Issue No. #4 29 January 2001 ISSN: 1532-1886

Make a Bundle with Bundling (Part 2) by Carl Wright

After writing Part 1, I researched bundling further and found an excellent, albeit academic, book titled Optimal Bundling. It cost me about $95.00 and runs 295 pages in length. This serves as the source for portions of this newsletter.

The Eight Forms of Bundling

My research has uncovered eight forms of bundling. I don't get the credit for inventing these. I didn't name these categories (see Optimal Bundling and its references). The credit goes to others who have worked harder at this than I. The following summarizes what they involve.

Type of Bundling Description
Separate Pricing Each item is priced separately. Not really bundled.
Pure Bundling The product is only available as a bundle.
Mixed Bundling The product is priced separately and as a bundle.
Tie-in Sales The lead product requires that you buy the tie-in product.
Add-on Bundling The add-on product is only sold to those who have bought the lead product.
Sales Rebates The vendor rebates money to buyers who meet defined spending levels.
Cross-couponing The product is couponed with another product. The lead product gives you a coupon for a discount on the couponed product.
Premium Bundling The bundle is priced higher than the prices of the items separately.

Separate Pricing

The products are offered and priced individually. This is pure component pricing or no bundling.

Figure 1. One price for each product

Pure Bundling

The products are only offered as a bundle. The products may not be purchased separately.

This is seen in "block booking" in the movie industry. Theaters have the choice to buy only combined assortments of movies, not just the expected blockbuster films.

You may have experienced this with cable TV providers. In North America, I've never heard of anyone being able to get just the Disney channel in addition to the basic cable channels. The Disney channel is always bundled with other premium channels.

Oracle Corporation started doing the same thing with their relational database software several years ago. You can no longer license just their relational database. You have to license their web development tools along with their relational database. The database is always bundled and is never sold separately.

Figure 2. All products in a bundle

Mixed Bundling

In this case, both the bundle of products and the individual products are available for purchase. The McDonald's fast food restaurant's Value Meals are an excellent example of this bundle. This is the most common form of bundling. Many of the writers on bundling argue that this provides the greatest increase of profitability.

Figure 3. Products priced separately and in bundles

Tie-in Sales

The buyer of the main product, typically a durable good, agrees to buy additional complementary products.

When I buy a copying machine, I also get maintenance for the copier. The price for the copier maintenance includes a fixed fee plus a variable fee based on the number of copies I make with the machine. The maintenance company has implemented a variable value-based pricing scheme and indexed it to the number of copies made. This would be a stronger example if I agreed to also buy all of my paper and copier supplies from the copier vendor.

A well-known example of the tie-in sales bundle was a pricing scheme used by IBM in the 1930s. In those days IBM dominated the tabulating machine business. If you purchased a tabulating machine from IBM, you also agreed to use only IBM punch cards. IBM extended their dominance in tabulating machines into punch cards (on which IBM had no monopoly). They abandoned this bundling in 1936 because of an anti-trust case.

Ignoring antitrust issues, IBM setup a variable value-based price bundle. If customers were allowed to buy cards elsewhere, the value pricing would have to be integrated into the machine cost. You can view this as a service to the customers where customers with low levels of usage (and value received) get lower prices and high volume users get commensurate high value pricing.

Figure 4. Lead product linked to repetitive tie-in product sales

Add-on Bundling

In this case the add-on product is only sold if its lead product is sold. Examples include Caller-ID (add-on product) sold with basic phone connectivity (the lead product) or the extra charge for nuts (add-on product) on my hot fudge sundae (the lead product).

Oracle licenses their database to customers and competes against other products (SQL Server, etc.) for the initial sale. To more effectively use the product, you need a performance tuning product or other add-ons. This is their add-on product to the lead product.

The price for these add-on products are less sensitive to competition (more profitable) since your buyers have already committed to buying the lead product. The lead product may become the "loss leader" where you shave the profits on the lead product, but make up the lost profits on the add-on products.

Figure 5. Add-on products only follow lead product

Sales Rebates

The vendor provides an annual rebate based on total sales across the company's product line. This loyalty bonus is a cross between bundling and nonlinear pricing.

This kind of bundle can also appear in the form of discounted annual contracts where the discount is based on the customer purchase commitment. When the fees are paid in advance, this can become difficult to distinguish from prompt payment or prepayment discounting.

Cross-couponing

In this bundle strategy we use coupons to promote other products. If you buy the lead product, you receive a coupon that entitles you to a discount on the couponed product. This is used to introduce new products or to shore up the sales of less popular products. This represents bundling because the buyer of both products receives a discount compared to someone who buys them separately without benefit of the coupon.

Premium Bundling

In this strategy the fee for the bundle of products is higher than the fee for the products separately. In this situation the combination of products must be more valuable by virtue of the combination, like a group of collectible items.

Reasons to Bundle Products

The most common reason to bundle products is to increase profits. In the next issue related to bundling, I'll cover other reasons that companies bundle products for sale.

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