Bundling - the sale of two or more products in a package - is everywhere. American consumers are stuffed with combo meals, value packs and the like. Microsoft even fought (and if somebody may wonder, still is fighting) one of the biggest legal battles in US history over it. But what makes bundling so attractive to companies and what are its legal pitfalls?
There are at least five factors that drive the success of bundling as a marketing strategy. If you sell products and are considering whether or not to bundles them together, here are some things you should think about before going ahead with your bundling plans. Also, here's how to avoid the pitfalls of Microsoft.
Consumer Diversity
If consumers are diverse in what they want to pay for a product, it pays to bundle. Simple economics can show why.
Suppose John is willing to pay up to $80 for a tennis racket and up to $50 for a pair of tennis shoes. Robert on the contrary wants to pay up to $120 for a tennis racket and up to $20 for a pair of tennis shoes. If a sports retailer wants to maximize his revenues by selling to John and Robert he should charge $80 for a tennis racket and $50 for a pair of shoes, and make $210 (in which case Robert will buy his tennis shoes in a cheaper store).
However, if the retailer gives a $10 discount to consumers who purchase both a pair of shoes and a tennis racket in his store, he could increase his sales by $60 to $240 (John and Robert would both buy a tennis racket and a pair of shoes!). So recognizing that consumers are diverse in what they want and what they're willing to pay can make bundling a more profitable way to go.
Maximization of Market Penetration
This factor is especially relevant for new products that seek to build a dominant market position. By bundling a new product with an existing product, companies can provide a new product with better visibility and subsidize trial. Since consumer behavior tends to be sticky (people generally buy tomorrow what they bought yesterday), bundling can have long-lasting effects. This was exactly what Microsoft aimed at with its bundling of Explorer with Windows. In including their browser for free in every copy of Windows and putting it prominently on the desktop, it enticed many consumers to try it out, which who eventually switched from Netscape and remained loyal users of Explorer.
Cost Savings
Bundling can also save costs in several ways.
First, bundling will increase sales volumes, since that's the entire point in the first place. This increase in sales volume may make the products cheaper to produce, due to economies of scale.
Second, bundling will also increase sales of other products that are included in a bundle. To the extent that the products in the bundle have common fixed costs (such as delivery for instance), bundling will lead to cost savings.
Finally, bundling is especially profitable if the bundled products have a relatively low fixed cost. In that case, extra sales strongly increase profits. From this point of view it is clear why software programs are bundled in suites and the like. Software programs have high fixed (development) costs and thus benefit strongly from an increase in sales volume through bundling. It also saves costs in packaging, support and such if they can be delivered in a single package.
Psychological Factors
Also psychological factors make bundling optimal. Psychologists have shown that people perceive multiple gains as more rewarding and multiple losses as more punishing than a single gain and a single loss of the same amount. Therefore, people like bundling because then they only have to pay once and they are less confronted with the pain of paying the bill for every product they buy. This partially explains all-inclusive formulas and all-you-can-eat buffets. People like these formulas because they are not charged for every item they consume, but just pay one overall price.
Added Value
Bundling can also be optimal because it adds value for consumers. Suppliers mostly create such added value by devising some form of integration between the bundled products. There are abundant examples of value-added bundles. Think of integrated stereo systems, which deliver superior performance and compactness, or even mutual funds, which deliver reduced risks.
Bundling in Court
But is bundling always legal? After the Microsoft case, few readers will actually say yes, of course. But when exactly is bundling illegal? Well, simply put, bundling is illegal if:
(1) the company does not also offer the bundled products separately;
(2) it concerns a company with market power, or in other words a company which can force a consumer to do something that he would not do in a competitive market;
(3) it poses a threat that the bundling firm acquires additional market power;
(4) it creates no plausible benefits to consumers.
While Microsoft's bundling of Explorer and Windows clearly met conditions (1)-(3), it is quite plausible that there were clear and immediate benefits to consumers of the integration of the browser in the operating system.
These bundling principles should have clarified two major points. One, bundling is a profitable business strategy in many circumstances. Two, bundling yields legal pitfalls if a company with market power (say companies such as AOL and Microsoft) wants to implement it.
