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To Bundle or Not to Bundle, That is the Question

For years, the cable industry has bundled its channels into tiers. They create “buy-throughs” which require a customer to purchase more than one tier to get to a particular channel the customer may want. For example, if the customer would like to have a channel in the second tier, the customer must also purchase the first tier along with the second tier bundle, of course, at a higher price.

Customers generally dislike this mode of pricing because they get many channels that they do not watch. The Wall Street Journal reports that Nielsen estimates that households watch an average of 18 channels out of the 130 they receive. So customers are paying for a lot of channels that are of little or no use to them.

This cable pricing approach to bundling is unusual. In the vast majority of cases, bundling is a tactic a company might use to reduce the impact of a falling price environment. With bundling, a company may sell more product, though at a lower price per unit of sale. The greater amount of product sold in the individual transaction, however, helps to preserve the company’s margins, even as prices fall.

There are two major types of bundling. The first type bundles several units of the same product into a package. For example, the airline Cape Air ran a program selling ticket books of ten one-way flights at discounted prices on its flights around Cape Cod and a few other destinations.

In the other type of bundling, a company would create a package of related products. As the recession hit the restaurant industry, Starbucks began offering breakfast deals in which a consumer could get a combination of an oatmeal and a latte or of a breakfast sandwich and a coffee for $3.95.

The cable industry has used the bundles to make the consumer feel like he is not paying a great deal for any one cable channel. The cable companies themselves are largely monopolies in their local areas. They have the freedom to raise their prices faster than inflation, and have done so for a number of years, using this bundled product approach.

Will this approach last for the long term future? That’s hard to say. (See “Video #3: Predicting the Direction of Margins” on StrategyStreet.com.) Certainly prices have gotten very high today. The cable companies have raised the price umbrella over new competition. Consumers would like to find lower prices and media producers are always looking for new channels of distribution. Increasingly, the internet is becoming an answer for both of these players. New services are arising that allow consumers to pick and choose individual programs to watch on the internet, or even on an internet equipped television. (See the Symptom and Implication, “Large competitors are maintaining price levels as smaller competitors discount” on StrategyStreet.com.) That is a real threat to the cable company’s bundled pricing stance.

Posted 2/22/10

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