Global Gas: March 2010

Sent to you by Joe via Google Reader:

The Pros and Cons of Bundled Pricing

via HBR.org by Anthony K. Tjan on 2/26/10

There are usually two ways to make a purchase: a la carte or as a packaged bundle. Think of buying a car. Should you prefer to purchase it as a breakdown of the base car plus handpicked options or are you better off buying it as one all-inclusive bundle? There is a simple and pretty consistent rule of thumb on the question. Here it is: unbundling or a la carte pricing benefits the buyer and packaged or bundled deals give the advantage to the seller.

Why is this? If you are the customer, unbundled pricing creates transparency and allows you to pick exactly the options you want. Most bundles make margin in giving you some of the things you want, but also some of the things that you will rarely use. Breaking things apart lets you see how the seller values each item, which is likely to differ from your perceived or real value in at least a few areas. Consider the following example. A $10 bottle of water feels egregious even in the best five-star hotel room, costing $750 per night, but including the bottle of water in the price of the hotel room and adding $10 and making the nightly hotel price, $760 creates a different set of perceptions for you as the customer. Priced in an unbundled fashion, the customer is more likely to be ticked off by the price (and therefore fewer people would purchase the add-on each) versus the very same person who has already mentally committed to spending $750 per night as a budget will not likely hesitate to spend $760 if that's the advertised rate.

By the same logic, bundling tends to favor the seller. First, there is the simplicity of a single priced product. If you can sell the same bundle to everyone, it makes life easier, which usually means lower marketing and selling costs. Think also of the fact that while most users of software use only a fraction of the available functionality, it is the basic users who are subsidizing the long-tail product development of features used by a relatively small number of advanced users. Microsoft Office is a good example of effective bundling.

When a seller unbundles options it opens up the transaction negotiation to line-by-line scrutiny. I remember receiving a legal bill that carefully showed the breakdown of all the expenses. As the buyer of these services, I appreciated the detail and it ended up playing to my advantage on renegotiating the legal bill. One expense line item jumped out: document reproduction of an article that was priced at $600. While we were originally very happy with all the work in totality that single line item made us angry and caused us to question several other items, which ultimately resulted in us receiving a lower bill. A single bundled price would have benefited the legal office. We were pleased with the work overall and would have readily paid the total bill on a "value-priced" basis if it were billed as a total fee.

But herein lies the issue for companies today, in a world demanding more transparency, how do you balance transparency with profit goals? The answer is simple: you should not confuse transparency with a pricing strategy. If you are the seller, focus on the total value provided which is fair for the customer and you. Show the list of all activities performed for a service without individually valuing them. Providing individual price breakdown can kill any perceived or real synergistic total value. And I have often found that price breakdowns by companies or suppliers are often arbitrary and more of an effort to reconcile with a total price value.

As usual, there are a couple of caveats. In some instances it is clear that bundling favors the customer, particularly in simple transactions in which separate and packaged pricing can be quickly compared. Think of bundled value meals at a fast food restaurant. But even in those cases, bundling can favor the seller in other ways, such as speeding up the execution process and selling a greater volume of goods overall. Another caveat is that bundled pricing does not necessarily require only one bundle. A happy medium for sellers and buyers is often three to four pre-set packages of offerings (e.g. the winter package or the sport package for new cars).

With those caveats, remember if you are the customer pushing to unbundle the package, asking for a price breakdown is almost always to your favor. Choice is a good thing for you. And if you are the seller, the opposite usually holds true. Keep it simple and more profitable with one package deal and the customer is likely to focus on the total experiential value, perceive greater total value, and try features that they may not have otherwise.