The relation between the knowledge of reservation prices and the degree of success of bundling strategies

International Journal of Business Strategy, Jan, 2008 by Jose G. Aguilar-Barcelo, Marco A. Pinto-Ramos, Natanael Ramirez-Angulo

ABSTRACT

In the last few years, there has been a significant increase of the commercial offers involving the sale of several independent goods or services in a bundle. The nature of this phenomenon is usually understood as a response to the grade of competition or the level of scale or scope economies of the firm -that are in turn well accepted by consumers because they can reduce search or information costs or simply take advantage of the savings-. Nevertheless, there are reasons not usually considered as part of the information used by the firm when designing its commercial offer. With the support of an economic model of a monopolist that maximize benefits selling two goods, in this paper we evaluate the impact that might have the reservation prices of consumers for the goods offered individually and in a bundle, in the offer decisions of the firm and in its prices and profits. We also analyze the impact of asymmetries in the mean value and the variance of these reservation prices and the cost of the products. The findings suggest that prices set by the firms and therefore their sales and profits are highly sensitive to the internalization of the information they have about the reservation prices of their consumers and, as a result, also will be the conformation of their commercial strategy. The empirical evidence corroborates the results and shows that the power of monopoly is even less sensitive to the levels of the geographical competition or the efficiencies in production than that of the asymmetry in the reservation prices.

Keywords: Bundling Strategies, Consumers' Reservation Prices, Lerner Index.

1. INTRODUCTION

Price or product bundling strategies are defined as a commercial offer of a set of two or more independent goods or services, i.e., those that have an individual demand in the end-user market (Kobayashi, 2005; Stremersch & Tellis, 2002). The growth of this phenomenon in the last few years has been explosive. The firms of almost any line of business make use of them. To mention just a few examples, we have the combos of the fast food franchises, the vacation programs of travel agencies, the triple play of the telephone firms, or the ticket package for the in-house season of a baseball team.

One of the main reasons why firms choose bundling strategies is that, through this practice, they achieve important cost savings. In this case, it occurs due to efficiency reasons. Therefore, bundling practice would have its origins in the economies of scope in the production or in the reduction of the transaction, information or searching costs of consumers (Salinger, 1995). Nonetheless, it is not unusual to see bundles comprised of products that do not show any type of production complementarities or in which savings granted to consumer do not become evident.

There is also the argument based on the market competition level, through which, the firm would be trying to take advantage of the market power it holds by mean of bundling strategies, e.g., leading to entry deterrence of a potential competitor (Bakos & Brynjolfsson, 1999, 2000; Nalebuff, 1999). Nonetheless, it is also true that this phenomenon is observed more in competitive environments.

The foregoing arguments disregard the possibility of the emergence of bundling because of the firm's knowledge and use of information about the products the firm offers and the consumers it has, e.g., the complimentary or substitutable relationship among the relevant goods or the extent of the correlation between consumers' reservation prices for these goods.

The bundle sales have been classified from different perspectives. One of them has a relation with the assortment of offers the firm makes for a set of goods. Thus, we have the pure bundling where the firm only sells the bundle and not the individual products (even when there is an individual demand for them) such as the constructor who offers its houses together with the kitchen furniture. There is also the mixed bundling where both the package and the individual goods are offered by the firm. We observed the latter, for instance, in the promotions of some mechanic shops that offer tune up and brake pads change both in a single package and separately. Lastly, there would be the case of unbundling where the firm sells its products only on a separate basis.

There is also another classification range: the one linked to that which is bundled. Accordingly, we would have the "price bundling" which refers to the discount found in the price of the package consisting of the addition of the single products with no other type of product integration. On the other hand, there would be the "product bundling" in which the goods in the package produce an extra value to the consumer because these are not simply the addition of the single goods such as a combo meal for children, which have a little toy and a packaging useful for the target market (Stremersch & Tellis, 2002). In this sense, the bundle result from the strictly sum of the individual products, but also consider the possibility of physical transformations in some of the products or in the package or the inclusion of additional benefits.