The recent lawsuits associated with HP preventing third-party ink cartridges from being used in their printers highlights the challenges of monopolizing complementary, or add-on, products. HP's case, though, might be considered the more contentious version of a common business practice. Movie theaters and concert venues often restrict people's ability to bring in cheaper snacks to prioritize their own, more expensive, options — and effective monopolies. But this practice is generally accepted (if not loved).

Research by Ashutosh Bhave, an assistant professor of marketing at the University of Arkansas, seeks to shed some light on pricing practices when it comes to complementary products. While there is some nuance to his findings, perhaps the biggest takeaway is that companies are often better off educating their consumers about the need to purchase add-on products to prevent regulation, which may be introduced to protect consumers unaware of the need, potentially hurting profits. 

Base and Complementary Products

Bhave explains that firms often use their control over a base product like printers, coffee pod machines or movie tickets to monopolize the complementary product market, such as ink cartridges, pods or snacks, respectively. They do this through tying arrangements — requiring customers to buy only the firm's add-ons, often at higher prices and restricting cheaper outside alternatives. While this strategy can boost a firm's profits, it can also distort competition and reduce consumer satisfaction.

Governments and regulators sometimes step in to curb such practices, as in historical cases involving IBM, Kodak, Microsoft or more recent rules allowing moviegoers in India to bring their own snacks. The effectiveness of these interventions, however, depends on what Bhave calls "consumer heterogeneity." He identifies two broad categories of consumers:

1. Sophisticated consumers who anticipate the need for add-ons, such as ink or pods, and factor those costs into their decisions.
2. Naïve consumers, who do not anticipate or who underestimate add-on costs until after purchasing the base product, represent a classic case of bounded rationality in which consumers fail to consider the full information.

Sophisticated customers are aware that third-party add-ons may exist. When firms do not allow outside options, these customers, although aware that they could purchase the add-on more cheaply elsewhere, are forced to buy from the firm, as long as the add-on valuation does exceed not what they are willing to pay. This is shown consistently in the paper across different assumptions.

Naïve customers, in contrast, not only fail to anticipate the need for add-ons, but even after learning about them, consider only the firm as a source. For example, consider a movie and candy: if naïve customers decide they want candy after buying a ticket, they will purchase it from the theater stand rather than exploring alternatives.

If regulation forces firms to allow outside options, sophisticated customers will rationally buy the add-on from an outside source. However, naive customers, despite the availability of outside options, still do not anticipate the need until after purchasing the base product. At that point, they typically purchase the add-on from the firm itself, due to convenience or lack of awareness of alternative sources.

Findings and Takeaway

Overall, Bhave found that if all consumers can be categorized as sophisticated, then a firm's profits remain largely unaffected by regulations that force them to allow outside options. 

When there is a mix of naïve and sophisticated customers, regulation reduces firm profits — though it may improve consumer welfare. Interestingly, unlike much of the prior literature, Bhave's results suggest that naïve customers can actually hurt firm profits, since regulations designed to protect them lower firms' ability to extract profits from all consumers.

Bhave suggest the upshot is firms should recognize the role of consumer heterogeneity when evaluating pricing strategies and anticipating regulation. In some cases, firms may even benefit from educating customers about complementary products to shift more consumers into the sophisticated segment. For regulators, a careful analysis of consumer awareness and market context is essential to ensure interventions improve overall welfare without unintended consequences. 

As a professor of marketing, Bhave is largely interested in what complementary pricing strategies mean for companies, and to what degree regulation affects those strategies. Yet for every transaction, there are two sides.

When it comes to consumers, Bhave says, "While aggregate firm profits may depend on the proportion of sophisticated versus naïve customers, for any individual it is always rational to be sophisticated. When firms are required to allow an outside option for the complementary product, they compensate by raising the price of the base product. Sophisticated customers anticipate this, purchase the complementary product externally, and thereby offset the higher base product price, leaving them better off than naïve customers."

Bhave's paper can be found in the Journal of Marketing Theory and Practice.