Tuesday, September 2, 2008

Economist's Notebookl: iPhone and Strategic Complements

My conversion to Apple is now virtually complete - I have been seduced by the iPhone 3G. Now I am one of the uber-hip cognoscenti that gets to ridicule Microsoft and can find the nearest pizza, listen to the latest uber-hip music and check my e-mail at the same time. (I think I can even call somebody if I want - but I'm not sure). Yes, I know, the battery is weak, the 3G network is weak, etc., but that is entirely missing the point - it is sooo cool (and no the fact that I purchased one is not evidence of the early onset of midlife crisis as my wife claims).

But the fact that I am now cool is not what I wanted to write about. What is interesting about the iPhone is that in the US it is a part of a pair with the AT&T wireless network and the utility that I derive from the iPhone depends not only on how well Apple designed it, but also how good AT&T has made their network. This creates something interesting in economics - strategic complements (in, in this case, quality). This term refers to the fact that if Apple makes a better iPhone, AT&T has the incentive to make a better network and vice-versa. Why, because each product is more valuable to consumers the better is the other thing. However, there is a catch: though AT&T could get people to pay more if they were to make their network better, they would not capture all of the increase in peoples willingness to pay, some would probably be caught by Apple (and, again, vice-versa). So this makes Apple and AT&T a bit uncomfortable bedfellows - they are both interested in similar things (selling as many phones and combined service contracts) - but they are ultimately interested only in increasing the values of their stock.

Thus it comes as no surprise to read in the New York Times recently that Apple and AT&Ts iPhone service is perhaps not quite as good as it should be and that each company probably wishes the other would do just a bit better.  Is there a solution?  Yes, Apple and AT&T could merge and become a single company.  Then incentives would be perfectly aligned and we should expect both better phones and a better network.  Another way is to get create separate markets for phones and networks (i.e., to require unlocked phones).  This is the way it works for the most part in Europe, I am told.  It is true that there is still the strategic complements aspect, but with stiff quality competition in each market, we should expect an efficient outcome there.  Imagine...an iPhone on Verizon's network - now that would be cool!  

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