Product Bundling: Why Individual Price Setting Still Matters
Product bundles are quite neat for a few reasons. Firstly, selling product bundles can actually be of great value to the customer. When you buy a television, it’s highly convenient that a remote control is included. If the bundle includes batteries for that remote control, even better. Another such, perhaps less obvious, example is insurance: in theory, when you buy a home insurance, you buy a bundle of several different insurances, with different risk and premia, which have been bundled together. For example, such a bundle may comprise insurance against flooding, insurance against fire, insurance against theft, and so on. Most people cannot comprehend what insurance policies they will need to be adequately covered; and so, the insurance company steps in and, with their expertise, compile different products into a bundle.
Secondly, creating bundles is very effective for upselling. Often, customers won’t even consider buying a product unless you tell them they’ll need it; that there is a product that goes well with the product they initially intended to buy. By bundling different items, you implicitly make a recommendation, and as you’re the one selling the products, your recommendation is very credible in the mind of the consumer. Think about it like a Prix Fixe menu at a restaurant: the chef, who must be an expert in the food that he himself is cooking, has decided to sell these food items together. That must mean they’re complementing each other well, right?
Finally, bundling is a great way to increase profit and extract more consumer surplus. Consider a situation where you have two customers, Jake and Josh who go to McDonald’s.
Jake is really hungry, but not very thirsty; Josh is not incredibly hungry, but really thirsty. A Big Mac menu consists of 3 items, a burger, fries and beverage, priced individually at $4.00, $2.00 and $1.50 respectively. A Big Mac menu costs, say, $6.50, i.e. you save $1.00 by purchasing the menu. Now, since Jake is really hungry, he’s willing to pay $5.00 for the burger, and $2.50 for fries. But he’s only willing to pay $0.50 for a drink as he’s not thirsty.
Josh, on the other hand, is really thirsty so he’ll happily pay $3.00 for a beverage, but only $3.00 for the burger and $1.00 for fries.
If the items weren’t bundled, Jake would buy a burger and fries, at a total of $6.00, even though his willingness to pay was higher. And Josh would only purchase the beverage at $1.50. Jake and Josh would generate McDonald’s $7.50 in total revenue if the items weren’t bundled.
However, as both Jake’s and Josh’s willingness to pay for the three menu items exceed $6.50, they will both buy a menu, generating a total revenue of $13.00: that’s $5.50 in additional revenue from product bundling.
Individual Prices Matter
You could be tempted to say that a chain like McDonald’s, who heavily relies on their product bundles, i.e. their menu products, won’t have to pay all that much attention to the prices of individual products, as long as bundle prices are on point. Wrong!
The obvious reason is that there are still going to be customers buying the products individually; and that is definitely important. But another reason that is often overlooked is the message your price is sending, and how it impacts the customer’s purchase decision.
Let’s assume you go to a McDonald’s, determined to buy a Big Mac menu, and the burger, fries and beverage are priced individually at $2.00, $1.50 and $5.00 respectively. You want all three items, and the menu price of $6.50 still seems like a bargain, but you will perceive it as the majority of this $6.50 is paying the ridiculously expensive beverage. You’ll feel the purchase is unwise, and perhaps not buy the bundle as a result thereof.
Moreover, if we assume you had never tried the Big Mac burger before, you may find it suspicious that it costs only $2.00. After all, it’s got two patties etc., it looks quite big in the picture, so if it’s only $2.00, it must be very low quality or the picture is deceptive. Either way, you’ll suspect the product’s quality simply because of the individual price.
In general, we advise clients to avoid showing individual prices of bundle items, if possible. In some cases, it will indeed appear suspicious to conceal individual prices, but especially if you’re selling service bundles, it is often wise to do so. We often encounter examples of service providers, who offer bundles perfectly reasonable prices, but still manage to upset customers because they show individual prices on the bill; especially, because service providers typically will include some fees that don’t create value for the customer, but are nevertheless necessary.
For instance, if a consultancy flies in an expert from another country to work on a project, the client might get upset if it comes to his attention that he’s paying the travel costs as this provides no additional value to him; however, it may eventually turn out that using this expert reduces the number of billable hours because he’s more efficient than the local consultants, resulting in a lower total price.
One common mistake, however, is to set individual prices incredibly high, if the primary goal is to sell bundles. For example, if you go to a cinema their prices tend to be an absolute disaster, with insane attempts at price anchoring and forcing customers to buy specific products and bundles. “Buy a medium coke at $8 or get a large coke and popcorn at $8.50”. Sounds familiar?
Despite that the bundle price may be OK, there are several drawbacks to this strategy: 1) Customers will feel exploited when encountering the $8.00 price tag, and if you really just want the drink, and don’t need the popcorn, you’ll feel your budget allocation is unwise if you purchase a bundle just to throw out the popcorn - even if you’re willing to pay $8.50 for a large coke alone.
Furthermore, when companies set almost irrational prices, the customer loses trust in the prices ability to convey value -- a fairly important function of prices from a consumer standpoint. Often, you don’t know what you’re going to get, and the price can be one of the only indicators. But if prices aren’t rationally set, they lose a key indicator for their purchase decision, and may not buy anything at all.
Summary: Bundles Are Great, But…
We really encourage bundling when it makes sense, as long as you make sure that the products you bundle are complementary -- a bundle is implicitly your recommendation to the buyer, and you lose their trust if you make poor recommendations.
Furthermore, make sure individual prices are on point, too -- even if you primarily want to sell your bundles. And finally, don’t try some excessive pricing strategy to force customers to buy bundles; they should buy them because they want to, not because they have to.