Bundling with Customer Self-Selection: A Simple Approach to Bundling Low-Marginal-Cost Goods

Abstract

With declining costs of distributing digital products comes renewed interest in strategies for pricing goods with low marginal costs. In this paper, we evaluate customized bundling, a pricing strategy that gives consumers the right to choose up to a quantity M of goods drawn from a larger pool of N different goods for a fixed price. We show that the complex mixed-bundle problem can be reduced to the customized-bundle problem under some commonly used assumptions. We also show that, for a monopoly seller of low marginal cost goods, this strategy outperforms individual selling (M = 1) and pure bundling (M = N) when goods have a positive marginal cost or when customers have heterogeneous preferences over goods. Comparative statics results also show that the optimal bundle size for customized bundling decreases in both heterogeneity of consumer preferences over different goods and marginal costs of production. We further explore how the customized-bundle solution is affected by factors such as the nature of distribution functions in which valuations are drawn, the correlations of values across goods, and the complementarity or substitutability among products. Altogether, our results suggest that customized bundling has a number of advantages-both in theory and practice-over other bundling strategies in many relevant settings. Bundling with Customer Self-Selection: A Simple Approach to Bundling Low Marginal Cost Goods AbstractThe reduction in distribution costs of digital products has renewed interest in strategies for pricing goods with low marginal costs. In this paper, we evaluate the concept of customized bundling in which consumers can choose up to a quantity M of goods drawn from a larger pool of N different goods (N>M) for a fixed price. We show that the complex mixed bundle problem can be reduced to the customized bundle problem under some commonly used assumptions. We also show that, for a monopoly seller of low marginal cost goods, this mechanism outperforms individual selling (M=1) and pure bundling (M=N) when goods have a positive (even small) marginal cost, when users face costs of evaluating goods in the bundle, or when customers have heterogeneous preferences over goods. Comparative statics results also show that the optimal bundle size for customized bundling decreases in both heterogeneity of consumer preferences over goods and marginal costs of production. Altogether, our results suggest that customized bundling provides an efficient and mathematically tractable pricing scheme for selling information and other low-marginal cost goods, especially when consumers have heterogeneous preferences over goods or are budget or attention constrained.1

Pricing Strategies of Software Vendors

“…Another variant is customized bundling which allows the customer to choose within certain specifications which of the products should be contained in the bundle. The vendor just determines the bundle's price and scope (Hitt and Chen 2005). Wu and Anandalingam (2002) show that offering several customized bundles can be beneficial for a monopolistic provider of information goods.…”

The effects of alliance information on Web service composition

“…It is well recognized that QoS driven and intelligent agent approaches can improve the usability of WSC (Canfora et al 2005;Kwon 2006). It is also been shown that selfselection of information goods bundling by customers extends both consumer cost satisfaction and seller profits (Bakos et al 2000;Hitt et al 2005). Therefore, both consumers and providers could benefit from the provisions of bundling Web services and the support of customized preferences.…”

“…Thus, service providers can promote sales by improving information sharing and reducing processing cost. In addition, selfselected customized bundling is particularly attractive to consumers when they are budget constrained, marginal costs are low but nonzero, and consumers' valuation is concentrated on a relatively small number of goods in both conditions of high and low correlations among goods (Hitt et al 2005). As a result, larger bundling providers will often extract more value than smaller ones do, including sellers of single goods.…”

A Brand Premium Pricing Model for Digital Music Market

“…Their results suggest that offering a menu of different bundles of large collection of information goods makes the consumer's valuation fairly predictable, thus a multi-product monopolist can achieve a higher profit by implementing the bundling strategy. A customized bundling strategy was introduced by Hitt and Chen [11] which allows the consumer to choose up to a certain number of goods from a pool of digital goods, their model show such bundling strategy is particularly attractive when the monopolist is selling information goods of high value and the heterogeneous consumers are budget constrained. An empirical study of the music CD bundling strategy by Lee, Tsai, and Wu [12] suggested that successful bundling directs the consumer's attention away from the pricing attribute to the content of the product, so a mixed-bundling strategy is more effective in influencing consumer's purchasing intent.…”