Review Two-parts pricing: Definition and Examples Best practice of two-parts pricing (with homogeneous consumers)

Lecture 16 Bundling and Tying

BUNDLING

Definitions A bundle is a group of products or services sold as a package. The constituents, which can be sold separately, are called ‘components’. Three commonly used terms: Pure bundling. Only the bundle is offered by the seller (at a bundle price). Pure components. Only the components are offered (at their separate prices). Mixed bundling – The bundle as well as some or all components, or smaller bundles, are priced and offered for sale.

Examples Pure bundling Mixed bundling (bundle and components) Music CD (when singles are not sold) Block booking of movies Mixed bundling (bundle and components) Gateway computer, monitor and printer Car with insurance Restaurant menus Cable channels Holiday package Pure components

Illustration Two components A and C. Let A + C = bundle B. Pure bundling: B is offered at PB and A & C not offered. (Offering A & C at extremely high prices is effectively the same). Pure components: A is offered at PA and C at PC, and no bundle. (Customers can make their own bundle at price PA+PC). If A, B, and C are offered at prices PA, PB, and PC, then the following relationships are likely to hold PB < PA + PC (else customers will not buy the bundle) PA, PC < PB (else customers will not buy the components)

Exceptions to PB < PA + PC The bundle price can be higher than the sum of component prices when it offers a convenience, lower assembly cost, guarantee of quality Example – A TV-VCR combo may be higher than the price of standalone TV and VCR.

The “value meal” example Size of segment Willingness-to-pay for fries Willingness-to-pay for burgers Pure components profit Pure bundling profit Fries lovers 100 $1.50 $0.50 Burger lovers $300 $400

Take-away A demand side explanation for bundling is that heterogeneous customer segments have demands for the components products that negatively correlate. Bundling improves profit by transferring customer surplus (“money left on the table”) from one component to the other. Bundling reduces heterogeneity in valuations, which causes inefficiency in pricing.

TYING

Definitions Tying differs from bundling as: Bundling occurs if the firm sells packages containing at least two different products or services. Tying occurs if the firm sells packages containing at least two units of the same product or service. Two commonly used terms: Pure tying. Only one package containing at least two units of the good is offered for sale. Mixed tying. If more than one package is offered for sale, and at least one package contains at least two units.

Examples Pure tying Mixed tying (bundle and components) Shopping TV which “doubles the offer” Dozens of eggs Mixed tying (bundle and components) Season and daily ski pass CU football Season and single-event tickets

The “ski pass” example $7 $6 $5 $4 $3 $2 $2 $3 $4 $5 $6 $7 # 1 # 2 # 3 Day # 1 # 2 # 3 # 4 # 5 # 6 Willingness to pay $7 $6 $5 $4 $3 $2 “A la carte” approach (cost = $0) Price $2 $3 $4 $5 $6 $7 Number of days sold Profit

The “ski pass” example 1 2 3 4 5 6 1 2 3 4 5 6 Number of days “tied” “Season pass” approach (cost = $0) Number of days “tied” 1 2 3 4 5 6 Profit “Season pass” approach (cost = $3) Number of days “tied” 1 2 3 4 5 6 Cost Profit

Take-away A demand side explanation for tying is that consumers have diminishing values for additional units of the same product/service, thus these values are negatively correlated. Tying improves profit by transferring customer surplus (“money left on the table”) from one unit to the other. Tying reduces heterogeneity in valuations, which causes inefficiency in pricing. The size of the package is negatively related with the marginal cost

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