Foundation Series: Substitutes and Complements

Do you know about substitute goods and complementary goods? If you’re doing any eCommerce, and are thinking about cross-sell and upsell, you should understand the basics about substitutes and complements.

Substitutes

You’re considering purchasing a specific product (e.g. a blank compact disc from Memorex). You could consider purchasing an alternate product (e.g. a blank compact disc from TDK), substituting the alternative for the original. At a high level, that’s the definition of a substitute good. Any product that could be substituted for another product, and still satisfy the needs that the original product was intended to address.

Complements

You’re purchasing one product (e.g. a slice of bread with peanut butter). The value you get from the original product would be increased by the purchase of a complementary product (e.g. a slice of bread spread with jelly). The basic definition of complementary goods is “products that are purchased together.”

Economic Models: Substitutes and Complements

The definitions for substitute products and complementary products come from the world of micro-economics. Substitutes and complements are used to model the interdependent nature of the changes of prices on the supply and demand of “related” products.

You can imagine a junior economist who tried a pricing experiment to determine the price elasticity of demand of Jif brand peanut butter. He predicted that by raising prices on the peanut butter, that the store would sell less peanut butter. Sure enough, demand (at the higher price) was lower, and sales dropped.

However, he also discovered that sales of Skippy brand peanut butter went up, almost by exactly the amount that Jif sales dropped. This is because Jif and Skippy peanut butter are substitute products (economists call them “goods”).

Later on, this economist tried another experiment. He raised the prices on both Jif and Skippy at the same time. This time, the store sold less peanut butter in total (there were no other brands), and the economist thought his experiment was concluded.

Another surprise for the economist – sales of jelly dropped too. Sales of peanut butter and of jelly are tied together – when you sell more of one, you sell more of the other. Economists, trying to be difficult, would say that when you raise the price of one, the demand for the other falls. Technically true, but a little confusing.

Thus entered substitute and complementary products into the world of economics and pricing.

Substitutes and Upselling

You know that you’re upselling – trying to replace one product that is about to be selected with an alternative product – when your customer is considering substitute products. Notice in the screenshot from amazon.com (above) that ~9% of the people who were otherwise going to buy the original product instead were convinced to buy a more expensive substitute product.

The goal in upselling is to create a win-win situation. Your customer gets more value from the substitute product, and you get more profit from the sale of the substitute than you would have received from the original. Everyone wins.

Complements and Cross-selling

The number one mistake I see when people talk about cross-selling is they call it “upselling [sic].” Its enough to make me Cranky. The example above, also from amazon.com, shows an encouragement, when purchasing the first book (in the series), to also purchase the second and third books. What’s especially clever is that there is no discount – the total price is the same as the sum of the prices if purchased individually.

You can take advantage of the complementary product model to create product bundles, identifying products that should be sold together.

Although that may not be the best idea.

Often, you will see bundles created by combining products that do not go well together – products that are not complements. This is a sneaky way for companies to sell products that otherwise would not sell as well.

The recording industry made money in the 1950s and 1960s selling singles. The recording industry then made a lot more money selling albums that “bundled” 8 or 9 mediocre songs with one or two hits when compact discs hit the market. Digital downloads have re-introduced the popular purchasing of singles, and revenues are declining – not because of piracy, but because a “take advantage of our customers” bundling practice is now broken.

Complementary goods should be used to create bundles that increase value for your customers.

A baking cookbook is a good complementary product for a customer purchasing a stand-mixer (a key appliance for baking).

Symmetric Substitutes and Asymmetric Complements in Context

Substitute products are symmetric – either product works effectively as a substitute for the other – in a specific context.

If you need a new computer to use at your desk, then a desktop computer and a laptop are symmetric substitutes. Regardless of which one is your originally selected product, the other is a valid alternative. If however, you are looking for a computer that you can use while travelling, the desktop is not a valid alternative for the laptop (nor would it be your first choice).

When you’re considering the travelling scenario, the products are not substitutes. Economists will say that they are substitutes as long as they share common uses. But economists are looking at aggregated behavior. You have to make decisions in context – and when the context implies that products are not substitutes, they are not substitutes.

Complementary goods are rarely symmetrical. Peanut butter and jelly is a good example of symmetric complements – they have comparable price points, and both generally can be improved by purchase of the other. In the mixer-cookbook example above, the cookbook is a great complement product for the mixer.

However, if your customer had selected the book initially, the encouragement to “add a stand mixer” would fall on deaf ears. Surprisingly, amazon.com still recommended adding a mixer to my book purchase. Technically rated a “toss up” by GetElastic in their great cross-selling do’s and don’ts article, but I put it squarely in the don’t bucket (until measured and proven otherwise).

Summary

• Complementary Products – consider cross-selling an additional product. Complements are usually asymmetrical.
• Substitute Products – an upsell is a suggestion to replace the original product with an alternative product. Substitutes are symmetrical, but only in a context where both products address the relevant needs of your customer.