Rafi Mohammed

Bundling Caution: It May Be More Complex Than It Appears

Posted on December 12th, 2006 (0 Comments)

I know it’s awkward to say, but I love the topic of bundling! I spent 5 long years studying bundling at Cornell University, which is located in upstate New York. Now that’s dedication! There’s really not much to do in upstate New York, winter starts in October, and three feet snowfalls are the norm. But luckily, with the help of some great classmates, a trusty rusted out 1972 Volvo (color: half rust, half yellow) and lots of trips to the Chapter House, my classmates and I all survived. I wrote my Ph.D. dissertation on bundling, which was later published in the Rand Journal of Economics, a top economics journal.

While it is one of the most popular pricing strategies, my bet is that few managers or academics truly understand how bundling should be implemented in the real world. We’ll discuss this further in future blogs – academics have advanced many theoretically correct hypotheses, but I am dubious about their relevancy to the real world. Managers tend to have a lackadaisical approach to bundling: “sure, let’s offer a discount to customers that purchase multiple services.” Unfortunately, implementing a bundling strategy is more complex.

Bundling has been considered the wave of the future for both telecom and financial services. It’s clearly caught on in telecom, but has not been as successful in financial services. Why the different outcomes? I believe the answer lies in switching costs. It’s relatively easy to change telecom providers. But as a friend of mine commented, “Rafi, I’d rather stick pins in my eyes than go through the hassle of changing my financial accounts.” He’s got a great point! I’ve had the paperwork to consolidate two brokerage accounts on my desk for close to one and a half years!

Carolyn Johnson, a writer for the Boston Globe, had an interesting article on bundling phone, cable, Internet, and cell phone service in yesterday’s paper. The article focused in great part on using discounts to attract bundled services customers. In the article, Phil Santoro, a Verizon spokesman claimed “Customers want more than just the ability to bundle all services on one bill.” I agree with Phil, since all of my services are automatically paid by credit card, there’s little advantage to having one bill.

Companies benefit from bundling in two ways: one-stop shopping (I move to a new residence and can easily purchase all my services) and cross service promotion (give me a reason to switch my cell service to my landline provider). In both cases, a discount helps motivate consumers to purchase the bundle. A fundamental question is what price should be charged for the bundle: how much of a discount should be offered, should the discount vary by how many services a customer purchases, how much should discounts vary? The next key question is what type of discount should be offered: limited time (“first six months at a 25% discount, full price after six months”), “good for life,” mail-in rebate, or an upfront (e.g., free installation)?

Companies are also searching for the “killer app” to make a bundle more valuable when all of its components are purchased together. A common bundling misnomer is the notion that a bundle has to be priced lower than the sum of its components. If the combination of bundled services enhances the value of your products, why not charge more for the bundle?

“Lots of unanswered questions Rafi,” you may be thinking. Remember what I said, implementing a bundling strategy is complex. And getting it right is important for two reasons: (1) In telecom, bundling is becoming highly competitive, so finding the right prices and bundles are critical, and (2) A few percent can have a significant impact on the bottom line.

Luckily, there is a straightforward market research technique called discrete choice analysis that can help managers make the right bundling decisions. By sampling customers and observing what bundles they select amidst different competitive bundling scenarios, managers can gain quantitative insights on what bundles and accompanying prices to offer. And you can have confidence in discrete choice analysis, it’s not a fly-by- night methodology. Dan McFadden, an economics professor at the University of California – Berkeley, won the economics Nobel Prize in 2000 for “his development of theory and methods to analyze discrete choice.” It’s a rock solid technique that can help companies bundle for profits and growth.

Have a question or comment, please feel free to send them to me!

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