What are Complementary Goods?
A complementary good or service is an item used in conjunction with another good or service. Usually, the complementary good has little to no value when consumed alone, but when combined with another good or service, it adds to the overall value of the offering. A product can be considered a complement when it shares a beneficial relationship with another product offering, for example, an iPhone and the apps used with it.
- A complementary good is one used in conjunction with another good or service.
- Such a good may have little value without its complement.
- When the price of a particular good rises the demand for its complement drops because consumers are unlikely to use the complement alone.
Understanding Complementary Goods
The joint demand nature of complementary goods causes an interplay between the consumer need for the second product as the price of the first product fluctuates. In economics, this connection is called negative cross-elasticity of demand. So, as the cost of a product increases, the user's demand for the complement product decreases as consumers are unlikely to use the complement product alone. Further, as consumer demand weakens, the market price of the complementary good or service may fall.
Complements and Elasticity
There are weak complementary goods and strong complementary goods. Weak complements have a low cross-elasticity of demand. For example, if the price of coffee increases it will only have a marginal impact on reducing the consumption of cream. In the case of Apple increasing the price for iPhones, this would reduce sales of iPhones and the demand for iOS apps.
Complementary goods differ from substitute goods, which are different products or services that satisfy the same consumer need. The Apple iPhone is a substitute for Samsung phones. These two products can, therefore, replace each other. So, rather than complement each other they become substitute goods. For this reason, if the price of the iPhone increases, the consumer demand for a substitute will also increase.
Examples of Complementary Goods
For example, should the price of hot dogs increase, it can cause a decrease in the demand for hot dog buns. Since the cost of hot dogs has an inverse relationship with the demand for hot dog buns, they are considered complementary products. Consumers may substitute hamburgers for their picnic, and weak complementary mustard and ketchup products will see little impact on the rising price of the hot dog.
Additionally, complementary pairs are not two-sided and often have one-sided effects. Using another example, if the price of car tires decreases, it will not necessarily increase the demand for cars. However, if the price of automobiles decreases, it will increase the demand for car tires as more are sold.
Real World Example
Complements are often used by merchants to increase sales. Supermarkets place related food products next to each other, such as tortillas next to refried beans, to increase sales of each. Merchants might also sell a product at a low price but charge more for add-on items that complement the first item. An example of this would be a razor and razor blades. Razors are typically sold at low prices whereas razor blades are sold at much higher prices.
Complementary goods are often more lucrative for producers vs. a substitute good. Netflix, Inc.(NFLX) could be considered a substitute good for traditional cable. However, with the potential unbundling of cable channels, financial analysts believe that Netflix may move from a substitute good to a complementary good.
The unbundling of channels refers to consumers' ability to pick and choose which cable channels they pay for rather than being required to purchase an entire cable package. The belief that Netflix may become a complementary good to cable once cable companies decide to unbundle has caused analysts like those to estimate increased subscriber growth for Netflix. Unbundling reduces the overall cost of cable, and with that extra cash, more users are expected to subscribe to Netflix in addition to their chosen cable channels.