Pricing the Bundle

How should a marketer price the bundle? This is one of the questions in a quiz posed by Mr. Reed Holden, one of the authors of Pricing with Confidence, in his website to test a marketer’s Pricing Quotient.  The multiple choice questions offers four choices

20.  When bundling products for a solution, companies should:

Give the services away for free
Price the solution higher than the component offerings
Price the solution lower than the component offerings
Price the solution equal to the component offerings

My answer is, there is no one answer.  It depends on the bundling method, customer demand and the market. The answer requires analysis to find the option that maximized profit. I will discuss this with examples, but first some definition:

Bundling: When  marketer sells two or more items of the same or different type as one bundle at one price.

The bundle can be one of the following three cases,

Case 1 – Multiple instances of the same widget:

Like a two pack milk or dozen soap bars, the marketer gives quantity discount to their customers. In this case the bundle is priced lower than the sum of the price of individual components. The pricing is based on demand schedule – customers may have high willingness to pay for single instances but not for multiple instances, hence the pricing discount to match customer willingness to pay.

In addition the marketer may want to price the bundle lower to thwart of competition. For example, in retail new product entry scenarios P&G may give away two pack Head and Shoulders at the same price of single unit if it knows Unilever is trying to introduce a new product. This results in soaking up customer demand and takes them out of the market for sometime. In such cases the additions are given away for free.

There is an interesting variation to  bundled pricing, it comes from a story quoted by Steven Levitt, author of Freakonomics, on pricing for  hair braiding. Levitt wrote about pricing at a hair braiding salon which had the following pricing posted:

3 braids: $10.

6 braids: $22.

Each additional braid: $4.

This is indeed an unusual pricing schedule where the price for the bundle of multiple instances of the same are priced higher than the sum of prices of individual instances. But there is a valid explanation for this, I will discuss this again in Case 3 below.

Case 2 – Bundle of different components with no integration:
The most commonly quotes examples here are Opera season pass or pairing of complementary offerings.  The bundled components are not integrated in any other way. The bundle with lower price than the sum of the individual prices will return higher profit than any other option when there are multiple customer segments with different preference for each component. In fact the customer preferences must be negatively correlated to each other (i.e., if we assume for simplicity there are only two customers 1 and 2 and only two components A and B, then if customer 1’s WTP for A is high then it should be low for B  and vice versa for customer 2).

There is a kind of loose bundling like the one practiced by Amazon.com. For example, when you search for Mr. Holden’s book, Pricing with Confidence in Amazon.com, Amazon will offer “Frequently bought together” bundle, combining other Pricing related books (Sidebar: I strongly recommendamazon_bundle one of the book in the bundle, Strategy and Tactics of Pricing).

The price of this recommended bundle is exactly the sum of the price of the three books. There is no reason for Amazon.com to give a pricing discount because this is just a “Nudge” and none of the conditions required to price the bundle lower exist.

Case 3 – Bundle of different components with integration:

In this case, the marketer provides an additional service, integration. For example, when buying computer systems, there is value to customers in buying a pre-configured and tested system that just works. Think Apple. Here the profit maximizing price for the bundle is one that is higher than the sum of the prices of components. Technically we should look at this additional service as one of the components of bundling and if it is of value to customers then the marketer should charge for it. Conversely, since the customers who buy the components separately perform their own integration, they must be compensated for it in the form of lower price.

Going back to hair braiding example from Steven Levitt, why did the salon price multiple braids at higher price? There is probably value to customers in getting the braids done at one sitting and by one hair braider for consistency and style. The customer also saves  time from waiting and gets more utility. In other words, the braiding example is Case 3 where the added component is integration. Hence the marketer should price the bundle higher.

By the way, why is the hair braider charging more per unit after the sixth braid. Simply based on customer willingness to pay. There is a difference between a casual customer who just wants a few braids for curiosity and hence usually has low willingness to pay vs. a dedicated customer who wants a head full of braids. The latter has higher utility and hence being charged a higher price. By the way, the cost to the hair braider is irrelevant to the argument except if it is the opportunity cost of losing casual customers.

The net is pricing a bundle is not a straightforward answer. A marketer needs to know the demand schedule, customer preferences, customer segments, and value add from bundling. The correct price is the one that maximizes profit.