What are the implications of this interaction term? If firms ignore demand interdependencies they can make serious errors in decision-making. Take a firm like GM, with its various divisions. If the Chevrolet division cuts the price of its Camaro model, this will undoubtedly increase its sales and possibly revenues, if demand is elastic. The management of the Chevy division may regard this as a profitable exercise, if the increase in revenues exceeds any increase in costs. However, the corporate management at GM may take a different view if they look over at the Pontiac division, specifically the Pontiac Firebird, essentially a sister-car to the Camaro and a close substitute, and see its sales and revenues fall.
An opposite error can occur in the case of the Gillette example. A price cut in its shavers may not increase the revenue or profit from those shavers involved, and therefore such a price cut may be rejected as unprofitable. However, if the resulting increased sales in complementary products like blades and after- shave are considered, the price cut may be a profitable strategy for the firm as a whole.
10.5.3 Production interrelationships
When firms produce many products, and sometimes when they produce a single product, other products tend automatically to be generated at the same time because of the nature of the production process. These other products are often referred to as by-products or joint products. A good example is the production of petrol, which automatically involves the production of diesel oil and heating oil, among other products. Sometimes the resulting by-products are not desired; for example the production of many chemicals involves the creation of toxic substances and pollution. Since this often does not affect the firm’s profit directly, this raises a public policy issue, which will be discussed in Chapter 12.
In many cases there are production interrelationships which are not inevitable but which are desirable. In Chapter 6 the concept of economies of scope was discussed; this referred to situations where it is less costly to produce two (or more) products together than to produce them separately. Such economies of scope are common in car production, the production of machinery and domestic appliances. Thus car manufacturing firms find it less costly to produce many different models, because they can share platforms and many production facilities. Better utilization of plant capacity becomes possible. The different models are not strictly joint products, but any pricing decision relating to one product must consider the effect on other products. For example, if Ford cuts the price of the Fiesta, the resulting increased sales may help to reduce unit costs of the Ford Focus, thus increasing profit through the cost complementarity between the two products.