Pricing and Revenue management

Week11_Lecture_PriceBundling.pdf

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Week 11 – Price Bundling

Company uses Bundles

Another Bundling: Season Tickets

• Packages of banking and insurance products, e.g., “select” suite of products, Fidelity’s Cash Management & Brokerage accounts.

• Vacation package – return airline ticket, rental car, & hotel room for six nights

• Home‐delivered pizza (Pizza + delivery) • Processor, hard disk and memory?

• Not separate for end users, so it is not a bundle of products, but a bundle of components (see conjoint).

• Laptop plus carrying bag

Bundling examples

• Capitalize on cost efficiencies or economies of scale • Use natural consumption complementarity • Increase sales in the same transaction to customers • Create switching costs • Capitalize on locked‐in customers • Create a powerful differentiator

Reasons for Bundling

• Bundling is the sale of two or more separate products in a single package

two main types:

(1) Price Bundling

(2) Product Bundling

Bundling?

• The integration and sale of two or more separate products or services* at any price.

Integration provides at least some consumers with added value and often this value can be substantial

* Each product should have its own market independent of other products in the bundle

What is Product Bundling?

• Product bundling creates added value for consumers over and above the additive value of bundled items

• Reduced risk (mutual funds instead of individual stocks) • Non‐duplicating coverage (one‐stop insurance) • Convenience (one bill for a telephone plus internet plus cable TV plan) • Seamless interaction (a suite of software applications)

Product Bundling

The sale of two or more separate products or services* in a package at a discount, without any integration of the products

* Each product or service must have its own market that is independent of other items in the bundle

What is Price Bundling?

Pizza Delivery

• Price bundling does not create any added value for consumers (beyond what is offered by items in the bundle)

• Reservation price* for the bundle = sum of the conditional reservation prices** of the separate products in the bundle

• *Reservation price = consumer’s maximum willingness‐to‐pay • **Conditional reservation price = reservation price of the product,

conditional on the consumer buying the other product or products

• Six pack of beer, Combo meal, Season ticket • What is the purpose of price bundling?

Price Bundling

Price vs. Product Bundling

Price bundling is primarily a pricing and promotional tool, product bundling is a strategic marketing activity.

1 Price bundling can be deployed easily, at short notice, and for a short duration • Creative marketing activity to take advantage of lower incremental cost of sales

2 Product bundling is a long‐ term differentiation strategy; often approached from a new product development perspective

Forms of Price Bundling

Pure bundling: Only the bundle is offered by the firm. Products can’t be purchased individually •This approach is called “Tying” •Basic cable package, magazine

01 Mixed bundling: Both the bundle and the individual products are offered for sale. The customer can choose

02 Unbundling: Only the separate products are offered, there is no bundle

• Price bundling enables to transfer consumer surplus from product A to product B.

Economic Value of Price Bundling

WTP Product A

WTP Product B

Price for products A and B

CS Product A

WTP A

Price A> =

Purchase A

WTP B

Price B< =

No Purchase B

WTP A+B

Price A+B> =

Purchase A+B

• Imagine a symphony orchestra that is preparing a short concert series with 2 programs (two different events). There are four potential audience segments of equal size with different music tastes.

• Evaluate the consequences of offering a single ticket for the concert series either in addition to, or in place of, offering tickets for each concert separately.

Concert Patron Problem

• Assume one concert patron of each type (or equal segments of each type)

• What will happen if only separate tickets are offered? • Candidate prices to charge for each concert are $5, $20, $40, and $45 • Corresponding demands = 4, 3, 2, and 1 tickets per concert • Revenue maximizing price = $40 (why?) • Total revenue for the two concerts = $160

Unbundled Strategy: Offer Only Separate Tickets

• What will happen if only combined ticket is offered? • Candidate prices to charge for combined ticket are $50 and $60 • Corresponding demands = 4 and 2 tickets • Revenue maximizing price = $50 (why?) • Total revenue for the two concerts = $200 • Selling a pure bundled ticket increases revenue ($160 vs $200)

Pure Bundled Strategy: Offer Only Combined Ticket

• This is the revenue maximizing strategy: Offer a ticket for the series ($60) and single tickets for each concert at $45 (why?)

• Revenue = $60 (Romantic) + $60 (Neo‐classical) + $45 (Tchaikovsky‐ lover) + $45 (Sophisticate) = $210 (vs $160 vs $200)

Mixed Bundled Strategy: Offer Combined Ticket & Single Tickets

• Unbundled pricing: If customers display similarity in their valuations • Pure price bundling: If market has two (or more) customer groups with dissimilar (negatively associated) component valuations

• In this case, bundling becomes “selective discounting” • If the market is characterized by a combination of customers – both those with “extreme” preferences and those with “balanced” preferences (seeing the products as equally valuable) – mixed bundling is likely to be the best concept

• Single price is as high as those extreme’s WTP

Lessons from the Concert Patron Problem

Microsoft In‐class exercise

Suppose that Microsoft produces Word and Excel each at zero marginal cost (but very high fixed costs). Further suppose that the demand for these products is characterized by five distinct and equal‐sized customer segments as described in the following table:

1) What are the optimal prices for Microsoft to charge for Word and Excel if it only sells the two products separately?

2) What is the optimal price for Microsoft to charge for both if it only sells the two in a bundle?

3) What are the optimal prices for a mixed bundling strategy?

What if segment sizes are different?

Price bundling and Behavioral Economics

• Transaction decoupling: Match frequency of price presentation and payment to frequency of consumption

• Backfiring effects from categorical reasoning: Be cautious when combining bundles that have products or services of different values. The high‐value item will be devalued by the low‐value item if you are not careful.

• Partitioned pricing: Understand the pros and cons of offering partitioned prices vs. all‐inclusive prices. Partitioning results in under‐ estimation and focus on secondary differentiated features of the product.

Price bundling and behavioral economics

Transaction Decoupling

Bundling price and payment leads to a dissociation or “decoupling” of transaction costs and benefits • Reduces customer’s attention to sunk costs • Decreases the customer’s likelihood of consuming a paid‐for service • Potentially reduces the likelihood they will buy the product again

Mary & Bill join a health‐club

• Bill pays $1,200 for a year, billed and paid annually, Mary selects the $100 per month plan, billed and paid monthly.

• Mary is more likely to use the membership, and more likely to renew.

24Source: Gourville & Soman, HBR, September 2002

• Price bundling masks the individual item’s cost, reducing the likelihood of its consumption at the correct time.

• Season tickets “hide” the cost of individual tickets. Eventually, less renewal. • People tend to consume products when awareness of price and the “pain of payment” is top‐of‐mind.

• Customers’ perceptions of price determine their likelihood of consuming paid‐for products. When people pay with credit cards, they’re less likely to remember the cost – or consume the product. At one theater, the no‐show rate for credit card customers was 10 times that for cash customers.

Implication of Transaction Decoupling

Backfiring effects from categorical reasoning

The Dieter’s Paradox

Random assignment to one of two groups

Estimate the number of calories you consumed

Chernev (2011). The Dieter’s Paradox, Journal of Consumer Psychology

The Dieter’s Paradox

Random assignment to one of two groups

711 calories

Chernev (2011). The Dieter’s Paradox, Journal of Consumer Psychology 28

The Dieter’s Paradox

Random assignment to one of two groups

711 calories

615 calories

Chernev (2011). The Dieter’s Paradox, Journal of Consumer Psychology 29

Source: This discussion is from Chernev (2011). The Dieter’s Paradox, Journal of Consumer Psychology

Chernev (2011). The Dieter’s Paradox, Journal of Consumer Psychology

Price = $2,299 in each case

Key Takeaway: The popular pricing strategy of adding premiums to make core products appear more attractive can hurt rather than increase sales.

Source: Brough, Aaron and Alexander Chernev (2012), “When Opposites Detract: Categorical Reasoning and Subtractive Valuations of Product Combinations” Journal of Consumer Research (August)

How to Bundle Without Reducing Value

Avoid combining a cheap item with an expensive item and promoting this mixed package. People will focus on the cheap item which will drive bundle value down.

1 If you are mixing products with different values, establish the value of the individual items first, and emphasize the most expensive one.

2 Take a lesson from infomercial producers and emphasize the additive nature of bundled items.

3 Focus on non‐price attributes of the product (e.g., durability or comfort) . This will reduce the devaluation occurring from mixed‐ value items.

1. Avoid combining cheap item with premium item

2. Individual items first, emphasize the most expensive one

3. Emphasize additive nature of bundles

Price Partitioning Should the offered price be presented as an all‐inclusive price or a list of itemized

prices?

What is Partitioned

pricing?

• Partitioned pricing is the method of presenting the price to the consumer as a list of mandatory charges attached to various features of an offer.

• The alternative is to charge an “all‐inclusive” price • Examples:

• $34 for shirt + $5.95 shipping and handling vs. $39.95 (includes free shipping) • $1,295 for Caribbean cruise + $140 mandatory port charges + $560 for meal plans VS. $1,995 all‐inclusive for the trip

• Distinction coincides partially with AYCE vs. à la carte pricing • In à la carte pricing, consumer has the choice of whether to pick additional features (or stick with the base offer). In partitioned pricing, all features are mandatory, there is no choice

Partitioned Pricing

Source: TripBadger.com

Partitioned pricing: RESORT FEE

Source: TripAdvisor review of Grand Cayman Beach Resort by Kendal UK on November 30, 2014

Partitioned pricing

Source: The Consumerist Guide to Understanding your Comcast Bill

Partitioned pricing

Source: The Consumerist Guide to Understanding your Comcast Bill

Partitioned pricing

Source: Ars Technica, January 31, 2018

All‐inclusive pricing

All‐inclusive prices

• Reasons for using all‐ inclusive pricing

• Simple • Just one number to communicate

• Facilitates consumer choice • Increases consumer satisfaction with pricing

Benefits of Partitioned prices • What does the research say?

• Strategy increases demand for products (Morwitz et al. 1998) • Large proportion of consumers do not account fully for surcharges and underestimate the total product cost

• They anchor on the larger price item in the set and do not account for the remaining smaller items

• Breaking down an expense into separate components makes pricing more transparent, enhancing perceptions of fairness, seller trustworthiness, and likelihood of purchase (Xia and Monroe 2004)

• It focuses consumer attention on secondary features of the offering (to which price is attached), highlighting dimensions of differentiation that may otherwise go unnoticed (Bertini and Wathieu 2008)

Underestimation under partitioned pricing

Pricing Method

Presentation Format

Recalled Price

All‐inclusive price $82.90 $83.90

Base price + surcharge in dollars

$69.95 + $12.95 $80.36

Base price + surcharge in percentage terms

$69.95 + 18.5% $75.43

Pricing Method

Presentation Format

All‐inclusive price $82.90

Base price + surcharge in dollars

$69.95 + $12.95

Base price + surcharge in percentage terms

$69.95 + 18.5%