Price bundling

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This article describes a pricing strategy used by sellers, typically in markets that suffer from imperfect competition, significant transaction costs or imperfect information.
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Definition

Price bundling is a strategy whereby a seller bundles together many different goods/items being sold and offers the entire bundle at a single price.

There are two forms of price bundling -- pure bundling, where the seller does not offer buyers the option of buying the items separately, and mixed bundling, where the seller offers the items separately at higher individual prices. Mixed bundling is usually preferable to pure bundling, both because there are fewer legal regulations forbidding it, and because the reference price effect makes it appear even more attractive to buyers.

Motivation behind price bundling

Exploit different valuations by different buyers

Suppose there are two buyers, and , and two products, and . Suppose buyer values product at units above the cost of production, and values at units above the cost of production. Suppose buyer values at units above the cost of production, and at units above the cost of production. Here is a simple of the value the buyers place.

Value place on product above the cost of production (i.e., reservation price - cost of production) Value placed on product above the cost of production Value placed on a bundle of and above the cost of production = Sum of preceding two columns
Buyer 20 15 35
Buyer 15 20 35

The ideal thing for the seller would be to practice price discrimination: charge each buyer the maximum that buyer is willing to pay. However, this may be forbidden by law or otherwise difficult to implement.

Instead, the seller can pursue the following bundling strategy: charge slightly under units above production cost for the combination of and . Since both buyers value the combination at units above the cost of production, this deal appeals to both buyers. This allows the seller the obtain the entire social surplus as producer surplus. (It isn't true in general that bundling allows the seller to capture the entire social surplus -- that is a special feature of this situation because both buyers have similar reservation prices for the total bundle. However, bundling does allow the seller to capture more of the social surplus in many situations).

The seller can even make this a mixed bundling strategy: offer both and individually for units above the cost of production, and offer the combination for slightly less than units above the cost of production.

External links

Weblog entries/articles

Particular weblog entries/articles of interest: