Interested in Mixed Bundling? I Think You Are Being Misled By the Experts!
As a student of mixed bundling for the last 19 years (I wrote my Ph.D. dissertation at Cornell University on the topic), I get asked about mixed bundling all of the time. And just recently, as I was reciting the standard explanation for why companies should offer mixed bundles, I began to feel there was something “fishy” about the explanation. After a contemplative walk around Boston’s Charles River, I came to the startling realization that the way pricing experts are teaching us to think about mixed bundling is not particularly relevant to the real world. Okay, perhaps you aren’t as excited about this insight as I am – but it’s an important revelation as mixed bundling is the most popular pricing strategy in the world. The fact that practitioners are being “incorrectly” (at least in terms of real word relevance) taught when to implement mixed bundling is a big deal. So, let me make my case to you.
First off, let’s define mixed bundling. Mixed bundling is the practice of selling products both individually as well as in a bundle. The bundle price is almost always lower than the sum of the individual product prices. A common mixed bundling example can be found at your local McDonald’s. The fast food giant offers a Big MacValue Meal that is typically priced 20% below the cost of the individual components (Big Mac, fries, and soda) of the Value Meal.
Refer to any pricing book or ask any pricing expert when a company should implement a mixed bundling strategy and inevitably, you’ll get the Adams and Yellen explanation. Adams and Yellen wrote a seminal mixed bundling article (“Commodity Bundling and the Burden of Monopoly,” Quarterly Journal of Economics, 1976) that assumes price discrimination (some customers pay more than others) is the primary driver of mixed bundling. In my opinion, where the authors lose touch with reality is their important assumption of the key reason when to implement mixed bundling. The authors argue that mixed bundling should only be implemented when you have customers that have negatively correlated demands for products in a bundle.
Let me beat you to the obvious question, “what the heck is negatively correlated demands?” It means that every person that purchases the bundle must have a high valuation for one of the products and a low valuation for the other product. To give you an example of Adams and Yellen’s thinking, let’s return to the Value Meal example. For simplicity, let’s assume the Value Meal only contains a Big Mac and Fries. Adams and Yellen assume that the discounted value meal bundle is targeted towards two primary customer types: Big Mac Lovers (willing to pay a lot for a Big Mac, not willing to pay much for Fries) and Fries Lovers (not willing to pay much Big Mac, willing to pay a lot for Fries).
The key driver of the Adams and Yellen’s explanation is the notion of demands being negatively correlated: The Big Mac Lover must not be fond of fries and the Fries Lover has to be less enamored with a Big Mac. These are the only two customer types that will purchase the bundle.
Before questioning the validity of Adams and Yellen’s assumptions, let me complete their mixed bundling explanation. The authors’ notion of price discrimination comes from the idea that Big Mac Lovers that purchase the bundle implicitly pay more for a Big Mac relative to Fries Lovers (who value a Big Mac less than Big Mac Lovers) that buy the same Value Meal.
While the Adams and Yellen mixed bundling explanation may make sense theoretically, I don’t think it’s realistic in the real world. Do you really think that targeting Big Mac Lovers and Fries Lovers is the primary reason why McDonald’s offers a Value Meal? … I don’t. How about the hotel that in addition to offering each product individually, offers a “Relaxation Weekend” package that includes champagne/strawberries at turndown and breakfast? Do you think this bundle is targeted to champagne/strawberry enthusiasts (that happen to also not highly value breakfast) and breakfast enthusiasts (that love breakfast but don’t highly value champagne/strawberries)? … I don’t. Do you think that Randy’s Car Wash in Watertown, Massachusetts offers a Premiere Package (Wash, Undercarriage Wash/Rust Inhibitor, Triple Foam Protectant Sealer Wash, Wheel Brite, and Tire Wash – a $28 value for $18) to target Wash/Rust Inhibitor Lovers (that also have a low value for Wheel Brite) and Wheel Brite Lovers (that coincidentally also have a low value for Wash/Rust Inhibitor)? … I don’t. In fact, I’m hard pressed to think of any mixed bundling strategy in the real world that was implemented for the reasons that Adams and Yellen assert is a basis for mixed bundling.
I’m curious, what do you think of the Adams and Yellen explanation? If you can think of real world instances where their explanation makes sense, I’d love to hear from you. Tomorrow I’ll list my reasons why firms should implement mixed bundling.
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