Bundling — New Products, New Markets, Low Risk
INCREASING NUMBER of companies are realizing the value of combining separate elements of their product lines into bundles. Creating a bundle is like creating a new product. Thus bundles, like new products, can be instruments for implementing company strategy. Although bundles act like new products in the marketplace, they are typically much less expensive and risky to create. Also, given the important market advantage of reduced product introduction time, bundling has an added appeal. This article is devoted to the strategic use of bundles and bundle pricing.
A bundle is a group of products or services offered as a package. Bundles can have a wide variety of features. Some bundles include some items that are not available separately. Other bundles are offered at a price less than the sum of the individual item prices. Still other bundles endow the buyer with entitlements such as priority seat selection. In the case of a pure bundle, all items must be purchased as a complete package; they are unavailable any other way. As consumers we see the marketing aspect of bundling, but decisions about bundles aren’t (or at least shouldn’t be) the sole province of the marketing department. Bundling decisions typically have serious cost and strategic considerations and thus deserve the attention of general management. Consider the following example:
In 1983, the Dodge Omni and Plymouth Horizon were endangered products.’ With the base car priced at $7,000 and all options priced separately (itemized pricing), these two variations on the same car could not compete with less expensive imports. At the time, the cars were available with a wide variety of options. Indeed, more than eight million combinations were possible. To become competitive, Chrysler switched to bundling and offered only forty-two combinations. The results were rather remarkable, as shown in Figure 1. Chrysler was able to reduce the price of the car, including a typical option package, by more than $1,000. The lower prices attracted new market segments and extended the profitable product life by several years. The price reductions were made possible by reduced manufacturing costs: longer production runs lowered setup costs; reduced interactions resulted in better quality; and reduced carrying and shipping costs alone accounted for a $2 million per year savings. Note that Chrysler presented the consumer with a new menu of choices at new prices; it introduced new products.
References
1. D. Sease, "Getting Smart: How U.S. Companies Devise Ways to Meet Challenge from Japan," Wall Street Journal, 16 September 1986, pp. 1, 24.
2. This example and data were provided by a major automobile company as part of a joint effort on bundling problems.
3. These data were provided by a software vendor in connection with a consulting engagement.
4. Business Week, 9 October 1989, pp. 134–138.
5. See H .G. Demmert, The Economics of Professional Team Sports (Lexington, Massachusetts: D.C. Heath, 1973); and R. Noll, Government and Sports Business (Washington, D.C: Brookings Institution, 1974).
6. Confidentiality requires some disguise of the particulars of costs and consumer segments.
7. The actual purchase decision is determined by the consumer surplus, the difference between the reservation and the market price. Consumers choose products that enhance their consumer surplus. In high involvement purchases, especially those using professional decision makers, we expect the consumer to choose the bundle with the maximum consumer surplus. For lower priced consumer products, it is often best to make the choice somewhat random, with a larger chance of being chosen for a product yielding large consumer surplus.
8. For information on the conjoint methods most appropriate to a bundling analysis, see:
P. Green and W. Desarbo, "Componential Segmentation in the Analysis of Consumer Tradeoffs," Journal of Marketing 43 (1979): 83–91;
S. Goldberg et al., "Conjoint Analysis of Price Premiums for Hotel Amenities," Journal of Business 57 (1984): 111–132; and W. Hausman and D. Montgomery, "Making Manufacturing Market Driven" (Stanford, California: Stanford University Graduate School of Business, Research Paper No. 1103, October 1990).
9. These prices and consumer decisions were obtained using the modeling software in:
W.A. Hanson and R.K. Martin, "Optimal Bundle Pricing," Management Science 36 (1990): 155–174. In addition to calculating the best prices and possible bundles, this methodology allows for a variety of sensitivity analyses, such as responses by competitors.