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

Author

Listed:
  • Lorin M. Hitt

    (The Wharton School, University of Pennsylvania, 571 Jon M. Huntsman Hall, Philadelphia, Pennsylvania 19104)

  • Pei-yu Chen

    (Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, Pennsylvania 15213)

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.

Suggested Citation

  • Lorin M. Hitt & Pei-yu Chen, 2005. "Bundling with Customer Self-Selection: A Simple Approach to Bundling Low-Marginal-Cost Goods," Management Science, INFORMS, vol. 51(10), pages 1481-1493, October.
    • Handle: RePEc:inm:ormnsc:v:51:y:2005:i:10:p:1481-1493
    DOI: 10.1287/mnsc.1050.0403
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    References listed on IDEAS

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