Bundling complementary products of the firm

Bundling is selling separable products or services to buyers only as a package, or “bundle.” For example, IBM bundled computer hardware, software, and service support for many years, while the manufacturers of antiknock additives for gasoline have traditionally provided various technical services along with their product all at a single price. Bundling in some form is pervasive, though not always recognized. Identifying when bundling is occurring often requires a rather fundamental look at an industry akin to that in segmentation (Chapter 7). All the potentially separable products and services that are offered must be isolated, even though they may not be seen as separate by industry participants. For example, delivery and after-sale service are often included as part of the product although they are potentially separable and could be sold separately. Similarly, retailers often provide free parking, while airlines provide free meals and baggage handling. Because some forms of bundling are age-old industry practices, firms may not even perceive that they are bundling.

Bundling means that all buyers are provided with the same package of products and services, regardless of differences in their needs. Some buyers of antiknock compounds, for example, would prefer to sacrifice the service provided by manufacturers in return for a lower price, but they do not have that option. Buyers often differ in their receptiveness to bundling because they want different collections of products or services, or because they differ in the intensity of their need for the various products or services. In either case, bundling is suboptimal for some buyers.

Bundling will not be desirable unless it has some countervailing benefits that overcome the fact that it is suboptimal for some buyers. Bundling can create competitive advantage in a number of ways, how-ever, that vary in importance from industry to industry and even by industry segment. In some industries bundling also has significant risks that must be identified.

1. Competitive Advantages of Bundling

The potential competitive advantages grow broadly out of the ability to share activities in the value chains for providing parts of the bundle if the entire bundle is supplied together. The advantages of bundling can be grouped into a number of categories:

Economies of Providing the Bundle. A firm may lower its costs by providing only a single package instead of whatever mix of products or services a particular buyer desires. These economies arise from interrelationships in a firm’s value chain that can be exploited by supplying only the package. Bundling can allow a firm to better share activities in the value chain in supplying the parts of the bundle. If the same bundle of products is sold to each buyer by the same salesperson, shipped on the same truck, or serviced by the same technician, for example, there may be cost savings in providing the bundle together. The price of the bundle could thus be lower than the collective price of the individual parts. For example, in providing services for offshore drilling for oil, a firm that provides two related services together may need only one person on the rig while competitors require a person for each service. Economies from bundling can also result from shared cost of gathering information about buyers. A consulting firm may learn about a client through providing one service, and apply this knowledge at low cost in providing other services in the bundle. The unbundled competitor must make the full investment in information even though it provides only one service.

Bundling may also reduce costs by promoting manufacturing economies of scale or learning. Providing the same package to all buyers guarantees an equivalent volume of all items in the bundle, perhaps lowering cost. For example, manufacturing a fire engine with standard features would allow a manufacturer to achieve greater economies of scale and learning than if each engine gets a different collection of bells and whistles, the current U.S. industry practice. Providing a common package may also increase the productivity of the sales force, by eliminating the need to inform the buyer about what parts of the bundle to select. Finally, bundling can significantly reduce administra-tive and selling costs. Providing the same package to all buyers usually simplifies transaction costs, including paperwork, logistical arrangements, and the like. Economies of standardization, scale, or learning can in some cases allow a firm to sell the bundle at a lower price than it would have to to charge customers who only wanted part of it.

Economies from bundling will yield a substantial competitive advantage to a bundled firm only if unbundled competitors cannot duplicate them through coalitions or contractual arrangements among themselves. However, the difficulties of reaching agreement on such coordination with independent firms often preclude a contractual solution.

Increased Differentiation. Bundling may allow a firm to differentiate itself vis-à-vis competitors selling only parts of the bundle. The role of bundling in differentiation arises from linkages among parts of the bundle in the buyer’s value chain because they are used or purchased together. Without bundling, a firm may not only forgo differentiation but be forced to compete with each specialist competitor in its area of greatest strength. Bundling can increase differentiation in the following ways:

MORE BASES FOR DIFFERENTIATION. A firm that can bundle has more dimensions on which to differentiate itself than a competitor with a more limited offering. For example, a bundled firm may be able to guarantee reliability of the entire bundle or offer a single point for after-sale service. Similarly, it may differentiate itself or its service even though its product is not unique.

HIGH-PERFORMING INTERFACE. Bundling may be necessary when the interface among complementary products is not standardized. Compatibility among items in the bundle is facilitated if the same firm provides the whole package of items needed jointly to meet the buyer’s needs. This presumes that interface technology is relatively difficult, and that compatibility cannot be achieved.

OPTIMIZED PACKAGE PERFORMANCE. Even if the interface among products in the bundle is standard, the bundled firm may be able to optimize the performance of the whole package (system) by controlling the design, manufacture, and service of all the parts. It may have better information about the capabilities of each part of the bundle than a specialist competitor who must gather information externally about parts of the bundle and cannot control their design directly. This advantage of bundling presumes that the parts of the bundle are interdependent in determining its overall performance.

ONE-STOP SHOPPING. Bundling simplifies the buyer’s shopping task. Offering the bundle may also reassure the buyer that all the items in the bundle will work, and reduce the buyer’s perceived risk of purchase. A single point of responsibility, a single place where complaints can be lodged, and a single service organization may also be valued by buyers. Buyer frustration over divided responsibility in the newly deregulated Bell System is a good example of how unbundling can lower differentiation through this mechanism.

Enhanced Opportunity for Price Discrimination. Bundling may allow a firm to increase total profits where different buyers have different price sensitivities for the individual parts of the bundle. Particularly in a “mixed” bundling strategy—where a firm offers both the full bundle at one price and the individual parts of the bundle at prices which sum to greater than the bundle price—bundling may increase total revenue compared to selling the parts separately.94

The mechanism by which this occurs is a function of the cost of the bundle versus the cost of the parts of the bundle a buyer would want if they could be purchased separately. Bundling can cause some buyers to buy the whole bundle even though they would not buy all the parts individually, provided the incremental cost of the whole bundle over the cost of the parts they desire is low. In addition, a mixed bundling strategy can allow the firm to extract high prices from buyers who strongly desire only one part of the bundle, while at the same time selling the whole bundle to other buyers.

The value of bundling in pricing depends on the distribution of buyer needs in the industry. Bundling is most likely to raise profits if buyers have widely differing price sensitivities for parts of the bundle. Bundling is a way of capturing differing price sensitivities without charging different prices to different buyers for the same product.

Increased Entry /Mobility Barriers. Bundling may lead to higher entry/mobility barriers, presuming there are one or more of the other competitive advantages of bundling. Bundling raises barriers because a competitor must develop capabilities in all parts of the bundle rather than being able to specialize.

Mitigated Rivalry. Rivalry among a group of bundled competitors may be more stable than rivalry in an industry containing both bundled and unbundled competitors. If all competitors offer the same bundle and the only industry price is the bundle price, the ability to recognize mutual dependence among firms is likely to be higher and the incentives for price cutting may be less than if competitors offer any part of the bundle separately.

2. Risks of Bundling

A bundled strategy involves a number of risks, which vary in importance depending on a firm’s strategy and industry structure. The risks of bundling are determined by the potential vulnerability of a bundled firm to attack by an unbundled competitor employing a more focused strategy.6 Sometimes a firm with a substantial competitive advantage can preserve bundling despite significant risks, as IBM did for many years in computers.

Diversity of Buyer Needs. Bundling presumes that a significant proportion of buyers desire and are willing to pay for the whole bundle. If buyer needs vary widely in an industry, a bundled strategy may be suboptimal for a segment of buyers and thereby vulnerable to a focused competitor who tailors the particular bundle it offers to the needs of the segment. For example, if the need for after- sale service varies widely among buyers in an industry, a focused competitor may be able to enter by selling only the product with no service included, and achieve enough market share to be viable. People Express, for example, unbundled the airline product by eliminating free meals, free baggage handling, and other parts of the traditional airline bundle. This appealed to price-sensitive buyers who had little need for the parts of the bundle that were eliminated. Similarly, off-price retailers have successfully attacked traditional retailers with strategies involving little service, no credit, no alterations, and no advertising to appeal to a particular buyer segment.

Buyer Ability to Assemble the Bundle. In a bundled strategy, the firm assembles the bundle and sells it as a package to the buyer. This strategy is vulnerable if buyers have the technological, financial, and administrative capabilities to assemble the bundle themselves. The buyer may purchase the parts of the bundle individually from suppliers and put them together, or purchase some parts from suppliers and produce others (e.g., service) in-house.

Specialist Ability to Provide Parts of the Bundle on More Favorable Terms. A bundling strategy is vulnerable if specialists that focus on one or a few parts of the bundle can achieve low cost or differentiation in producing them. A specialist may gain a competitive advantage for the reasons described in Chapter 7. It can tailor its value chain to produce and sell just one item in the bundle that it views as its primary business. A specialist may also avoid costs of coordination or compromise with shared activities supplying other parts of the bundle that are borne by a bundled competitor.

A specialist that focuses on one part of the bundle can also potentially reap advantages from interrelationships with other industries. A specialist electronics company may have a cost advantage in producing an electronic part for an electromechanical system vis-a-vis a bundled competitor who provides the entire system, for example, because the electronics company can share value activities (e.g., R&D, test equipment) with other related electronics businesses.95

Bundling Through Coalitions. A bundled competitor is vulnerable if the advantages of bundling can be duplicated by focused competitors who form coalitions among themselves. Coalitions can take many forms, such as technology sharing and joint sales or service organizations.

3. Bundled Versus Unbundled Strategies

The balance between the competitive advantages of bundling and its risks determines the appropriateness of the bundled strategy for a firm. The risks of bundling provide the strategic levers with which focused competitors attack bundled competitors. Bundling will be the predominant strategy in an industry if the competitive advantages of the bundled firm are significant and the risks of bundling low. Bundled and unbundled strategies are natural adversaries, however, and the balance between them can shift quickly in an industry in either direction.

In many industries, it may be difficult for the bundled and unbundled strategies to coexist. If a successful unbundled competitor becomes established, this creates pressure on the bundled competitor to unbundle. The presence of an unbundled competitor makes buyers more aware that their needs are not being exactly met by the bundled firm, and provides an alternative to purchasing the whole bundle.

In entering an industry against bundled firms, an unbundled competitor is likely to attack those parts of the bundle that by themselves would fully satisfy the needs of a significant group of buyers, such as a basic product without the ancillary services. Another likely avenue of attack is to supply a peripheral item such as spare parts or service, where the bundled competitor is inefficient or overcharging. Attacking a bundled firm through unbundling is one of the characteristic ways of gaining market position that are discussed in detail in Chapter 15.

After the first entry by an unbundler, the incentive is created for other unbundled competitors to enter and offer other parts of the bundle. Over time, then, more buyers are able to construct the particular bundle they desire. Once a number of unbundled competitors achieve significant market penetration, some of the motivations for bundling, such as scale economies, rivalry reduction, or building barriers, are often eliminated. Thus the remaining bundled competitors may be forced to unbundle.

The bundled and unbundled strategies can coexist in an industry, however, if there are wide differences in buyer needs and compelling advantages to bundling for some buyer segments that are not a function of volume (or of bundling being the dominant strategy). For example, optimization of system performance through bundling may be particularly critical for some buyers, and thus a bundled strategy will remain sustainable for this buyer segment despite the fact that specialist competitors supply parts of the bundle to other segments. Bundling may also be particularly valued by less sophisticated buyers, even though sophisticated buyers want to assemble the bundle themselves. In business aircraft, for example, Cessna is offering a bundle including a plane, maintenance, pilots, a hangar, office space, and landing fees all for a single monthly price. This appeals to buyers that want the convenience of one firm’s taking responsibility for everything. A strat-egy of mixed bundling may also be appropriate depending on the particular competitive advantages sought from bundling. While offering the buyer an option to purchase either the whole bundle or parts of it from the same firm tends to undermine the firm’s ability to sell the bundle, mixed bundling may be appropriate if the key advantage to bundling is differentiation or price discrimination.

4. Bundling and Industry Evolution

The appropriateness of bundling often changes as an industry evolves, because industry structural change alters advantages of bundling or the risks. There is no valid generalization possible about whether bundling becomes more or less attractive as an industry evolves, because many patterns are observed in practice. In the majority of industries, however, there seems to be a tendency towards unbundling as an industry evolves. In commercial insurance, for example, standardized insurance packages have been replaced by the separate sale of services such as loss prevention counseling. Buyers are able today to purchase broad coverage or specialized services depending on their needs. Another industry where unbundling may well occur is video systems. Just as audio systems were once bundled but are now often unbundled, video systems are likely to unbundle into displays, speakers, controllers, game units, and so on. Unbundling trends have also been evident in such other industries as building control systems, gasoline retailing, computers, and hospital management services.

The tendency for unbundling to occur over time is due to some characteristic changes in the competitive advantages and risks of bundling that accompany industry evolution:

Buyer Ability to Assemble the Bundle Increases. Buyer learning over time, coupled with diffusion of technology, implies that buyers may become more able to assemble the bundle themselves. Buyers can gain the expertise to ensure compatibility, and need less reassurance from a single source of responsibility. This is reinforced by the tendency of buyers to backward integrate as industry volume grows. Buyers become more able to make some parts of the bundle themselves, and therefore do not desire the whole package.

Product/Technological Standardization Occurs. Standardization of the product as an industry matures often reduces the need to control the entire package in order to optimize system performance. It also lowers entry barriers into parts of the bundle, and simplifies the buyer’s task of assembling the bundle in-house. The problems of interface compatibility also tend to be reduced over time as an industry matures and standards are established. Qualified suppliers thus appear for parts of the bundle where there were none previously, and trigger the unbundling process described above.

Needs for Various Parts of the Bundle Are Reduced/Changed. Industry maturity tends to reduce the need of many buyers for service, applications engineering, and other parts of the bundle. Early in industry development, product quality is often erratic, products are unproven, and the perceived risk of purchase is often high (see Chapter 8). All of these characteristics lead buyers to seek the security of a bundled competitor, and bundling may be necessary to get an industry off the ground (the case in fiber optics and in electronic fuel injection systems for cars). As the industry matures, however, service and sup- port either move in-house or are less needed by buyers. In addition, new buyers are often attracted to the industry and/or competitors segment the industry more finely, increasing the diversity of buyer needs. Different bundles thus become appropriate for different buyers, and the stage is set for an unbundled competitor to enter.

Industry Size Offsets Bundling Scale Economies. As an industry passes from emerging to maturing, the increase in industry size may make it possible for specialists to viably provide only parts of the bundle. Growth in demand for the parts of the bundle overcomes manufacturing scale thresholds as well as fixed selling costs. This is a special case of the emergence of a new segment as viable for a focus strategy, discussed in Chapter 7.

Increasing Buyer Price Sensitivity Leads to Pressures for Cost Reduction through Unbundling. Increasing buyer price sensitivity leads buyers to press for cost savings. One avenue is often for a buyer to purchase parts of the bundle and assemble it in-house, or to purchase just those parts of the bundle that it needs. Buyers often provide the impetus for unbundling even if no specialist competitors emerge.

Specialist Competitors Are Attracted. The success and growth of bundled firms may attract competitors looking for a way to get into the industry. Since entering with a bundled strategy usually involves overcoming higher entry barriers, new entrants naturally gravitate toward unbundled strategies (see Chapter 15). All the other forces described above provide the opening for them to succeed.

The tendency for unbundling to occur over time tends to be accentuated where an industry has powerful, capable buyers. Such buyers often have the technological strength to quickly develop in-house capability to assemble the bundle themselves, the bargaining leverage to force suppliers to unbundle, and the resources to lower the barriers facing specialist competitors. For example, the leading automobile firms purchase entire systems such as brake systems or fuel injection systems only very early in their development. Later, when the technology becomes developed, these firms break the systems into parts to be sourced from separate suppliers. They in the process often help put unbundled suppliers in business.

Unbundling is also  triggered or accelerated during periods of intense industry rivalry, such as an economic downturn. Desperate competitors turn to unbundling for incremental revenue, setting in motion an often irreversible process. This pattern seems to have been at work in commercial insurance, where a disastrous downcycle has made firms anxious to gain incremental sales. Industry followers or new entrants are often the first to break down the bundle. Followers tend to lead unbundling because of their desire to neutralize their competitive disadvantages in competing with bundled competitors. Often the best hope is to change the competitive rules in order to lower mobility barriers. New entrants also often break down the bundle by identifying latent or emerging segments or situations where there is no clear economic motivation for bundling, where bundling creates mixed motives in retaliation for bundled firms, or where buyer needs are changing. A prime source of new entrants that unbundle is spinoffs from bundled competitors, who recognize that some buyers’ needs are not being served.

Despite a tendency for unbundling to occur over time, bundling is sustainable if the competitive advantages from bundling remain significant and unattainable any other way. Performance or cost benefits of bundling can persist, for example, even after the buyer’s need for reassurance or assistance in assembling the bundle disappears. Bundling is also sustainable if an industry leader controls a proprietary part of the bundle and buyers are forced to purchase the entire bundle to gain access to it. Moreover, a leader can sometimes protect the bundle by protecting proprietary interfaces among parts of it. By making the problem of interfacing with its products difficult, the leader can deter the entry of specialist competitors.97 IBM has been accused of such behavior, for example.

While the more common direction of change is from bundled to unbundled competition, it is important to recognize the opposite possibility. Technological changes may lead to product performance or interface motivations for bundling. Economies of scale in providing the bundle may also sometimes increase over time if the manufacturing process changes. Regulatory barriers that prevented economically rational bundling may fall. Unbundled strategies may also have developed over time in an industry where in fact there are economic motivations for bundling. If many specialists initially entered the industry and no firm had the resources or orientation to develop total capability in the whole bundle, buyers may have been forced to take the role of assembling the bundle themselves. A strategic innovation by one firm in bundling may transform the industry structure.

Two cases where bundling appears to be supplanting unbundled strategies are financial services and health care. Services such as Merrill Lynch’s Cash Management Account (CMA), which combine stock brokerage, a checking account, a credit card, and other financial services, are bundles of previously separate services. They are a manifestation of deregulation as well as developments in information system technology that made such accounts feasible. Similarly, health maintenance organizations are combining separate services. In the same health care sector, however, home care services and specialized emergency room or firms performing minor surgery are a form of unbundling of the product line offered by hospitals. This example illustrates how the competitive advantages of bundling must be viewed on a segment- by- segment basis.

5. Strategic Implications of Bundling

The analysis of bundling carries important strategic implications for both bundled and unbundled competitors. There is usually a constant tension between bundled and unbundled strategies that requires that both be continually reexamined:

Bundle Where the Advantages Outweigh the Risks. Bundling can be a powerful source of competitive advantage where the benefits de-scribed above outweigh the risks. Where producers of products have lost sight of the buyer’s ultimate need to integrate them into a system, a bundled competitor can sometimes transform the industry in its favor. Sophisticated analysis of the buyers value chain and how it varies by segment is a prerequisite to effective choices to bundle and unbundle.

Avoid Unconscious Bundling. Many companies have de facto bundled strategies though they do not recognize them as such. Unconscious bundling is dangerous because a bundled firm may be vulnerable to attack by a focused competitor but may not perceive the threat. A bundled strategy should be the result of a conscious decision in which the advantages of bundling are judged to outweigh the risks, and not the result of a failure to distinguish among the potentially separable products or services that the firm offers.

Be Prepared to Unbundle Over Time if Conditions Change. Given the tendency for unbundling to occur over time, a bundled competitor must be constantly aware of the potential need to unbundle if the balance of advantages and risks shifts. A firm must distinguish between hard economic reasons for bundling and reasons based on lack of buyer sophistication that may be transient. Many bundled competitors have surrendered market share unnecessarily because they have stubbornly clung to bundled strategies.

Bundled Competitors May Represent Opportunities for Industry Restructuring. Bundling can create vulnerabilities that an unbundled competitor can exploit, particularly if bundling is unconscious or if the industry is evolving structurally. Industries in which bundling is being practiced, ideally as a long- standing industry convention, are potential entry targets for a firm.

Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.

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