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PGP 2010-12, INDIAN INSTITTUTE OF MANAGEMENT RAIPUR
Anant Bibhore
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The practice of marketing two or more products and/orservices in a single "package" for a special price.
Examples in consumer services:
Banks offering credit cards at no annual fee, free traveler's checksand other services for customers with large certificates of deposit
Hotels are offering weekend packages that combine lodging andsome meals at special rates.
Airlines offering vacation packages combining air travel with car
rentals and lodging
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Rationale for bundling is based on two realities:
1. High ratio of fixed to variable costs and a high degreeof cost sharing (the same facilities, equipment, andpersonnel are used to provide multiple services)
2. The services offered by most service businesses aregenerally interdependent in terms of demand
Effectiveness of price bundling is a function of degree towhich it stimulates demand in a way that achieves costeconomies.
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Pure bundling
Services available only in bundled from
Mixed bundling
Either purchase one or more services individually or to bundle
MIXED-LEADER: one product at discounted price, other productat regular price
MIXED-JOINT: a single price is set for two products purchasedjointly.
Understanding where each form of mixed bundling islikely to be effective in pricing services.
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Basic economic rationaleis transfer of consumersurplus.
Assumptions
Seller holds monopoly overat least one element
Independence of demand
Assumption do not holdfor services firms because Firms operate in a
competitive environment
Services may have acomplementary relationship
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Reservation price forbundle may exceedsum of reservation
prices of individualservices.
Relaxation of additivityassumptions
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Cross-selling targetsegments 1 and 2
Acquisition of new
customer targetsegment 4
Retention targetsegment 3
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Full distribution ofreservation prices forA and B may not beknown, howeverdemand levels withineach segment may beestimated
Demand responsesrequired to changebehavior may bedeciphered
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UQA substantiallygreater than UQB, thenunder mixed leader Awill be best leader.
When UQA and UQB areapprox equal, volumegains from bundlingmay be equal in bothdirections.
Mixed-leader givesunidirectional gains Mixed-joint appropriate
for bidirectional gains
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For cross-selling, key to effective demand response tobundling is degree and type of complementarity.
Three types of complementarity relationships Complements due to economies in time and effort
Search economies real cost to customer is reduced
Enhancement in level of satisfaction with other products
Enhanced customer satisfaction
one-way complementarity
Enhancement in overall image of seller
Bidirectional effects
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One of the products say A, is regularly/continuouslypurchased & UQA >UQB; A is the leader.
Issue How to close the gap (PB - RPB/A)
If customers buy competitors service D instead of B, the gap is(RPD PD) + (PB RPB/A)
Ways to reduce gap Direct transfer of any consumer surplus from A to B
Price reduction on the leader A that increases consumer surpluson A
Selection of B so as to enhance utility of A (so that RPA/B > RPA)
Create search economies, reducing real cost of B (PB RPB/A)
Gains in case of unidirectional complementaries
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One of the services is already purchased, say A
Issue
If customers to add B, the gap is (RPD - PD) + (PB RPB/A)
Ways to reduce gap B enhances A
Price of A + B is sufficiently reduced.
Such gains are clearly more likely to occur to the extentthat bidirectional complementaries is present betweenthe two services
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Customer acquisition is the primary bundling objectivewhen the strategic focus is potential new customerthose buying neither A nor B
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Considering product A & B where A is the leader.
A must be worth more if B also is purchased fromthe same source than A would be worth if
purchase alone. A should be price elastic and B must be
complement of A.
Complementarity probability must be derivedfrom the degree to which B enhances the searchattributes of A.
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In this case, since customer must evaluate thetotal package ( A+B), the gap between pricesand reservation prices can be overcome only if
the price discount for the bundle generates alarge gain in bundled sales.
Bidirectional complemantary relationships arestrong but have not been established previously
in the consumers mind
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Assuming most bundling offers will be accessible to currentcustomers, the profit effect will depend largely on theextent of cannibalization due to:-
Reduce profit margin among customers already buying both
A and B
Reduced number (though at the same margin) of A-only orB-only buyers.
Any reduction in the number of A-only and B-only buyerspresumably occurs because these buyers now purchasethe bundle
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Select A & B where UQA+B (the quantity of A & B sold withoutbundling) is small to minimized cannibalization effects.
Even if cross selling is the primary objective, selecting
products that also generate new customers for both A & B willhelp offset cannibalization effects.
In mixed-leader bundling, the leader should be the lowermargin product.
Mixed-joint bundling will be more attractive when the marginsof the two services are about equal and when the unbundledsales volumes (UQA & UQB) are about equal.
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Conditions leading to success of Bundling Programs
Cross-Selling/Mixed Leader Cross-Selling/Mixed Joint
UQA > UQB
(PA CA) < (PB CB)
Large consumer surplus on A
B enhances value of A and/orsearch economies reduce the realcost of B
UQA = UQB
(PA CA) = (PB CB)
Each consumer has largeconsumer surplus on A or on B
Bidirectional complementaritybetween A & B due either toenhances image of seller or to
joint search economies.
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Conditions leading to success of Bundling Programs
Customer acquisition/MixedLeader
Customer acquisition/MixedJoint
If A is a leader, demand A forelastic
B and A complements because ofsearch economies or enhancedvalue.
A valued much more highly thanB
Demand for A + B elastic ( both Aand B composed primarily ofsearch attributes)
Strong bidirectionalcomplementarity ( or it can beestablished ) between A and B.
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Add-on bundling
It is an add-on service that will not be purchased unless thelead service is purchased
Add-on bundling has the following key features:
Because customer must choose between A and A+B,(i.e PB = 0). Mixed-joint form is the only feasible bundlingapproach.
RPB/A = RPB because complimentarity must be
unidirectional in the add-on case Most add-on services will be so intertwined with the lead
service that split relationship among service providers arenot feasible.
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