Bundling

I’ve been reading about discriminatory pricing and here’s something I’d not realized before about product bundling.

In pricing problems the puzzle the seller is trying to solve is to
get the maximum revenue while remaining both reasonably ethical and
avoiding an unreasonable amount of negotiation. A key part of this
puzzle is trying to guess what the buyer is actually willing to pay.
Of course different buyers are willing to pay different amounts. So
you might be able to sell your widgets to group A for a hundred bucks
but only sell them to group B for fifty bucks. If the product’s
production cost is five bucks then, in the seller’s fantasies at
least, he needs figure out how to sell to both group A and B at their
maximum price.

There are lots of solutions to that puzzle. For example book
publishers sell hard cover books to group A and then make group B wait
for the paper back. Consumer electronics makers sell to group A at
list price and then force group B to shop around a lot until they find
a coupon or a “open-box” or “refurbished” version for sale. In both
cases group B is forced to do some work (waiting, shopping) to prove
(negotiate) they are really part of group B; that seems kind-a-fair so
these schemes are kind-a-ethical.

I’d not realized that bundling provides another solution to this
problem – in some cases.

Imagine your selling two products: widgets and gadgets. You
discover that group A and B have opposite preferences. So your
faced with a willingness pay that looks like this:

group A group B
widgets 100$ 50$
gadgets 50$ 100$

Assuming the two groups are about the same size and you have to
pick a single price your going to pick 100$ and forgo the revenue from
the group that isn’t that interested.

But wait! What if you bundle the products. Then you get this:

group A group B
bundle 150$ 150$

Happy day, now your grabbing all the money on the table. In fact
if group A and B are equal size this trick grabbed a 25% increase in
revenue.

You can see this pricing strategy in practice with the pricing of
Microsoft Office. While you are likely to only use one or two of the
products in the office bundle the you tend to figure that the
remaining products are worth another ten or twenty bucks, so why not
get the bundle.

You can also see this in automobiles where option packages are
typically full of junk that you don’t want, but you take the option
package because of one or two features you value highly. For example
one person might highly value the cruise control and another might
highly value the rear seat air conditioning. It costs the vendor
practically nothing to add these features but he wants to charge you
what you think they are worth.

One aspect of discriminatory pricing that has caught my interest
recently is how it feeds back into the problem of design, i.e. the
problem of engineering. For example most engineers appreciate the
value of modularity and simplicity in a design. But both modularity
and simplicity become slightly different design principles in the face
of the demand for pricing flexibility.

A modular design can deliver to marketing a range of pricing
options. I find that extremely interesting because engineering tends
to value rich option spaces (i.e. things with tool like nature) and
marketing tends not to (i.e. they prefer things with solution like
nature). That’s why it’s often hard to convince marketing of the
benefit of adding a scripting language to a product.

A simple design will have a preference toward not bundling
features. But, as we can see above bundling features can offer ways
to substantially increase revenues. This, I think, goes a long way
toward explaining why Microsoft Word is such a hair ball of
features.

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