You must have come across campaigns of the following kind. “Buy one, get the second at half-price”. A camera is sold in a box with a free film; a hotel room often comes with accompanying breakfast. These are examples of Bundling. Bundling is the practice of selling two or more separate products together for a single price i.e. bundling takes place when goods or services which could be sold separately are sold as a package. A codification of bundling practices and definitions of selling strategies is:
Pure bundling: products are sold only as bundles;
Mixed-bundling: products are sold both separately and as a bundle; and
Tying: The purchase of the main product (tying product) requires the purchase of another product (tied product) which is generally an additional complementary product.
This is not an exhaustive list but covers the most frequently encountered cases.
Pure bundling involves selling two products only as a package and not separately.For example, Reliance WLL -cellphone instrument (handset) and connection are only available together and not available separately. Microsoft’s bundle of Windows and Internet Explorer could be considered a pure bundle. Also Cable TV Channels are an example of pure bundling. In North America it is not possible to get only Disney Channel has it is always bundled with other premium channels. In India, the prospective CAS(Conditional Access System) also has similar channel packages where some of the channels can’t be purchased separately like Zee TV, would only be available with other, Zee Channels.
Mixed Bundling involves selling products separately as well as a bundle. McDonald’s Value Meals and Microsoft Office are examples of Mixed Bundling. In a recently introduced offer, The Times of India and The Economic Times can be purchased together for weekdays for a price much less than if purchased separately. This is also an example of mixed bundling. In most cases mixed bundling provides price savings for consumers.
Tying involves purchase of the main product (tying product) along with purchase of another product (tied product) which is generally an additional complementary product.
A well known example is that used by IBM in 1930s wherein if you purchased IBM tabulating machines agreed to purchase IBM punch cards. As a result, IBM was trying to extend its monopoly from one market to another. But it had to abandon this practice of it in 1936 due to antitrust cases. In 1950’s customers who leased a Xerox Copying Machine had to buy Xerox Paper. Another case of tying was that by Kodak in which Kodak held a monopoly in the market for Kodak Copier Parts. Kodak engaged in tying when it refused to sell it’s parts to consumers or independent service providers except in connection with a Kodak Service Contract. Today when you buy a Mach3 razor, you must buy the tied product i.e. the cartridge that fits into the Mach3 razor. Financial bundling has become widespread. It has been suggested that manufacturers such as GE, General Motors and Lucent grow ever more involved in providing finance, so “manufacturing is becoming the loss-leader of the profit chain for many companies.” In other words, give away the product; make money on the lending that is bundled with it. In India too, a number of automobile companies are providing finance and bundling the automobile with financing.
Bundling can be good for consumers. It can reduce “search costs” (the bundled goods are in the same place), as well as the producer’s distribution costs. There are lower “transaction costs” (because a single purchase is cheaper to carry out than multiple ones). And the producer may be a more efficient bundler than the customer: few of us choose, after all, to buy the individual parts of a computer to assemble them ourselves.
In perfectly competitive markets, bundling should happen only if it is more efficient than selling the products separately. Where there is less than perfect competition – that is, most markets – economic models suggest that bundling sometimes benefits consumers and sometimes producers. When firms have a measure of market power, they can engage in price discrimination, charging different prices to different customers. Bundling can play a part in price discrimination, as different bundles of goods and prices may appeal to different customers.
In a celebrated case that caught much media attention, Microsoft was accused of anti-competitive conduct in ‘bundling’ Internet Explorer and Windows as a pure bundle. Microsoft claimed they are not a bundle at all, rather a single product incapable of being broken into parts. It is of course difficult to settle such arguments and these go beyond the economic domain to the judicial domain, and are settled in courts. But the interesting aspect is that the company does not consider its product (Windows and Internet Explorer) as being capable of being broken into parts.
One of their techniques requires buyers to pay a fee for the right to purchase their product and then to pay a regular price per unit of the product. For example, your cable TV company charges you a base fee for hooking into its system and then charges you extra for pay-by-view transmissions. Similarly, many local telephone companies charge a monthly base fee and then charge additional fees based on message units.
The fee for privilege of service plus prices for services consumed is called a two part tariff. Theme parks such as Disney World usually employ such a pricing scheme to increase their profits. To see how the scheme works, suppose you operate a theme park and have a local monopoly. Figure-3 shows the demand for rides at your theme park by any given tourist, along with the marginal revenue and marginal cost of the rides. If you charge a single monopoly price, your rides will be priced at $6 each and each tourist will consume four rides per visit, spending $24.
Now let’s see if a bit more can be extracted from each tourist. Given the demand curve drawn, each tourist would be willing to pay more than $24 to enter your theme park and take four rides. If you know the demand curve for rides, you know that the typical tourist is enjoying a consumer surplus of $8, corresponding to the area of triangle ABC in the graph (area ABC=1/2*4*4). Therefore, if you charge an entry fee of $8 in addition to $6 per ride, you can add $8 per tourist to your profit. Given the demand curve of a typical tourist, you can add still more to your revenue from each tourist if you simply eliminate the price per ride and just charge an admission fee equal to consumer surplus at zero price per ride. For example, if the price per ride were zero, a tourist would go on 10 rides per visit and you would get revenue of $50 per tourist –0.5 ($10)(10)—instead of the $32 you would get from the two-part pricing scheme. But be careful. With more rides your marginal costs will increase, and thus your profit might not increase. Also, if you extract the entire consumer surplus with a single entry fee, you increase the tourists’ cost per visit, so the total number of admissions will fall.
A two-part tariff is often a good way to increase profit by extracting some, but not all, of the consumer surplus from a monopolist’s clients. Monopolists usually experiment with various two-part tariff pricing schemes before hitting on the one that gives them maximum profit.
When Esselworld opened in December 1989, it was the first amusement park of its kind in Mumbai and so had no precedent to go by. As the objective was to sell the concept to as many people as possible, it avoided charging a composite fee, for a stiff entrance fee would keep families away. Instead, it selected what seemed the most sensible approach: pay-as-you-go. It charged and entrance fee of Rs. 5 for children and Rs. 10 for adults. And the individual rides were priced between Rs. 2 and Rs. 15. In February 1990, however, Essel world jettisoned the split pricing strategy and switched over to composite pricing. Under the new tariff structure children were charged a fee of Rs. 80, while adults had to pay Rs 100. There were no charges levied on the rides. What prompted the switch? According to their vice-president they found difficult to implement the pay-as-you-go strategy because of logistical problems.
PRICING OF JOINT PRODUCTS
Products can be related in production as well as demand. One type of production interdependency exists when goods are jointly produced in fixed proportions. The process of producing beef and hides in a slaughterhouse is a good example of fixed proportions in production. Each carcass provides a certain amount of meat and one hide. There is little that the slaughterhouse can do to alter the proportions of the two products.
When goods are produced in fixed proportions, they should be thought of as a “product package.” Because there is no way to produce one part of this package without also producing the other part, there is no conceptual basis for allocating total production costs between the two goods. These costs have meaning only in terms of the product package.
Calculating the Profit-Maximizing Prices for Joint Products
Assume a rancher sells hides and beef. The two goods are assumed to be jointly produced in fixed proportions. The marginal cost equation for the beef-hide product package is given by MC = 30 +5Q The demand and marginal revenue equations for the two products are
What prices should be charged for beef and hides? How many units for the product package should produced? Summing the two marginal revenue (MRT) equations gives
MRT = 140 – 6Q
The optimal quantity is determined by equating MRT and MC and solving for Q.
140-6Q = 30 +5Q
and, hence, Q = 10
Substituting Q =10 into the demand curves yields a price of $50 for beef and $60 for hides. However, before concluding that these prices maximize profits, the marginal revenue at this output rate should be computed for each product to assure that neither is negative. Substituting Q=10 into the two marginal revenue equations gives 40 for each good.Because both marginal revenues are positive, the prices just given maximize profits. If marginal revenue for either product is negative, the quantity sold of that product should be reduced to the point where marginal revenue equals zero.