Pricing Innovation：Review Of Bundling.ppt

PRICING INNOVATION TOPIC AREAREVIEW OF BUNDLINGJune 2001,PURPOSE OF THE DOCUMENT,The document presents a set of logics explaining why a firm would consider bundling For each logic the document covers:The contextual factors that determine the benefit derived from bundlingRules-of-thumb for successful bundlingExamples of how firms have successfully bundledIn-depth back-up to explain the effect of bundlingPlease refer to Bundling In Telecommunications for an example of client engagement materials Enhanced Bundling In Telecommunications-Proposal for a complete proposal deck on bundling review for a telecommunications company,AGENDA,Bundling-what is it and why is it important?Benefits of bundling and how to capture themBundling in the competitive arena,WHAT IS A BUNDLE?,Definition,Bundling is the practice of selling two or more goods/services,which could also be sold separately.Purchasing the bundle is different from purchasing the products separately,in at least one of several ways,e.g.,The goods/services are not sold separately(pure/partially mixed bundle)The bundle is sold at a different price to the sum of the individual productsThe products are integrated to form a combined product,Pure Bundles,Partially Mixed Bundles,Fully Mixed Bundles,OUR CLIENTS ARE GRAPPLING WITH BUNDLING ISSUES,Global family restaurant chainWhat products should be included in the bundle?What are the optimal prices for the bundle and individual products?Major financial services institutionHow can bundling be used to charge for value?Major telecommunications companyIs bundling the right tactic to use?What products should be included in the bundle?What level of discount should be given and how should it be structured?,THE BUNDLING DECISION IS COMPLEX,Issues Raised By Incumbent Telco Executive,The markets were punishing us for not offering bundles-so we had to get some out quickly,Are we leaving money on the table with our discounts?,We dont understand the retention benefits of including products in the bundle,Are there any further bundling opportunities we should explore?,European Bank,Approximately 500m in economic profit(EP)due to at risk current account balancesProtect at risk balancesIncrease transactional EPIncrease perceived value of offeringPotential for cannibalisation of profits through better customer money management,BUNDLING IS A HIGH STAKES GAME,Bundling StakesBundling GoalsBundling Risks,Australian Telco,Losing more than$225m in revenue this year due to net loss of customersBuild competitive advantageReduce attrition of customersRisk of leaving money on the table through discountsCurrent bundles giving potentially more than$100m in discounts this year,BCG Bundling Cases,Source:BCG Case Experience,BUNDLING WILL BECOME MORE IMPORTANT IN THE FUTURE,Important Business Trends,DeregulationSearch for growthDeconstruction,Drive Towards Bundling,Increased competition drives bundling as a means for building loyalty through switching costs(1)Competition in new markets makes bundling attractive to cross-sell new products with existing products(1)Information goods become are separated form the physical goods.Bundling makes the economics of information goods,which have zero marginal cost,more attractive(2),(1)See slides 12-30 for a discussion of this effect(2)See slides 31-48 for a discussion of this effect,AGENDA,Bundling-what is it and why is it important?Benefits of bundling and how to capture themBundling in the competitive arena,OUR CLIENTS CAN CREATE VALUEWITH WELL DESIGNED BUNDLES,Bundling can create significant value for companiesBundling can positively affect all three elements of the value equationIncrease/defend sales volume,now,or in the futureIncrease price realisationReduce unit costsA number of factors determines the extent of value creationBundle design should be tailored to the types of benefits targetedCompetitor and customer responses to bundling must be considered,BUNDLING CAN CREATE SIGNIFICANT VALUE FOR COMPANIES,McDonalds Extra Value Meal,McDonalds introduced the Extra Value Meal in 1991By 199310%increase in dinner revenues per restaurant40%of orders were for Extra Value Meal,Microsoft Office,Microsoft introduced its Office software suite in 1990By 1993Microsoft had 80%market share of office suitesMarket was US$1b and growing strongly,Chrysler Automobiles,Chrysler introduced standard options in its compact car in 1983By 1986Annual cost savings of$2m were realisedMarket share increased from 7%to 18%because of lower prices,Examples Of Successful Bundles,COMPANIES HAVE USED BUNDLING TO CREATEVALUE IN A NUMBER OF DIFFERENT WAYS,Example:Sources Of Value From McDonalds Bundles,Additional Sales,Discount when purchasing products as a bundleCustomers purchase additional productsMcDonalds increases sales and profit,Increased Price Realisation,Numbering system for extra-value mealsCustomers can be served more quickly,enhancing the experienceCustomer is willing to pay more for the bundle,Increased Loyalty,Collectable toy bundled into Happy Meal for childrenCustomers are more likely to buy the bundle again to collect the complete setMcDonalds increases future sales and profits,Element Of Bundled Offer,Customer Response,Value For McDonalds,WE HAVE IDENTIFIED SIX MAIN WAYSIN WHICH BUNDLING CAN CREATE VALUE FOR FIRMS,Type Of Bundling,1.Non-Competitive Cross-Sell Bundling2.Competitive Cross-Sell Bundling3.Value-Added Bundling4.Price Aggregation Bundling5.Economies Of Scope Bundling6.Complexity Reduction Bundling,Logic Behind Bundling,The dispersion of customer valuations for the bundle is less than for the individual products,allowing the vendor to more precisely price to increase volumeBundle is valuable to customer(creates value,or is discounted),or one product can only be purchased as part of the bundle,encouraging customers to make all purchases with a single vendorincreases current salesincreases customer retention,since bundle has increased switching costsBundle is valuable to the customer(creates value),allowing the vendor to increase price for the bundleBundle aggregates prices,so that purchase decisions are made on an aggregated base rather than for individual products,improving the customers price perception Products in the bundle share types of costs including production,distribution sales and service costs,reducing the average unit costOffering predetermined bundles of products allows reduction in number of product lines and hence costs of complexity,Value Driver,Increased volumeIncreased volumeIncreased priceIncreased priceReduced costReduced cost,NON-COMPETITIVE CROSS-SELL ALLOWS INCREASED VOLUME OF SALES THROUGH NARROWED DISPERSION OF VALUATIONS,Demand For Product 1,Demand For Product 2,Demand For Bundle,Customer,Willingness To Pay($),Label,Customer,Willingness To Pay($),Label,Customer,Willingness To Pay($),Label,Optimum Pricing For Product 1,Price=$7Volume=3Profit=$21,Optimum Pricing For Product 2,Price=$7Volume=3Profit=$21,Optimum Pricing For Bundle,Price=$13Volume=4Profit=$52($42),Range Of Valuations:$7,Range Of Valuations:$8,Range Of Valuations:$3,Optimum Pricing In A Two-Product Monopoly,A NUMBER OF FACTORS DETERMINES THE POTENTIAL FOR VALUE CREATION THROUGH NON-COMPETITIVE CROSS-SELL,Potential For Non-Competitive Cross-Sell,Low Potential,High Potential,Customer Demand,Cost Structure,Competitive Environment,Product Attributes,Industry Context,Products which cannot be well price differentiated between segmentsProducts which are at similar price levelsProducts with wide variation in customer valuationsProducts with negative or independent correlation in demandProducts which are targeted at the same customer segmentsLow marginal cost productsHigh market power,Products which can be well price differentiated between segmentsProducts which are at vastly different price levelsProducts with low variation in customer valuationsProducts with positively correlated demandProducts which are targeted at different customer segmentsHigh marginal cost productsNo market power,Note:See Pricing Primer for further explanation of the industry context concept,SEVERAL INDUSTRIES ALREADY EMPLOY NON-COMPETITIVE CROSS-SELL BUNDLING,Industry,Information GoodsSoftwareMusicArticlesFast FoodPharmaceuticals,Example,Office suitesOnline music librariesOnline article librariesExtra value mealsNight and Day cold tablets,Rationale,Wide variation in customer valuationsNon-correlated demandVery low marginal costsNon-correlated demandVery low marginal costsNon-correlated demandVery low marginal costNon-correlated demandLow marginal costsProducts targeted at the same segmentsNon-correlated demandLow marginal costsTargeted at the same customers,MCDONALDS INTRODUCED EXTRA-VALUE MEALS IN 1991,Three Individual Food Products(1),=$2.04,=$1.31,=$1.09,=$3.19,(1)Prices are based on average 2000 Chicago prices,Now Also Sold As McValue Meal(1),Competitors followed with competing bundles,Example,VALUE MEALS SUCCESSFULLYINCREASED SALES REVENUES FOR MCDONALDS,Large discounts were offeredSavings of between 10%to 15%compared with purchasing items individually(1)McDonalds successfully boosted revenues10%increase in dinner revenues between 1991 and 1993 through discounted value meals(2)More than 40%of orders at McDonalds now are for extra value meals(2)Other players had some success with bundlesChains offering the combination meals estimate they account for about 20%of sales(1),(1)Nations Restaurant News 17/01/1994(2)USA Today 24/11/1993,Example,BUNDLES MUST BE CAREFULLY DESIGNED TO INCREASE PROFIT BY SELLING ADDITIONAL PRODUCTS,Increase profit through sales of additional products,Bundle appropriate productsProducts currently charged at a single,undifferentiated priceProducts which are at similar price levelsProducts with wide variation in valuations across customersProducts with negative or independent correlation in demandProducts which are targeted at the same customer segmentsLow marginal cost productsOffer a fully mixed bundlePrice the bundle at a discount to the individual product pricesBe prepared to increase the individual product prices,especially low margin products,to push sales of the bundle,Bundling To Sell Additional Products:Design Heuristics,A GRAPHICAL ANALYSIS OF THIS EFFECT DEMONSTRATESTHE REQUIRED PRODUCT CHARACTERISTICS,We consider the case of a two product monopolyIt is assumed that customers place zero value on the second unit of each productThis assumption does not hold for many products,such as local phone callsThese products must be thought of in a different way,e.g.,one months access to local phone calls to use this graphical analysisThe analysis assumes that only one price can be charged for the individual products and the bundleProducts which are differentiated between segments cannot be analysed in this way,nor are they likely to have large benefits from this effectPhone calls,as thought of as one months access to local phone calls,are often price differentiated by volume of usage,WE WILL ILLUSTRATE THE EFFECTS OF BUNDLING BY CONSIDERING CUSTOMERS VALUATIONS OF TWO PRODUCTS,Willingness To Pay(Product 1),V1,Willingness To Pay(Product 2),V2,The Two Product Purchasing Decision,Note:See Adams and Yellen,1976;McAfee et al,1989,for another example of use of this construct,CUSTOMERS CAN BE MAPPED AS DOTSBY THEIR VALUATIONS FOR THE TWO PRODUCTS,The Two Product Purchasing Decision,Willingness To Pay(Product 1),V1,Willingness To Pay(Product 2),V2,In practice customers would be considered in segments rather than individually,Illustrative,THE POSITION OF A CUSTOMER ON THE MAP DETERMINES THEIR PURCHASING DECISION,Cost,Price,Cost,Price,These customers buy both products(in a bundle if available),These customers buy one product,These customers buy no products,The Two Product Purchasing Decision(No Bundle),Willingness To Pay(Product 1),V1,Willingness To Pay(Product 2),V2,Illustrative,INTRODUCTION OF A MIXED BUNDLE CHANGES CONSUMERS PURCHASING DECISION,These customers buy both products(in a bundle if available),These customers buy one product,These customers buy no products,The Two Product Purchasing Decision(Mixed Bundle),Note:See Adams and Yellen,1976;McAfee et al,1989,for another example of use of this construct,Customers in this area purchase bundle instead of product 1 only,Customers in this area purchase bundle instead of product 2 only,Customers in this area purchase bundle at a cheaper price,Customers in this area purchase bundle instead of no products,Cost,Price,Cost,Price,Willingness To Pay(Product 1),V1,Willingness To Pay(Product 2),V2,Illustrative,V1+V2=PBundle,LEADING TO CHANGES IN PROFIT FROM DIFFERENT CUSTOMER GROUPS,These customers buy both products(in a bundle if available),These customers buy one product,These customers buy no products,The Two Product Purchasing Decision(Mixed Bundle),$,Profit decrease fromcustomers in this area,Illustrative,Illustrative,V1+V2=PBundle,Cost,Price,Cost,Price,Willingness To Pay(Product 1),V1,Willingness To Pay(Product 2),V2,$,$,$,$,Profit increases fromcustomers in this area,$,DISTRIBUTION OF CUSTOMERS VALUATIONS DETERMINES IF BUNDLING WILL LEAD TO A NET PROFIT INCREASE,These customers buy both products(in a bundle if available),These customers buy one product,These customers buy no products,The Two Product Purchasing Decision(Mixed Bundle),Net profit increase if extra sales outweigh the cannibalised profit due to lower price realisation,Bundling is most beneficial when there are many customers in these areas,Cost,Price,Cost,Price,Willingness To Pay(Product 1),V1,Willingness To Pay(Product 2),V2,Illustrative,$,V1+V2=PBundle,$,$,$,Profit decrease fromcustomers in this area,$,Profit increases fromcustomers in this area,$,These customers buy both products(in a bundle if available),These customers buy one product,These customers buy no products,The Two Product Purchasing Decision(Mixed Bundle),Bulk of customers when demand is negatively correlated,BUNDLING IS MOST BENEFICIAL WHEN DEMAND IS NEGATIVELY CORRELATED,Cost,Price,Cost,Price,Willingness To Pay(Product 1),V1,Willingness To Pay(Product 2),V2,Illustrative,V1+V2=PBundleVendor can set the bundled price to win many customers,BUNDLING IS MOST BENEFICIAL IF THERE IS A LARGE OVERLAP OF PROFITABLE CUSTOMERS FOR BOTH PRODUCTS,These customers buy both products(in a bundle if available),These customers buy one product,These customers buy no products,The Two Product Purchasing Decision(Mixed Bundle),Bulk of customers when there is a large overlap of customers,This occurs if marginal costs are low or if the products are targeted at the same customers,Cost,Price,Cost,Price,Willingness To Pay(Product 1),V1,Willingness To Pay(Product 2),V2,Illustrative,V1+V2=PBundle,BUNDLING IS NOT VERY BENEFICIAL IF THERE IS NOT A LARGE VARIATION IN CUSTOMER VALUATIONS OF THE PRODUCTS,These customers buy both products(in a bundle if available),These customers buy one product,These customers buy no products,The Two Product Purchasing Decision(Mixed Bundle),Vendor can capture most of the custome