22 Feb 2012  Working Papers

The Dynamic Effects of Bundling as a Product Strategy

Executive Summary — This paper investigates the practice of bundling as a product strategy, and identifies how consumers make choices between products and bundles in a dynamic environment. Authors Timothy Derdenger and Vineet Kumar look at the handheld video game market to study bundling in a platform setting with the goal of investigating several key questions of interest to practitioners who make product decisions: First, do consumers value bundles over and beyond their component products, indicating a synergy, which some researchers have hypothesized? Second, have there been differing opinions on whether mixed bundling, that is offering both the bundle and individual products for sale, is more effective than offering only pure bundles or even compared to offering only the products for sale? Given the prevalence of bundling in technology markets, it is critical to understand whether bundling is more effective in environments with strong network effects or with weak network effects. Key concepts include:

  • Consumers have a negative synergy effect, that is they are willing to pay less for the bundle than for the individual console and game, leading to the question of whether introducing such bundles can increase revenue.
  • Because bundles act similar to damaged goods, they work well in dynamically segmenting consumers and allow for purchases to occur earlier in time—the presence of bundles induces consumers to purchase earlier rather than wait. The time shifting of hardware purchases has a strong effect on software sales, since more consumers who own consoles will purchase video games over a longer time frame.
  • Mixed bundling is especially effective compared to pure bundling, and the authors find that moving to pure bundling would reduce sales by over 20 percent.
  • Strong network effects do not enhance the value of bundling, suggesting that bundling may instead prove more useful in settings with weak network effects. Bundling is thus a strategy that could serve as a substitute to creating stronger network effects.

 

Author Abstract

Several key questions in bundling have not been empirically examined: Do consumers value bundles over and beyond their component products, indicating synergy? Is mixed bundling more effective than pure bundling or pure components? Is bundling more effective when consumer valuations for products in the bundle are more or less correlated? Does bundling serve as a complement or substitute to network effects? We develop a consumer-choice model from micro-foundations to address these questions. Our setting is the handheld video game console market, where consoles and games are marketed as bundles, in addition to being sold separately. We provide a framework to understand the dynamic, long-term impacts of bundling on demand. We find that hardware sales diminish in the absence of bundling, and consumers who had previously purchased bundles may not always purchase pure consoles, even though consoles may be cheaper than bundles. The type of bundling chosen is critical to extracting value from consumers, with pure bundling performing significantly worse than both mixed bundling and pure components. We find that consumers perceive a negative synergy between the components of a bundle. Modeling the dynamic nature of durable good purchases also helps us uncover a finding that contradicts prior static models: positive correlation between products enables bundling to be more effective than negative correlation.

Paper Information