Pricing a Durable &

Bundling

What is a Durable?

Movie Ticket?
Text Book?
How long does a product last?
How much is the time gap between
two runs of production?
If the time for consumption of the
goods> the time between two
production runs, it is a Durable.

 Understand the philosophy

If the economic life of the product is less
than the interval between two product
runs, then the focus is also on the reusers i.e. the market regenerates itself.
If the economic life of the product is
more than the interval between two
production runs, then the supplier is in
competition with its future self! This is
the basic problem with the durable.

 Should the revised edition of a Text

Book be 5 years or two years?
The issue is that faster a text books
new edition is out, the more a used
textbook becomes valuable. So,
essentially, you are competing with
yourself!

So, the Problem

Assume there is a monopolist who can
sell throughout the year a product
whose economic life is 1 year.
The number of customers is 1000 and
that the WTP is uniformly distributed,
i.e. the 1st customer is willing to pay
Rs.1000 and the last customer is willing
to pay Rs.0. For example at Rs. 600 you
can sell to 400 customers and so on.

So, the questions

What is the revenue of the company
if it sells only once?
What is the revenue of the company
if it sells once in January and again in
July the products produced in
January.

 What is the optimal revenue if the

customer sells only in January?
Obviously 500! Why?
Optimal Revenue is 250,000 (why?)

 What if he sells in January and in

July?
At the 1st sight it seems obvious that he
sells to customers with higher valuation
in January and then in July he sells the
product to customers with lower
valuation by decreasing the price. So, he
ought to make more money. Is this true?
Let us see!

 The January sale price is 500

In July the valuation of the product is
halvedWhy?because the economic life
of the product is 1 year!
So, for a customer to be indifferent
between the January and July, the price in
July must be 250.
So, to sell in July, the seller must price the
product less than 250 otherwise there is no
point.

 So, the supplier would have to decrease

the price from 250 in July. Let this
decrease be by 10.
Therefore the price in July is 240
So, some customers who did not buy in
January will now buy
What is this number? 20 (why)
What is the additional revenue? 20*240
= 4800

However,
There are some buyers in January for
whom the price of 240 in July is more
attractive than a price of 500 in
January
How many? Again 20
But what is the loss in revenue =
20*500 20 * 240) = 5200
So, gain is 4800 and loss is 5200. So,
the company loses by selling twice.

The catch
The customers correctly predict the price
in July.
Nave customers would believe that the
prices in July will be half that in Januaryin
such a case the company can get away by
pricing the product at 125 in July.
Suppose it were so i.e. the company
disguises its price for July and customers in
January have no clue of the prices in July

Rational

Nave

Commitment Possible

Price in January = 500

Price in July is greater
than 250
Max revenue =
250000

Price in January = 500

Price in July = 125
Max revenue =
281250

Commitment
Impossible

Price in January = 450

Price in July = 150
Maximum Revenue =
225000

Price in January = 500

Price in July = 125
Max revenue =
281250

How to tackle such

problems?
Guaranteed rebate Price protection clause
Give a guarantee to the customer in January that prices will not
fall in July.
Does it work?

Lease instead of sell.

Customer pays monthly installments converting a durable to a
non-durable
The problem of Moral-Hazard behavior (customers take less care
of the leased asset) and adverse selection (attracts customers
who are less qualified for the asset)

Hide discounts: We used to call it hidden rebates in

Paradeep Phosphates Ltd. Worked for the 1st year, the
customers could predict for future.
Bundle the durable with a non-durable

Why Bundling?
Leveraging on existing high selling productsBundle Surf
with Wheel
Generally leads to focused players to become more broad
in their product lines
It makes sense for HUL to have more products which it could be
leveraged on the more popular product. So there appears to be
a kind of line filling use of bundling
Most companies in M&A focus on bundling advantages
This helps in tackling the problem called non-additivity in
value from bundling and helps both resources as well as
product

More revenue from a bundled product than single product.

This comes from the fact that more people buy at
higher Price

When can we bundle?

Bundling makes sense when
When the reservation prices for two products are
negatively co-related.
Non-Additivity in value
Additivity means that the reservation price of the bundle is
equal to the sum of the reservation prices of each individual
product. Non-additivity means that the reservation price of
the bundle is either higher (supra) or lower (sub) than the
sum of the reservation prices of the individual products.
Supra: Ski lesson + ski rental
Sub: Usually substitutes (Detergent + whitner)
Bundling helps in the supra additivity in value and subadditivity in costs.

Types of bundling
Pure Bundling:
Where the products cannot be sold singly (Room with
breakfast, Car with service, MBA with books, etc.)

Mixed Bundling:
Where the products can be sold singly Gillette can
bundle shaving foam with razor. But the products are
also available individualy

Same company products bundlingHP Laptop with

free service
Different companies bundle their productsHP
Laptop with free internet connectivity from Tata
Indicom.

So, we face two challenges.

Concert Series

Concert SeriesSelling Single

Tickets
Candida Deman
te
d
Prices

Revenu
e

20

20

60

40

80

45

45

Therefore the revenue from the

series is 160
What is the consumer surplus?
10

Concert SeriesSelling Joint Tickets

Candida Deman
te
d
Prices

Revenu
e

50

200

60

180

Therefore the revenue from the

series is 200
What is the consumer surplus =
20

 Basically, what the seller has done is

engineer a single price rule.
Delivered price is always more profitable
than FOB price
Mis-Absorption of Shipping costs.

It is obviously good for the seller, is it

for the buyer? Look at value creation!

When is Bundling not

possible?

Arbitrage
No variation in WTP
Segmentation on WTP is not possible
Bundling lowers the WTP for
customers!
But is bundling the best one can do?

Optimal Price
Price individual at 45, and bundle at
60 gives total revenue of 210.
So, bundling rule.
Price individual products at the highest
WTP and bundle at the highest WTP for
the series.

Let us see some other features of

bundling
What is the company is selling multiple
products?
Mixed Bundling
Pure Bundling

Let you be a company selling

SpreadsheetsPreferred by Bankers but not
lawyers
Word-ProcessersPreferred by lawyers but not
bankers
Spreadsheets and Word-processors preferred by
consultants

Spreadsheet
100
Will buy S
Will buy S

50
Will not
buy S

Will not
buy S

10000

Word Processor
100
Will buy W
Will buy W

50
Will not
buy W

Will not
buy W

10000

Spread Sheet and Word

Processor
100

WTP

Spreadsheet

Accountants
Will buy S
only

Consultants
Will buy both S & W

50
Will buy W
only
Lawyers

50

100
WTP

Word processor

 For constant WTP, the optimal price is 50 for

both. At which the company will sell to 5000
consumers both products A, and B. Therefore
the Maximum revenue is 50* 10000 =
500,000
If we bundle the products and sell at 100,
what happens.
We will not be able to sell anything. Why? 0
lawyers will buy at price being 100 for the B, and
0 banker will buy at price 100 for the A. So,
bundling is a wash.

But,
What if we lower the price a bit? Say,
now the bundle is priced at 80
Intuitively, one can see, that when
we bundle the product, we get a
revenue more than that if we sell the
product individually at 50. How?

WTP

Spreadsheet

80

Will buy S
Will buy S & W

40

Do not Buy
Will buy W

40

50

80

WTP

Word processor

 What is the optimal price for a

multiproduct company when the
company bundles only?
$ ((2/3) X 100) = 82 for the bundled
Revenue = $ (8/27) X 1,000,000 =
544331

What are the optimal prices for

mixed bundle?
(2/3 X 100) = $ 65 for each component
$ ((4 2 )/ 3) X 100 = 86 for the

 What is the optimal price for a

multiproduct company when the
company bundles only?
$ ((2/3) X 100) = 82 for the bundled
Revenue = $ (8/27) X 1,000,000 =
544331

What are the optimal prices for

mixed bundle?
(2/3 X 100) = $ 65 for each component
$ ((4 2 )/ 3) X 100 = 86 for the

So, to conclude
For pure bundle $ ((n/(n+1))
WTP)
For mixed bundling

X Average

(n/(n+1) X Average WTP) for each component

((2n n2 )/ (n+1)) X Average WTP for the
bundle happens if we bundle
1.What

two products from different

companies?
2.What happens if instead of
direct bundling we give
coupons off the 2nd product if

Further.
1.What happens if we bundle two
products from different companies?
2.What happens if instead of direct
bundling we give coupons off the 2nd
product if the 1st product is bought?

Spread Sheet and Word

Processor
100

WTP

Spreadsheet

Accountants
Will buy S
only

Consultants
Will buy both S & W

50
Will buy W
only
Lawyers

50

100
WTP

Word processor

Spread Sheet and Word

Processor
d
c
100
e

WTP

Spreadsheet

90

50

Will buy S
only

Will buy both S & W

40

40

50

g
Will buy W
only

90

100
WTP

Word processor

 Consumer who lie in bcdh will switch

from buying only S to W&S
Consumer who lie in ahgf will switch
from buying only W to W & S.
Consumers who lie in abh will switch
from buying nothing to buying both.

Let us put numbers to

this..
Suppose for every S people buy they
get 10 off W
So, the new buyers of S are areas ahgf
and area abh
Area ahgf = 10*50 = 500
Area abh = *10*10 = 50

Therefore new buyers of S are 550

At Rs. 50 per unit the additional
revenue = 27500

Similarly, for W
The new buyers of S are areas ahgf
and area abh
Area bcdh = 10*50 = 500
Area abh = *10*10 = 50

Therefore new buyers of S are 550

At Rs. 40 per unit the additional
revenue = 22000

However,
Number of old & new buyers of W
who also bought S (abcdefg) =
60*50-50= 2950.
These people will now be paying Rs.
10 less for W
Therefore loss in revenue = 2950*10
= 29500

Therefore net gain

Gain from S = 27500

Gain from W= 22000
Loss from W = 29500
Therefore net gain 19000
Moral: The product on which the
discount is given always makes a
loss! Here S gains, W loses but there
is a net gain.

So,
Therefore, if you are bundling two products of
the same company be sure to compensate the
product manager whose product you are
discounting.
If you are bundling two products of different
companies for every Sony camera you buy,
you get 15% discount on makemytrip.com
Sony gains at the loss of makemytrip.com. If
you are Sony and makemytrip.com is nave, go
ahead. But if you are makemytrip.com, be sure
to negotiate with Sony for a cut in the revenue!

However,
What if in the Sony &
makemytrip.com dealI buy the
Sony Camera and give the discount
to my sister who is a frequent
traveler? Does the economics still
hold? Or, I sell the free gift away?
This is a trick question.

 Intuitively reselling by the buyer

hurts the seller. Now purchasers of S
who have no intention of purchasing
W will sell their coupons to the those
who want to purchase W without any
intention of purchasing S. So, now
the seller makes a loss of 10 for
every sale of W to a buyer who will
not buy S also. Clearly this is a loss.

 However, some argue that the sale of S will

go up. How? Allowing resale reduced the
price of S from 50 to the resale price.
Suppose you bought S and got a coupon of
Rs. 10 on W. You sell the coupon to a person
who wants W (but not S) at (say) Rs. 5. So,
now your Ss price is 45 instead of 50! So,
more number of people should buy S and
this cycle continues till the price of coupon
becomes 0. So, does reselling help?

Now consider
Without re-sale S and W were available at 90 only (and only
if) the customer bought both. Else, they had to pay 50 for
each product if they bought only S or W
If we allow re-sale, it is like offering the products at 45 each.
This is certainly a suboptimal pricesince optimality is at 50
per product.
The re-sale market is a separate market and what happens
there is a transfer of value between customersit has no
bearing on the sellers market. The seller may be able to sell
more of one productbut the price is sub-optimal and
therefore, does not make sense.
Therefore, never allow re-sale. Realize that if you allow
resale, all coupons will be redeemed. And you will now start
selling W at a cheaper price.

Some other thoughts on

Bundling
Pure Bundling works only when the marginal costs of
providing the products is the same or else zero. It also
works when the company is providing a large number
of products, the cost of individual products is difficult
to estimate.
Pure Bundling is more prone to over-supply and undersupply situations than mixed or pure components.
Under-supply occurs because pure bundling forces the
transfer of consumer surplus from one product to the other.
Over- occurs because a customer may choose to forgo a
bundle (who otherwise would have bought a component)
since buying it is against his rationality.

 Products need not be perfectly negatively corelated in terms of the WTP. All it needs is a
correlation coefficient of less than +1.
Supra Additvity in value comes from
complementary nature of products.
Decrease in search costs.
Enhanced customer satisfaction
Enhanced image of the brands in question.
However, pure bundling is optimal for perfect
complements, while mixed bundling is good for weak
complements. However if the marginal costs are high,
it is better to go for pure components.

Substitutes
Pure components are for perfect
substitutes
Mixed Bundling for weak substitutes
Pure Bundling is sub-optimal

Competition
In a competitive market, mixed
bundling is more profitable than pure
bundling

Costs
Bundling works if the marginal costs
are low.
Bundling works when the economies
of scale and scope is possible.
If the costs are sub-additive then
bundling makes sense.

How to bundle?
What are the products that can be
bundled?
How do we approach this problem?
Hybrid Categorical Conjoint Approach
The Balance Model
Co-Branding Approach

Hybrid Categorical Conjoint

Approach
Here the customer chooses the attributes (at
attribute level), preference importance of
attributes and the likelihood of choosing a
bundle.
What we get here is the bundle of amenities
and add-ons to be offered and their associated
prices, we also get the attribute importance
and part-worths
One can handle a large number of attributes
and basically here we extend the conjoint to
correlated attributes.

Balance Model
Basic Premise
The products that go into a bundle must
consider the interactions among the
attributes that define the product
The bundle so chosen should provide
the best balance of features.

Balance comes from homogeneity in

some attributes and heterogeneity in
others.

Co-Branding Approach
Lenovo PCs with Intel Inside
Basically two companies try and
forge alliances with synergistic
partners.

How to find price of the

bundle?
Same way as to find the WTP,
especially for complex bundles.

Taking Stock
The Power of Price1% increase in price leads to 11%
increase in profits
The price waterfall
The concept of Zone of Possible AgreementZOPA
The idea of pricing power (The PPL graph!)
The Paradox of CompositionOne company giving a
discount to one group of customers leads to an increase in
the total market.
Therefore, couponing can be effectively used by companies
which otherwise cannot get to choose the higher WTP
customers.
Price Discrimination is good and can be done with very
little apparent pricing power

Taking Stock
Focus on Behavioral Pricing
Acquisitional vs. transactional utility
Price that
Price that
referance
Price that

customer is willing to pay

customer thinks he ought to pay or
price
he actually pays

We saw how losses and gains are to be treated.

Segregate Gains
Integrate Losses
Segregate a small gain and a big loss (Silver Lining
Principle)
Integrate a big gain and a small loss

Taking Stock
Principle of Marginal Utility being different for
different products (Price of Product/Reference
price)
Issue of Self Control
The Principle of Budgeting
The problem of lack of fungibility of Money

The strategy with respect to

Gifts
High Priced products
Implications of transactional utilitySellouts and
Scalping, on-going relationships, Transfer of
Transactional dis-utility to the black marketers.

Taking Stock
The problem of Price-Performance Curve
Concept of Value
Concept of Fair Value Line
How to value
FMCG
Engineering Costs
Importance ratings

Price Response Curves

Logit Curves used for existing companies
Van-Westondrop for new products
Conjoint for new products

Taking Stock
Capacity Constrained Industries
Creation of actual and artificial shortages
Concept of posted prices and price discovery methods.
When to use variable pricing methods
Yield Management
Network Pricing

Defined Durability
Saw that durability is a function of

Technology
Price
Saw methods of getting over the durability problem
How price Discounts lead to durability

Took up the bundling problem

Concept of Simple Bundles
The concert Series Gamebundling when customers have opposing WTPs
The Multiproduct Gamebundling even when customers do not have opposing WTPs
Couponing as a bundling issue

Next Class
Pricing Techniques
EDLP and Hi-Lo