The Pitfalls of Subsystem Integration: When Less is More

Abstract

In various industries end-product manufacturers acquire core subsystems from upstream technology provider firms, and focus primarily on efficient end-product integration.We examine the strategic interactions between a technology firm that introduces a new subsystem, and the respective end-product manufacturers (’integrators’). We analyze how the fraction of end-product functionalities pre-packaged into the subsystem impacts the optimal introduction strategy and the relative value appropriation power across the industries. Offering a subsystem that performs many end-product functions has a dual effect on the provider’s profits. On the positive side, the provider extracts a higher ease-of-use rent from the integrators because of the easier/cheaper integration. On the negative side, such subsystems may curtail the adopters’ ability for competitive differentiation, and render adoption less valuable. We discuss the role of subsystem functionality in value appropriation in technology markets, and we highlight the perils of subsystem over-integration.