Author: Sengupta, Sanjit; Bucklin, Louis P. Title: To ally or not to ally? Journal: Marketing Management v4, n2 (Fall 1995):24-33. (10 pages). Copyright American Marketing Association 1995 In 1981, IBM, in a radical departure from historic policy, launched its PC built with outsourced components and software. IBM contracted with Microsoft to provide the operating system for its PC and obtained nonexclusive rights for its use. Microsoft's first-to-market position--and its relationship with IBM--helped DOS become the industry standard operating system. Because IBM did not have exclusive rights to Microsoft's DOS, other manufacturers licensed MSDOS and built computers that could run the same application programs as IBM's. These clones, with their lower prices, soon sold in great volume. IBM lost market share and was forced to reduce gross margins while the rise of the clones served to expand Microsoft's market. Despite these difficulties, IBM signed a Joint Development Agreement in June 1985 with Microsoft to create the next generation operating system. Microsoft became an ally (not a simple vendor), and IBM and Microsoft took joint ownership rights to the new operating system, OS/2. However, differences between the two firms continued. Microsoft pushed Windows, the graphical interface it had created to work with DOS, but IBM preferred its own Presentation Manager. It soon became obvious that Microsoft and IBM were competing to have the same third-party ,software vendors develop applications for Windows and OS/2, respectively. The first versions of OS/2 found only a limited market while the sales of Windows began to soar. The relationship between the firms became increasingly acrimonious until 1991, when IBM and Microsoft finally parted company. IBM was left to ponder the wisdom of its dramatic departure from in-house e development of complementary products as it watched its former partner take over industry leadership in personal computers. Bolstering New Products Even though companies make huge investments in new product development, the failure rate has historically been high. Complementary products--those which add value to some new or existing item through joint use--often improve the odds for success. The value of the personal computer, for example, is augmented dramatically by such complementary products as CD-ROM drives, modems, fax boards, and application software. Likewise, having an inadequate range of complementary products to bolster a new product can spell its demise. The failure of the Next workstation can be attributed, in part, to the lack of available application software. Apple Computer, facing declining interest from software developers in its system, has taken to licensing the operating system to competitors. By increasing the number of Macintosh-compatible computers, Apple hopes to make its operating system software more attractive to application developers. If this is successful, and more programs are created, the value of the Mac operating system and hardware will increase. Apple's management expects the ensuing growth in demand for its hardware and operating system to more than offset the impact of clone competition from its licensees. Herein lies the dilemma. By joining forces with other firms to exploit complementary business opportunities, both new entrants and existing players can solidify or augment their market positions. At the same time, if innovating firms are not careful, they can create competitors that successfully ride their coattails to positions of market dominance. Managing the Strategy How the complementary product strategy is managed can dramatically affect company fortunes, as the volatile relationship between IBM and Microsoft clearly shows. IBM initially employed a make strategy, manufacturing virtually all the products that complemented its mainframe computers. In developing its personal computer, IBM shifted to a buy strategy, negotiating with suppliers for the provision of complementary products. Still later, it formed an alliance with Microsoft to develop OS/2. However, the company was not successful in managing this relationship. A fourth approach to complementary product strategy is interface management. When a firm does not want to invest resources directly in the complementary product, it can instead provide an interface between its existing product and complementary products available from independent third parties. The interface is the set of linkages through which complementary products interact and work together. The most obvious is that of input/output, the means whereby work accomplished in one product is transferred to another for further processing. For instance, a personal computer needs an RS232C interface to connect to a printer and a SCSI interface to connect to an external hard disk drive. A Strategic Framework For innovating firms, the strategic question is: To what extent should we enlist the help of existing or potential competitors in developing complementary products? In our search for an answer, we studied the product development strategies employed by high technology firms, the conditions under which they sought to enlist partners, the methods they used, and the degree of success that followed (see "Study Overview" on page 28). We then distilled the experiences of senior executives from R&D, marketing, and strategic planning into the Complementary Business Strategy Framework to guide strategic decision-making (see Exhibit 1). Traditionally, firms developing new products have had two options, make or buy. Our study revealed that alliances and interfaces are additional means of offering complementary products to customers. We learned that many firms do not systematically consider all possible product development approaches. Instead, visceral instinct and internal politics often play a major role in such decisions. For example: *Production personnel frequently lobbied for the make option because this would expand their territory. *Marketing personnel often argued for a buy because this would ensure complementary product availability with desired features, or at the lowest cost. *Entrepreneurs with potential complementary products continuously bombarded the executive suites of established manufacturers with proposals for alliances, leaving the decision to the fate of personal rapport. In short, we did not find any broad-based, formal guidelines for managing complementary product strategy, which points up the need for our framework. Alliances and Interfaces Our study uncovered an important distinction between alliances and arm' s length relationships. An arm's length relationship between firms is one in which they define reciprocal obligations as outcomes, e.g., quantities to be delivered, quality specifications, time and payment terms. In true alliances, the emphasis is on process. Cooperative processes evolve to define joint goals and the means for implementing them. Outcomes are a result of this interaction. Alliances can assume either a horizontal or vertical character, or perhaps include elements of both. Horizontal alliances are formed between firms at the same level in different value chains; an example would be an alliance between two producers, such as a hardware and software firm, to link their products. Specifically, co-development alliances, where firms share R&D expenditures, and co-marketing alliances, where firms share marketing expenditures for a complementary product, are horizontal alliances. Vertical alliances are formed between firms at different levels within the same value chain. Hewlett-Packard's keystone relationship with Canon to provide laser-printer engines is an example of a vertical alliance. Here, the firm works closely with an original equipment manufacturer (OEM) supplier to develop the appropriate product and typically resells it under its own name. Because the reseller associates its brand name with the supplier's product, the relationship calls for close cooperation between the parties. The reseller firm makes investments in inventory and marketing for the new brand. Interface relationships come in two types: proprietary and standard. A proprietary interface is developed and owned by the firm. Substantial opportunities for gain can flow from licensing a proprietary interface. For instance, Matsushita was very successful in licensing its VHS recording format to studios and manufacturers of videotapes and recorders. Finally, a standard interface is one that is available in the market and widely adopted by firms, either voluntarily or by agreement among members of a standards-making group. In the PC industry, for example, all the clone manufacturers adopted the standard DOS operating system interface from Microsoft. Adopting a standard interface requires payment of licensing fees, but it's generally cheaper than developing a proprietary interface. Determining the Best Approach Exhibit 2 summarizes the three major considerations that underlie the choice of which approach managers were likely to take toward complementary product development. The most prominent of the three related to managers' reluctance to become involved with complementary products that spread the company's resources across technologies or markets unrelated to its core competencies. We call this "organizational fit," the match between a firm's current resources and those required to create and market the best complementary product. Resources include R&D skill, manufacturing capacity, market access, and finances. A strong organizational fit meant that the firm could harness all necessary resources rapidly and bring the complementary product to market within the window of opportunity at competitive cost. The second consideration involved the "business opportunity" for the complementary product. Profitability, volume, and 1 expected growth of the complementary product were important considerations, as was the opportunity to learn about emerging technologies that could have future commercial payoffs. The third consideration was what we call the "multiplier effect." The multiplier is the incremental volume of existing product sales that the complementary product will generate. If for every sale of two units of a complementary product, one incremental unit of the of the existing product line is sold, the multiplier is 50%. The strength of the multiplier arises from the incremental value that the complementary product contributes to end users of the existing product. Organizational fit, business opportunity, and 1 the multiplier effect on existing products all were associated with a willingness of the existing product manufacturer to choose an approach that allows for more involvement in the development of the complementary product. With good organizational fit, greater involvement makes sense because the product could be produced and marketed using the company's existing resources. If the complementary product required new resources or competencies, managers were inclined to be less involved and to rely more heavily on outside resources. Next quit workstation hardware manufacturing because of poor organizational fit and now focuses exclusively on its software business. Complementary business opportunity also played a role in manufacturer involvement. Unless market studies uncovered a significant opportunity for the complementary product on its own merits, managers did not view it as a venture in which to invest significant resources. Considerations of profitability, volume and expected growth motivated Hewlett-Packard to make a preemptive entry into the laser printer market in the early '80s. Managers avoid close involvement with complementary products of limited opportunity because they produce weaker results. Increases in the multiplier effect also translated into greater involvement. Greater involvement with the complementary product increases the likelihood that customers will choose the firm's existing product when the complementary product is the reason for the purchase. Apple developed the first application software packages, MacWrite and MacPaint, on its own to enhance the appeal and boost sales of the first Macintosh. At the same time, it launched a successful evangelism program to get independent software developers excited about the Macintosh and provide new application software for it. Involvement with the complementary product declines as we move towards higher cell numbers in our framework. Fewer resources are invested as market conditions deteriorate. Greater involvement provides greater control over the complementary product development process and inhibits competitor access to the technology. It also ensures that firms realize end-user benefits from joint use by maintaining a high level of interface quality, thus creating fresh opportunity for differential advantage. Less involvement provides the firm with more flexibility and reduced exposure, and it invigorates competitive forces that positively affect complementary product demand. To use the framework, managers must first define their company's position on each of these three factors (see "Questionnaire for Assessing Involvement" on page 30). If the assessment reveals a "low" organizational fit, business opportunity, or multiplier effect, it is probably not worth participating in development of the complementary product at all. Most managers will find their assessment fits into one of the eight cells shown in the framework in Exhibit 1. Inside cell is the recommended strategy. In-house development of complementary products appears to be appropriate only when organizational fit, complementary business opportunity, and multiplier effect are high. At the other end of the continuum, adopting a standard interface is appropriate when all three conditions are moderate. In between these two extremes, various forms of interorganizational relationship are appropriate. A Case Example: Kodak Photo CD Eastman Kodak's development of its photo CD system illustrates how companies can use our framework. Although Kodak did not have access to the framework, our study results suggest that it is capable of closely shadowing careful business analysis of the risks and opportunities in this type of endeavor. Photo CD is a value-added range of products complementary to Kodak's existing flagship product, silver halide photographic film. Consumers use Kodak film to take pictures with conventional cameras and then send rolls of exposed film to qualified photo finishers. In return, consumers receive both hard-copy prints and a Photo CD disk. The Photo CD disk provides an alternative storage medium that holds digital images of the prints. The Photo CD player is a complementary product to finished film. It displays digital images on a TV screen or computer monitor. It also provides easy storage, organization, image manipulation, and retrieval. Thus, the Photo CD system enhances and preserves the value of photographic film to Kodak customers and represents Kodak's first-line defense against the evolving potential of affordable digital imaging as a substitute for chemical film and processing. In addition to the disk and player the Photo CD system comprises a photo finishing sub-system for commercial film developers. This sub-system has a scanner, workstation with photo finishing software, and a CD recorder. Kodak used several different product development approaches for the different pieces of the Photo CD system. Organizational fit. In 1988, a Kodak management team visited Philips Electronics in the Netherlands to see a demonstration of Philips' new CD-I (compact disk interactive) player for displaying visual images. Even though the still-picture quality of CD-I was not as good as film, Kodak saw an opportunity if the technology could be altered to make it an easily recordable medium or film. Although Kodak had frontier knowledge about the manipulation of digital images, it had no access to proprietary technology such as the CD-I. As a consequence, we rated the company as having only moderate organizational fit with respect to the CD-I specification. At this early stage of product conceptualization, we characterized the complementary business opportunity and the multiplier effect as moderate (see Exhibit 3). (Exhibit 3 omitted). Early on, Kodak undertook only a limited involvement, requesting simply that Philips modify the CD-I specification so that it could accept Photo CD disks. As a result of obtaining access to the CD-I standard from Philips, Kodak's organizational fit improved from moderate to high. Then Kodak and Philips co-developed the proprietary Photo CD interface specification. Business opportunity. With the availability of the Photo CD interface specification, business opportunities expanded. There would be sales not only of Photo CD players and Kodak film, but also of media and photo finishing equipment. Kodak upgraded its relationship with Philips to a co-development program for the Photo CD player. Kodak developed the concepts and prototypes while Philips created the production design. From its knowledge of consumer needs, Kodak suggested certain features for the CD player, such as zoom and crop. Kodak developed necessary integrated circuit designs with cooperation from Philips designers. Multiplier effect. When prototypes of Photo CD players showed digital images of improved quality, their appeal to a broader customer base seemed likely. Business applications for Photo CD could be anticipated from advertising agencies, architects, and designers who could use stock images from Photo CD disks to improve presentation materials, brochures, or newsletters. This, in turn, could stimulate demand for Kodak film, increasing the multiplier effect from moderate to high. Nevertheless, compared to Philips, Kodak did not have the high-volume manufacturing capability for the players. Its organizational fit with the Photo CD player was therefore moderate. Philips became an OEM supplier of Photo CD players to Kodak, which then resold these under its own brand name. As Exhibit 3 shows, our predictions for each level of product development correspond closely with the actions taken by Kodak, with the exception of the Photo CD interface specification. Here, in contrast to the predicted proprietary interface, Philips and Kodak co-developed the specifications and held joint ownership. The case study shows how the framework can be updated and used during product evolution as underlying conditions change. Prescription for Success Our framework is based on inductive reasoning from our field studies. It is prescriptive in nature, recommending what complementary product strategy firms ought to pursue. Any discrepancies between a firm's current practices and framework recommendations might be attributed to factors beyond the framework. However, we believe our three factors capture the most important aspects of a rational managerial decision process. The framework, along with the questionnaire, can help managers understand the types of data needed and questions that must be resolved to make good decisions. In situations where decisions are made informally and are likely to be affected by organizational politics or hidden personal agendas, the framework provides a basis for objective evaluation. As more industries take on the characteristics of high technology industries, such as complex product systems and cutthroat global competition, complementary product strategies will become more common. The Complementary Business Strategy Framework can provide insights into the best means for meeting these new opportunities and challenges. About the Authors Sanjit Sengupta is Assistant Professor of Marketing at the College of Business and Management, University of Maryland at College Park. He has several years of sales and marketing experience in the computer industry in India and received his PhD in Business Administration from the University of California at Berkeley. Sanjit's research interests span issues in product innovation and strategic alliances. He has published articles in the Journal of Marketing, Journal of Product Innovation Management and Marketing Letters. He co-authored (with Louis P. Bucklin) the article, "Organizing Successful Co-Marketing Alliances," which won the Alpha Kappa Psi best paper award in 1993 from the Journal of Marketing. He holds a bachelor's degree in aeronautical engineering from the Indian Institute of Technology, Kanpur, and an MBA from the University of Bombay. Louis P. Bucklin is a professor at the Walter A. Haas School of Business, University of California at Berkeley. Apart from the United States, his teaching assignments have taken him to Sweden, France, Japan, and the Netherlands. Pete has been an active consultant with leading government and private organizations. His research interests are in the areas of distribution channels, marketing of high-technology products, and international marketing. He has published more than 75 monographs, journal articles, and books in these areas. The AMA honored Pete with the Paul D. Converse Award in 1986 for his many contributions to the discipline of marketing. He received his bachelor's degree from Dartmouth College, an MBA from Harvard, and a PhD from Northwestern University. EXHIBIT 1 Complementary Product Strategy Framework 1. The strong market conditions in this cell create a condition of major strategic importance to the firm. Because the firm also has organizational fit, this approach is optimal. Making the complementary product lets me firm capture all the profits by itself. Intel, the leading manufacturer of microprocessors, has made and launched two products, ProShare Document and ProShare VideoSystem 2000, that lets PC users in separate locations edit the same document and do videoconferencing at the same time. Because these products require high computing power, they ill increase the demand Intel Pentium microprocessors. 2. Here, the multiplier effect declines to moderate, diminishing the aggregate opportunity relative to Cell 1. The firm, as a consequence, ought to have better uses for its resources. However. because the market for the complementary product is expected to be large and the firm has strong front-line skills, it should seek some benefits. It can obtain these benefits by sharing development resources with an exclusive partner who would take a major role in complementary product development. Recently. Digital Equipment and Oracle have co-developed a new database server system that optimizes Oracle's relational database software for enhanced performance on Digital's Alphaserver hardware. 3. In this cell, the complementary business opportunity has declined from Cell 2, but the multiplier effect is high. This should deter the firm from either the make or an exclusive co-development decision. Because of a high multiplier effect, it is advantageous for the firm to encourage greater competition and lower prices in the complementary product market. This can be accomplished by creating selective co-development alliances. Competition among the partners stimulates demand r the complementary product, leads to a larger profit pie, and higher profits for each partner. For Windows NT, Microsoft has worked with a number of hard-are vendors like Digital, Compaq, and AT&T so that its product benefits from the multiplier effect of running on several different platforms. 4. With moderate complementary business opportunity and multiplier effect, motivation for participation in complementary product development diminishes still further. However, because the firm has strong technical skills, it can use these to create a powerful, proprietary interface, permitting its product to work with complementary products made by independent firms. Successful licensing of this interface to others generates revenue, spurs growth in the complementary product market, and enables the firm to capture multiplier benefits from complementary products. Nintendo obtained significant competitive advantage by licensing its proprietary game player interface to independent developers of game software. 5. In the moderate organizational fit cube, we see an overall reduction in the firm's knowledge and capabilities about the complementary product. In Cell 5, a buy or OEM strategy for reselling the complementary product is appropriate. The OEM strategy permits the firm to acquire the complementary product from a leading supplier. By rebranding and marketing the complementary product, e firm capitalizes on the strengths of its supplier but also takes advantage of the large complementary business opportunity and high multiplier. However, the firm should retain the original brand name if it has value to customers. An exclusive relationship enables the firm to gain a larger share of the profit pie than having multiple relationships. Hewlett-Packard bought laser printer engines exclusively from Canon for a number of years, added software and electronics, and rebranded these as HP laser printers. 6. Here, the multiplier effect and organizational fit are both moderate, hence the firm seeks (o establish a select number of co-marketing or OEM alliances with manufacturers of the complementary product. Co-marketing calls for a coupling of marketing efforts by both parties to access new market segments, improve user understanding of joint benefits, and stimulate demand for existing and complementary products. As before, OEM alliances call or reselling another manufacturer's product under its original or a new brand name. Alliances with several partners enable a firm to capture more benefits from the multiplier. In each application software category, Apple co-markets the offerings of selected developers in its product catalog. For hard disk drives, Apple has a couple of OEM suppliers such as Sony and Quantum. 7. With both complementary business opportunity and organizational fit moderate, the firm reduces involvement through multiple relation ships with producers of the complementary products. Essentially, to capture the high multiplier effect, the firm intensively seeks to persuade numerous third parties to create or modify their complementary products to link seamlessly with its own. Few, if any, product development or marketing resources need to be shared with third-party developers. IBM's AS/400 minicomputer had such a program that made available 1,000 pieces of software from 130 independent business partners. 8. In this last cell, organizational fit, opportunity, and multiplier are all moderate. This causes conditions of minimum return and maximum risk for involvement in complementary product development. In this instance, the firm adopts a standard interface available in the market so that available complementary products work seamlessly with the existing product. Resource expended are licensing fees and some internal development costs to match interface requirements. While this approach forsakes direct gains from the modest complementary business opportunity, the firm provides its end users' access to available complementary products in the marker. In high definition television, an industry coalition has adopted Zenith Corp.'s vestigial sideband technology as the U.S. standard. To be successful, all TV set manufacturers wishing to market products in the U.S. will have to adopt this standard. Furthermore, broadcasters will produce digital programming compatible with this standard. EXHIBIT 2 Major considerations in complementary product strategy Organizational Fit *Compatibility with core technological and market competencies. *Response speed sufficient to exploit window of opportunity at competitive cost. *Availability of human, physical and financial resources. Business Opportunity *Availability of attractive profit margins and market volumes. *Predictable opportunity for continued growth. *Potential for increased competitive advantage. Multiplier Effect *Create new users for the existing product. *Provide added value for end users of existing product. *Enable superior interface between existing and complementary product. Questionnaire for Assessing Involvement "Yes" answers to most of the following questions means the firm's position is probably "high" on that dimension. If the answers have a balanced mix of "yes" and "no," the firm's position is probably "moderate." And, if the answer is "no" to most of the questions, the firm's position is probably "low" on that dimension. Organizational Fit *Do we have the financial resources to develop the complementary product? *Do we have the technical skills to develop the complementary product? *Do we have the managerial skills to supervise in-house development of the complementary product? *Do we have the equipment, plant and facilities to manufacture the complementary product? *Do we have the distribution channels required for the complementary product? *Does the complementary product have a good fit with our existing core competencies, resources and assets? *Can we develop, manufacture, and distribute the complementary product at a lower cost than other firms? *Can we develop the complementary product in a shorter time frame than other firms? *Does the complementary product have synergy with the rest of our product line that lets us reduce overall costs or investment? Business Opportunity *Is the market size for the complementary product attractive? *Will the market for the complementary product grow significantly in future? *Can the complementary product provide us with attractive gross margins? *Can the complementary product help us meet our profitability objectives? *Does the complementary product involve key future technologies that we need to learn about in our organization? *Can the complementary product give us significant advantages over our competitors? Multiplier Effect *Does the complementary product enhance the value of our existing product to end users? *Do our end users expect us to make the complementary product available? *Do our end users tell us that the complementary product is critical to their needs? *Will the complementary product drive the sales of our existing products?