How to Use Pure Bundling to Increase Profits
Pure bundling is a business strategy in managerial economics that exists when consumers can only purchase the goods together. It isn’t possible to purchase the goods separately.
This pricing strategy is found in many restaurants where the entrée comes automatically with a side dish — the entrée and side dish can’t be purchased separately. Satellite and cable television also use pure bundling — you can’t pick and choose the channels you want; you must choose among the packages offered by the service.
The illustration shows pure bundling for two computer software programs — a word-processing program, Software W, and a spreadsheet program, Software X.
In order to simplify the analysis, 1,200 customers are uniformly distributed over the range of possible reservation prices for both software programs. The reservation prices for Software W appear on the vertical axis and range from $0 to $40.00. The reservation prices for Software X appear on the horizontal axis and range from $0 to $30.00.
Assume that you initially price each software program separately. You charge $20.00 for Software W and $15.00 for Software X. These prices divide the upper panel into four quadrants of equal size.
Going back to the assumption that you have 1,200 customers, each quadrant represents one-quarter of the customers or 300 customers. Given this situation, 300 customers purchase only Software W at $20.00 because their reservation price is $20.00 or higher. These customers are in block A.
Customers purchase a good only if its price is less than the customer’s reservation price. Customers with a reservation price higher than $20.00 — for example, $25.00, or even the highest reservation price of $40.00 — will purchase Software W. Customers with reservation prices less than $20.00 — for example, $18.00 — won’t purchase Software W because it isn’t worth $20.00 to them.
Another 300 customers purchase only Software X because their reservation price is higher than Software X’s $15.00 price. These customers are in block C. A third group of customers is in block B. These customers buy both Software W and Software X because their reservation price for Software W is higher than $20.00 and their reservation price for Software X is higher than $15.00.
Finally, the customers in block D don’t buy anything, because their reservation price for Software W is less than $20.00 and their reservation price for Software X is less than $15.00.
Your total revenue in this case equals $21,000. To determine your total revenue, you take the following steps:
Calculate the revenue for customers who purchase only Software W.
Multiply 300 customers by the $20.00 price.
Calculate the revenue for customers who purchase only Software X.
Multiply 300 customers by the $15.00 price.
Calculate the revenue for customers who purchase both Software W and Software X.
Multiply 300 customers by $35.00, the combined prices of Software W, $20.00, and Software X, $15.00.
Add the revenue you receive from all three groups of customers.
By pricing each software program separately, you earn $21,000 in revenue.
Instead of selling each software program separately, you can sell them as a pure bundle — customers must buy software programs W and X together. In this situation, you charge a single price for both programs — for example, you set a price of $24.00 for a package containing both Software W and Software X. The lower panel describes this situation.
Customers consider whether or not to purchase the pure bundle by adding together their reservation prices for Software W and Software X. So, if the customer’s reservation price for Software W is $22.00 and the customer’s reservation price for Software X is $16.00, the customer purchases the pure bundle because the combined reservation price of $38.00 is higher than the actual price of $24.00.
However, note that given these reservation prices, this customer purchases the two software programs even if they’re priced separately at $20.00 and $15.00.
On the other hand, another customer has a reservation price of $18.00 for Software W and $10.00 for Software X. If the software programs are priced separately at $20.00 and $15.00, this customer purchases neither program. The customer’s reservation price is less than the actual price for each program.
However, if the software programs are sold as a bundle for $24.00, the customer purchases the bundle because the customer’s combined reservation price of $28.00 — $18.00 plus $10.00 — is higher than the actual price of $24.00. Thus, you’re able to sell the pure bundle to customers who purchase nothing if the programs are priced separately.
This enables you to increase your revenue. In the lower panel, the diagonal line separates the customers who don’t purchase the pure bundle, the lower left corner, from customers who do purchase the bundle, the upper right shaded area.