8. Bundling

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From the course by National Research University Higher School of Economics

Industrial Organization: Strategy and Competition in Business

2 оценки

National Research University Higher School of Economics

Industrial Organization: Strategy and Competition in Business

2 оценки

Industrial Organization is the area of economics that studies the markets as institutions, the state of competition and strategic interaction among firms, the industrial policy and the business decisions firms make within the market framework. The course looks at the markets from three different perspectives: the economic theory, the applied business perspective and the institutional and legal perspective. The focus of the course is split equally between the economic theory and business perspective but there is a significant legal component incorporated in various topics. The course includes economic modeling, game theory, numerous real life examples and several case studies. We explore interesting topics of market organization such as negotiations, antitrust, networks, platforms, electronic markets, intellectual property, business strategies, predation, entry deterrence and many others. The basic objective of the course is to enable the student to understand the structure of markets and the nature of strategic competition. Knowledge in this course will be valuable for the students in acquiring managing and governance skills, enriching their understanding of the institutional framework of business, and improve their analytical ability in negotiations. Prerequisites: The course requires understanding of basic economic modeling, knowledge of intermediate microeconomics (especially production/cost theory), knowledge of basic concepts and methodologies of game theory, intermediate econometrics and basic calculus.

From the lesson

Price discrimination

The topic for this lecture is pricing. In general in economics, we are used in a paradigm in which firms set only one price for each of their products. Sometimes this is indeed the case but, often, we observe that firms charge different prices to different consumers or different occasions or different purchased quantities. In reality, when a firm has some market power and the consumers are each not willing to pay the same for every unit, the firm can price-discriminate to increase its profits. We will analyze the three degrees of price discrimination, tying, bundling and several other methods of advanced pricing. We will also present a brilliant pricing case study with Polaroid.

8. Bundling10:02

9. Legal framework for PD4:59

Meet the Instructors

Kosmas Marinakis
Assistant Professor
ICEF and Faculty of Economics Sciences, HSE

The last method of pricing that we will examine

today is a method of advanced pricing and it's called bundling.

Bundling is when two or more different products

are combined and offered together as a package.

Do not confuse it with a tying sales while we have

a prerequisite product and then, a complimentary good.

These products as we're talking about here in bundling,

there are two different products that they cover

similar needs and they can be used independently also.

While in the tying sales,

the products cannot be used independently.

You cannot use independently the camera and the film.

Bundling requires to have different types of consumers.

If you do not have different types of consumers,

or you cannot identify types,

then this means of bundling will not make a difference.

You do not have any reason to bundle.

Bundling will give you a pricing advantage in one specific condition.

And be very careful here because this is also a little tricky,

but if you're careful and you get it,

you will be able to understand everything afterwards.

Bundling gives you a pricing advantage only when

the demands of different types are negatively correlated.

What does this mean exactly?

That some customers are willing to pay more for

one product of the bundle and

some other customers are willing to pay more for the other product.

So, you have two different products that you bundle them together.

That group wants to pay more for one product,

the other group wants to pay more for the other product.

So, this is what we call here,

negatively correlation of the demands curves of the two groups.

Let me give you an example which will make it clear.

We have George who was interested into taking dancing lessons.

And there are two different dances that they are let's say,

Tango and Kizomba, new modern dance.

So, George is willing to pay 12 euros for

Tango and just eight euros for a Kizomba lesson.

And then, we also have Olga,

another customer, another type,

that is willing to pay 15 for Tango more than George and nine for Kizomba.

Also, more than George.

But what we have here is that these demands are positively correlated because they

both prefer to pay more for Tango than for Kizomba.

Now, let's see. If we are a dance school and we want to

extract as much revenue as possible from these two clients,

how are we going to do it?

If we pay separately,

we do not bundle the two dances together,

but we price separately lessons

for the one kind of dance and lessons for the other kind of dance,

how is this going to work?

So, the price for Tango should be 12.

Why? If we price anything above 15,

no one will buy because they're willing to pay up to 15.

Olga is willing to pay up to 15.

There's no more valuation here.

If we price anything between 12 and 15,

above 12 and below 15,

then George is not going to buy.

So, we're only going to get Olga.

If we price for example, 15,

we're only going to get 15 rubles from Olga and nothing more.

However, if we price 12,

both of them will buy.

So, therefore, we'll have 12 from Olga and 12 from George.

This will give us much more a revenue than only pricing in Olga by charging 15,

and this will give us a revenue for 15.

So, we will price tango equal to 12.

With the same logic,

we will price Kizomba equal to eight.

This will give us a total price of the two of 20.

And then, this means that 20 times two,

I will have a revenue that will be equal to 40.

If now, we say that we're not selling the two lessons separately,

you just enroll in our school and this gives you

the right to take both lessons if you want,

or only one, but we are not going to change the price.

So, you just bundle the two products,

the two dancing lessons together.

So, what would be the right price to do that?

So, if we go with the valuation of George,

this would be 12 plus eight,

this will give us 20 again.

So, we'll get 20 from George and 20

from Olga in the same way because they have to have the same prices.

So, this will give me again a price of the bundle

20 and my revenue will be 40, which is the same.

So, what do we see here is that if you have positively correlated demands,

both consumers like more the same product,

then bundling will not give you a pricing advantage,

will make no difference.

In a different example, we have again George with the same valuations.

And now, we have Irene who is willing to pay nine for Tango,

but 15 for Kizomba.

She likes much more to dance Kizomba than Tango.

So, will price discrimination now with bundling gives us a better result? Let's see it.

If we're priced separately, now,

we should charge nine for Tango because Irene is willing to pay just nine.

And if we charge 12,

this is going to pricing only George and not Irene.

We'll have a revenue of 12 in this case,

but if we price nine,

we're going to have a revenue of nine plus nine equal to 18.

And the price for Kizomba would stay at eight units, and therefore,

would have a revenue of nine plus eight times two, this is 34.

If we bundle them together,

what we can do is that we can price the bundle equal to 20.

And this is because George has a total willingness to pay 12 plus eight,

which prices came in with a price of bundle equal to 20.

But Irene also has a total valuation of nine plus 15 equal to 24,

so still, is going to buy.

She also is going to buy the bundle.

Therefore, we can sell this bundle to both of

our consumers and we will get a revenue of 40,

which is significantly higher than 34 than we've had before.

So, if you have a negatively correlated demands plus

some other conditions that you can work with variables there,

and you can realize for yourself,

you will see that negatively correlated demand

is a necessary condition in order for bundling to work.

So, bundling yields higher profit than separate pricing.

In practice, bundling happens all the time.

In car purchasing, when you are going to buy a car,

they have different versions of the same car.

And each version is first of all,

there is a basic version,

there is the luxury version,

there is the sports version,

and they have some additional things that they

bundle things together that they seem irrelevant.

So, they bundled together,

park-assist, the system that will help you park the car with leather interior.

And this is something that appeals to

two different types of consumers, two different products.

Park-assist, you want if you are more practical customer.

Leather seats, you want if you are a customer that you value luxury more.

And usually, these two types,

they do not coincide with most of the things.

Vacation travel that we usually see websites that they sell tickets and hotels,

that they try to convince you to bundle different things together.

Cable television, you buy cable television and you see that they bundle sports,

that's most likely the audience is men with fashion channels,

that most likely the most of

the audience they are target audience is more women than men.

So, they target this because they target to different audiences and this makes

bundling to make sense because you have

negative correlation in the demands between sports and fashion,

or hotel and airfare,

or park-assist and leather.

So, this is something that shows you that bundling in

practice does make a difference and is applied very often. Stay with us.

We're going to continue with the last segment for today.

And we will talk about the legal framework of price discrimination.

Is it illegal to discriminate different consumers with price?

We will see very soon. Stay with us.

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