs by other FLOSS IDEs (apropos of IBM and Java, Eclipse)
- in programming communities (especially functional languages like Haskell/O’Caml/Scala/Clojure), it is common for a lot of work on compilers/libraries/tutorials/books to be sponsored by web development or consultancies, serving both as advertisements for their capabilities and also removing pain points to use of said programming languages and thus increasing demand for their services. (If nobody uses Haskell because GHC has a major bug, nobody is going to hire a Haskell consultancy like Well-Typed, either. In the sales funnel, you have to have customers entering the funnel to get any customers out.)
- ISPS vs tech companies via Net neutrality (eg spectrum auctions, Google Fiber, zero-rating)
- special-purpose networking hardware (especially Cisco Systems) vs Software-defined networking (as employed by Google/Microsoft/Amazon/cloud giants)
- Windows Mobile/Android/iOS vs smartphone manufacturers
- iOS/apps: to put it bluntly,
Apple Doesn’t Want Your iPhone App to Make Moneyand if your app does anyway, it’ll take a 30% cut.
- incompatibility of video call apps across platforms
- Samsung Bixby/Google Assistant & services
- Qualcomm vs Apple with Intel as wedge
- iPhone vs telecom ISPs: demand for the iPhone was so enormous it was used as a wedge to force cellphone networks into allowing things they didn’t want - such as letting a large fraction of all smartphones on their network out of their control and extracting unusual concessions
pausesin the famous graph of genome sequencing cost dropping exponentially over time); in response to the high prices, heavy users of genome sequencing have launched desperate attempts to escape the Illumina monopoly, such as BGI’s ill-fated acquisition of Complete Genomics whose sequencers ultimately proved inadequate after sowing internal chaos & wrecking many projects; rumor has it that 23andMe launched its own very expensive internal attempt to develop replacement genome sequencers, and this was a major contributor to its financial woes after the FDA debacle.
- Uber/Lyft vs self-employed drivers vs self-driving cars
- Crypton’s Vocaloid vs singers: the voice-synthesizer software sparked an amateur explosion of song production, as apparently even finicky software made high-quality singing far more accessible; Crypton maintains control over specific characters like Hatsune Miku (sampled from minor voice actress Saki Fujita) and particularly over all licensing and commercial revenue, which formerly would have to be shared with the human idol
- FB’s Open Compute Project, and acquisitions of Instagram/WhatsApp
- Darknet markets: many DNMs provided an API for the DNM search engine
Gramswhen small6, then neglected or revoked it at some point; this has an easy interpretation: DNM sellers and buyers want markets to be commodities that they can smoothly move their reputations & business between as DNMs go up or down (as they historically have); while of course, markets want vendors to be trapped and locked into them, and the market able to raise commissions
- Imgur vs Reddit:
The Decline of Imgur on Reddit and the Rise of Reddit’s Native Image Hosting
- Nvidia’s GPUs/CUDA vs AMD/OpenCL vs Google TensorFlow/TPUs
- Amazon vs PayPal
cloud providers vs abstraction layers like
- booking agencies vs hotels/airlines: exemplified by the story of Room Key
- media/music companies vs the Internet: Vevo vs YouTube (
a former YouTube execis quoted as saying
Huge huge success for YouTube…YouTube needed Vevo to exist for just long enough to become so popular that the labels had no leverage anymore.) , Hulu vs Netflix/Amazon/BitTorrent…
It was republished in the 2004 anthology, Joel on Software: And on Diverse and Occasionally Related Matters That Will Prove of Interest to Software Developers, Designers, and Managers, and to Those Who, Whether by Good Fortune or Ill Luck, Work with Them in Some Capacity, but I only spotted minor formatting changes like removing some hyperlinks, so the 2002 blog post is the canonical version.↩
Of course, this can pose a problem of its own: if the other layers of the stack have near-zero profits, how will they afford to develop new technology that the incumbent might desire? Apple, for example, apparently has to extend large loans and provide other life-support for hardware makers to get the new materials & manufacturing techniques it wants. This does not always end well, like in the case of the ultra-hard sapphire screens for the iPhone (TechCrunch; WSJ).↩
Anyone who said that the 1990s prosecution of Microsoft didn’t accomplish anything - that it was companies like Google, rather than government lawyers, that humbled Microsoft - didn’t know what they were talking about, Reback said. In fact, he argued, the opposite was true: The antitrust attacks on Microsoft made all the difference. Condemning Microsoft as a monopoly is why Google exists today, he said.
Surprisingly, some people who worked at Microsoft in the 1990s and early 2000s agree with him. In the days when federal prosecutors were attacking Microsoft day and night, the company might have publicly brushed off the salvos, insiders say. But within the workplace, the attitude was totally different. As the government sued, Microsoft executives became so anxious and gun-shy that they essentially undermined their own monopoly out of terror they might be pilloried again. It wasn’t the consent decrees or court decisions that made the difference, according to multiple current and former Microsoft employees. It was
the constant scrutiny and being in the newspaper all the time,said Gene Burrus, a former Microsoft lawyer.
People started second-guessing themselves. No one wanted to test the regulators anymore.
In public, Bill Gates was declaring victory, but inside Microsoft, executives were demanding that lawyers and other compliance officials - the kinds of people who, previously, were routinely ignored - be invited to every meeting. Software engineers began casually dropping by attorneys’ desks and describing new software features, and then asking, in desperate whispers, if anything they’d mentioned might trigger a subpoena. One Microsoft senior executive moved an extra chair into his office so a compliance official could sit alongside him during product reviews. Every time a programmer detailed a new idea, the executive turned to the official, who would point his thumb up or down like a capricious Roman emperor. In the early 2000s, Microsoft’s top executives told some divisions that their plans would be proactively shared with competitors - literally describing what the company intended to create before software was even built - to make sure it wouldn’t offend anyone who was likely to sue. Microsoft’s engineers were outraged. But they went along with it. And most important, as Microsoft lived under government scrutiny, employees abandoned what had been nascent internal discussions about crushing a young, emerging competitor - Google. There had been informal conjectures about reprogramming Microsoft’s web browser, the popular Internet Explorer, so that anytime people typed in
Google,they would be redirected to MSN Search, according to company insiders. Or, perhaps a warning message might pop up:
Did you know Google uses your data in ways you can’t control?
Microsoft was so powerful, and Google so new, that the young search engine could have been killed off, some insiders at both companies believe.
But there was a new culture of compliance, and we didn’t want to get in trouble again, so nothing happened,Burrus said. The myth that Google humbled Microsoft on its own is wrong. The government’s antitrust lawsuit is one reason that Google was eventually able to break Microsoft’s monopoly.
If Microsoft hadn’t been sued, all of technology would be different today,Reback told me.
Jon Mittelhauser(NCSA Mosaic co-author/Netscape co-founder):
The actual license for the Netscape browser was free for noncommercial use, but commercial companies had to pay. … We were actually bringing in a fair amount of browser revenue. Microsoft came along and just gave away the browser for free, for any use, for commercial use, noncommercial use, whatever. That undercut that whole business.
Harry First(antitrust bureau chief, New York Attorney General’s Office):
It wasn’t being free that was a bad thing. It was the end result of that being that Internet Explorer would be the exclusive browser and that no other competitor would arise as a competing operating system. … It was basically exclusionary behavior. It was an effort to smother Netscape in the cradle and cut off its air supply.
Gary Reback(antitrust lawyer representing Netscape):
What Microsoft was doing was not just damaging to a company - namely Netscape - but it was damaging to a whole new generation of technology.
What both Microsoft and Netscape missed out on was that realization that the browser didn’t really matter. It was sites that mattered. We easily could have bought Yahoo, Google, etc. But the Google guys and the Yahoo guys basically worked with us and we helped get them set up.
Stephen Houck(antitrust bureau chief, New York Attorney General’s Office):
Some people say the decree caused Microsoft to lose its edge. I’m not really convinced that was the case. I think what it did do is make them very careful about using market power they had in Windows to affect related areas of software like the browser or search or operating systems for handheld devices.
Steve Lohr(technology and economics reporter, The New York Times):
It helped provide an opening for Google, for sure. I remember doing this story when Google was upset because Microsoft was trying to hide the Google Search box. And then they fell away from that, they had to make it easier for the Google Search box to appear.
If there hadn’t been the lawsuit or hadn’t been the [consent] decree, based on their past behavior, Microsoft very well might have done things that made it a lot more difficult for Google. Even with desktop search, that was one of the areas we were looking at in terms of what Microsoft could and couldn’t do with Windows. Google was probably one of the beneficiaries.
Microsoft had run Netscape out of the browser market. Internet Explorer was literally 98% of the market. The only way you could get to Google was through Microsoft. You had to go onto the Microsoft browser and typeDon’t click on this site. It’s a bad site. It takes your personal information without telling you …" I have long asserted, based on my conversations with Microsoft people, that they didn’t do it because they were tired of getting fined a billion euros a pop. It was clear what would happen to them if they killed Google or the next generation of technology. The reason they didn’t do that was the threat of antitrust enforcement. Because of antitrust enforcement, that’s why we have Google. There is no other reason."
www.google.com. Now if you did that, there’s no reason Microsoft had to send you to Google. They could have just put up the big red warning screen, saying
It’s interesting to think about the right to compete on the Microsoft platform and the right to compete on the Facebook or Google platform. Google and Facebook create innovation platforms, but they reserve the right perpetually to decide whether your application is allowed to run, and they can pull the plug anytime they want, and they do. With Microsoft running software on the operating system they provided, they never asserted the power to determine which programs were allowed to run or not. … Microsoft might have learned a lesson and behaved in a more open or respectful way with competitors, but the whole industry moved to a world where the platform owner has more power than the platform owner ever presumed to have in the days of Microsoft. That’s an important difference, which you might say undermines the significance of the case.
The thing about these technology industries is I can’t go back and fix things. If something anticompetitive happened in the airline industry, I could easily go back in and fix things and break things up. They’re still the same planes, they’re the same passengers, they’re the same gates, they’re the same air routes. They don’t change. That’s not the case with technology. Once a new technology is crushed, it’s gone. It’s not coming back - ever. We can’t do the same kind of fix easily. We’re at a situation with Google where I can’t go back and restore competition. If I’m going to make some competition, I’m going to have to do it by breaking the company apart, and that becomes all the more difficult.