Review of Industrial Organization
12: 781–791, 1997.
1997 Kluwer Academic Publishers. Printed in the Netherlands.
Strategic Substitutes and Strategic Complements
With Interdependent Demands
DAVID G. LOOMIS
Department of Economics, Illinois State University, Campus Box 4200, Normal, IL 61790-4200,
Abstract. Strategic substitutes and complements have become standard tools of analysis in industrial
organization. Bulow et al. (1985) original model which introduced these concepts focused on mul-
timarket oligopoly. Building upon that model, this paper shows that there becomes not one but two
strategic interaction terms if the demands between markets is interdependent and the ﬁrms compete
in prices. This new model is applied to the telecommunications industry, where the local exchange
carriers face competition from competitive access providers. The theoretical model shows the critical
variables in the local exchange carriers’ strategic pricing decision.
Key words: Interaction, multimarket, oligopoly, pricing, telecommunications.
Strategic substitutes and strategic complements have become standard tools of
analysisin industrial organization. Jean Tirole, in his bookThe Theory of Industrial
Organization, uses this taxonomy of business strategies to examine entry, exit, and
accommodation. The applications of this taxonomy range from learning by doing
to quotas and tariffs to vertical integration.
While the uses of this type of analysis are very broad, the original model by
Bulow, Geanakoplos and Klemperer (BGK model) deals with the speciﬁc case of
There are two ﬁrms and two markets in the BGK model.
The ﬁrst ﬁrm has a monopoly in the ﬁrst market but faces competition from the
other ﬁrm in the second market. The ﬁrms compete in quantities and there are
economies or diseconomies of scope. The model shows that there are strategic
effects in the market where the two ﬁrms compete due to the existence of a second
market. These strategic effects are deﬁned as strategic substitutes and strategic
The author wishes to thank Dr. Michael Goetz and Dr. Erwin Blackstone for valuable comments
on an earlier draft.
Fudenberg and Tirole (1984) developed a similar taxonomy independent of Bulow et al. Fuden-
berg and Tirole concentrate on investment strategies and use animal analogies to describe their
strategies. The Bulow model was chosen in this article because it is broader in scope and more
rigorous in technical detail.