Issue No. #5 21 February 2001 ISSN: 1532-1886

Other Issues with Bundling (Part 3) by Carl Wright

Hawaiian Bundling

Mr. George Burnett, Telecommunications Chief of the State Civil Defense division in Hawaii sent me e-mail asking about the pricing of CLASS services, like Caller ID and Call Forwarding. He said the following.

My interest has to do with the GTE/Verizon practice in Hawaii of only offering "enhanced" services at a premium price, such as Caller ID $7.95, Call Forwarding $4.00, etc. This is all on top of the normal basic service rate for a consumer telephone line.

Do you have similar situations in the areas you analyze? Any analysis or discussion would be helpful to aid consumers here in Hawaii, when Verizon goes in to the Public Utility Commission (PUC) for its next rate hike.

I hope you'll recognize this as a situation where an add-on product bundle is being sold. This kind of pricing for enhanced services is common in the United States. These kinds of bundles often have a lower priced, cost competitive lead-in product (the basic service rate) that are followed by a higher profit add-on product. Once you've decided to purchase the lead-in product, you can only buy the add-on product from the vendor. I don't know the profitability of these enhanced services, but I am sure that the PUC monitors the charges for the normal basic rate service. Minimizing the basic rate service charge supports the PUC's goal of universal telecommunications service. You can understand how the PUC might trade off control of the basic rate service charge against control of the pricing for enhanced services.

Figure 1. Add-on product bundling structure

A powerful strategy to reduce the cost of these enhanced services involves breaking the connection between this lead-in product and the add-on product. If other vendors can sell the the enhanced service products, then they become competitive and their pricing should come down.

Calling Card Breakage and Its Inherent Profit Delivery

One of our readers in the United Kingdom asked me to talk about prepaid calling cards. I'll write more in the future to respond to his request, but I want to tell you about a form of bundling within prepaid accounts. Prepaid calling cards and prepaid accounts have an inherent profit enhancer. It is called "breakage" in the United States.

When you use a prepaid calling card or prepaid account, you pay an amount of money in advance. Breakage refers to the phenomenon where don't or can't use up all the money you have prepaid. Typically this is left dormant in the account for a period of time and then after the "waiting period" it is forfeited to the service provider.

The breakage is characterized as either "voluntary breakage" or "forced breakage". Voluntary breakage is when you just don't use all the money paid on the account. Forced breakage is when the structure of charges prevent you from spend the remainder of an account. An example of forced breakage is when the cost of the first minute of a international phone call is $2.50 and you have $2.30 remaining in your account. The prepaid switching equipment won't let you begin the call. You can either recharge the account with more money or request a refund of the account balance.

Figure 2. Forced breakage example

This profit from breakage varies in size. Some customers buy calling cards and then lose them. Some people buy more services than they need and then just don't use them. I have heard stories about collectors of calling cards who thought that they could not use the prepaid money if they wanted the card in mint collectable condition. This doesn't make sense since a collector of calling cards is interested in the card's appearance, not the money in the prepaid account that the card represents. I hope that this is an exaggeration to amuse the reader. In all of these cases, you buy more than you consume. This is like the quantity bundling that I discussed in Rating Matters issue number 2 with GTE Verizon local calling plans.

I'm not trying to paint prepaid service providers as villains. They provide convenience, anonymity, and portability. Consumers pay higher "real rates" for these advantages. If your customer base can be interested in this method of charging for services, you can increase your average profitability from this form of bundling.

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