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Bundling: An Example
+ Bundling: An Example
correlated: consumers who value one good much more than other and there is heterogeneity in tastes.
Bundling
Extend
Costs Mixed
Setting
Suppose
A consumers
Without
With
R1 P 1 R2 P2
II
Consumers buy only good 2
R1 P 1 R2 P2
I
Consumers buy both goods
P2
R1 P 1 R2 P2
III
Consumers buy neither good
R1 P 1 R2 P2
IV
Consumers buy only Good 1
For any prices P1 and P2, consumers can be categorized according to whether they have higher reservation prices R1 and R2 for one of the goods, none of the goods, or both of the goods
P1
r1
Pure Bundling
R2 I
Consumers buy bundle
With pure bundling only bundles, and not separate goods, are offered Consumers will buy the good if and only if R1+ R2 PB
R1+ R2 >PB
R1+ R2 =PB
II
Consumers do not buy bundle
R1+ R2 <PB R1
Two consumers
Price goods separately: pE = p D = 3 Profits = 6 Better alternative: sell menus for $4 Profits = 8
entree
3 2 1 1 2 3
dessert
correlated: consumers who value one good much more than other and there are heterogeneity in tastes.
Bundling
Extend
Mixed
Example
Suppose
There
has reservation prices R1J=1 and R2J=2 Karen has reservation prices R1K=2 and R2K=1
bundling the firm should set P1=2 and P2=2 and sell one unit of each good
would give a profit of 22-20.5=3
This With
pure bundling, the firm could charge PB=3 for each bundle
would give profit 23-40.5=4
This
Al
has reservation prices R1A=2 and R2A=0.5 and Beth has reservation prices R1B=0.5 and R2B=2 bundling the optimal prices would be P1=2, P2=2 giving a profit of 42-40.5=6
pure bundling neither Al nor Beth would buy the bundle at price PB=3
Without
With
if the goods were also sold separately at prices P1=2 and P2=2, then Al would buy good 1, Beth would buy good 2, and James and Karen would buy the bundle
would give a profit of 23+22-60.5=7
This
Bundling Again
Bundling
Mixed
But
Bundling May
limit competition
Issue
Pricing decision:
Entering a highly saturated cell phone service industry, while targeting an unsaturated market segment Attempting to earn a profit from a limited income market Target market is:
Young (15-29)
Trendy
Different than traditional cell phone users
Different needs
Limited purchasing power According to marketing research, target market does not trust industry pricing plans. -Dan Schulman, CEO, Virgin Mobile USA
Objectives
Discussed Alternatives
Cons
Give customers more features for the same price Easy to promote, use current models Limited spending power on promotion may be a justifiable factor Viable with Virgin Mobiles limited advertising budget
May drive margins down if additional features are costly Reduces competitive advantage Difficult to penetrate saturated market with similar offer as competitors Competitive with other cell phone providers and packages; does not support strong market differentiation
Cons
Drive sales and market share Accounts for limited spending power of target market
Margins and profitability will be driven down Inconsistent with company goal of profitability Cannot compete in price wars Not a long term solution
Cons
Differentiate from competition Cater to the needs of target market Flexibility is attractive to target market
Profitability is key
Eliminates risk of missed payments
Contracts:
Take AT&T example: customer base = 20.5 million If AT&T abandons the contract based plan how many new customers would it need to acquire to offset customers from an increased churn rate?
__________________
$370 (case p.2) __________________
Not surprising that major players still continue to hold the contracts.
Bucket/Menu Pricing
In reality most consumers are paying more than their optimal rate = if they new exactly how much they will consume
Industry makes money from consumer confusion Pricing menus allow carriers to advertise low per minute rates But most consumers end up choosing the wrong menu.
Hidden Fees
Able to promote low per minute prices, but still collect additional revenues
Acquisition Costs
LTV =
M 1- r+ i
- AC
M = margin the customer generates in a year r = annual retention rate = (1-12*monthly churn rate) i = interest rate (assume 5%) AC = acquisition cost
= ______________
LTV =
- 370 =
LTV =
- 370 =
LTV =
- 370 =
LTV =
- 370 =
Loathe contracts Fail credit checks Ideal plan: no contracts, no menus, no hidden fees
How to differentiate itself, and have a positive LTV Look at the factors that affect LTV
Handset subsidies:
Current industry handset cost: $150 to $300 (assume $225) (p.5) Current industry handset subsidy: $100 to $200 (assume $150) (p.9) Current industry handset subsidy as a %: 67% Virgins handset cost: $60 to $100 (assume $80) Assume Virgins subsidy around 30% = $30
Acquisition Costs
Sales commission: $30 Advertising per gross add: $60 Handset Subsidy $30 Total: _______
Break Even analysis: at what per minute price would Virgin break even:
Assume Virgins customers use 200 minutes per month (midpoint of estimate between 100 and 300, p.7) Assume monlty cost to serve is 45% of revenues (Exhibit 11)
LTV =
- _____ > 0
p > ________
What if Virgin charged per minute price comparable to other industry prices, somewhere in between 10 and 25 cents:
At 10 cents:
LTV =
- ____ = _____
At 25 cents:
LTV =
- _____ = ____
A prepaid plan No contracts No hidden charges No peak off peak hours Very low handset subsidies No credit checks
No Monthly bills
Price: 25 cents per minute for the first 10 minutes; 10 cents/minute for the rest of the day No exact numbers, but churn rate lower than 6%