Misperceiving Interactions Among Complements and Substitutes: Organizational Consequences

Systems composed of activity choices that interact in nonsimple ways can allow firms to create and sustain a competitive advantage. However, in complex systems, decision makers may not always have a precise understanding of the exact strength of the interaction between activities. Likewise, incentive and accounting systems may lead decision makers to ignore or misperceive interactions. This paper studies formally the consequences of misperceiving interaction effects between activity choices. Our results suggest that misperceptions with respect to complements are more costly than with respect to substitutes. As a result, firms should optimally invest more to gather information about interactions among complementary activities—e.g., concerning network effects—than about interactions among substitute activities. Similarly, the use of division-based incentive schemes appears to be more advisable for divisions whose products are substitutes than for divisions that produce complements. It is further shown that system fragility is not necessarily positively correlated with the strength of the interaction between choices. While systems of complements become increasingly fragile as the strength of interaction increases, systems of substitutes can become increasingly stable. (Interactions; Systems of Activities; Complementarities; Misperceptions; Substitutes; Organizational Design; Supermodularity; Fragility; Complexity; Division-Based Incentives)