March 30, 2017
About the author : Joni holds a PhD in marketing. He is currently working as a postdoctoral researcher at Qatar Computing Research Institute and Turku School of Economics. Contact: joolsa (at) utu.fi
When we were young, me and my brother used to buy and sell game consoles on Huuto.net (local eBay) and on various gamer discussion forums (Konsolifin BBS, for example). We didn’t have much money, so this was a great way to earn some cash — plus it taught us some useful business lessons along the years.
What we would often do was to buy a bundle (console+games), break it apart and sell the pieces individually. At that time we didn’t know anything about economics, but intuitively it felt the right thing to do. Indeed, we would always make money with that strategy, as we knew the market prices (or their range) of each individual item.
Looking back, I can now try and explain with economic terms why this was a successful strategy. In other words, why individual selling of items in a complement bundle is a winning strategy.
Let’s first define the concepts.
Briefly, it is so because the tastes of the market are randomly distributed and do not align with the exact contents of the bundle. It then follows that the exact set of complements does not maximize any individual’s utility, so they will bid accordingly (e.g., “I like those two games (out of five), but not the three so I don’t put much value to them”) and the market price of the bundle will set below the full value of its individual parts.
In contrast, by breaking apart and selling individually each complement can be appraised at full value (“I like that game, so I’ll pay its real value”). In other words, the seller will need to find a buyer for each piece who appreciates that piece to its full value (=has a preference for it).
Tastes and preferences differ, which reflects to individuals’ utility functions and therefore willingness to pay. Selling a bundle is a compromise from the perspective of the seller – he compromises his full price, because the buyer is willing to pay only according to his preferences (utility function) which do not match completely with the contents of the bundle.
There are two exceptions I can think of:
1) Highly valued complements (or homogeneous tastes)
Say all the complements are of high value in the market (e.g., popular hit games). Then, a large portion of the market assigns full value to them, and the bundle sets close or equal to the sum of individual full prices. Similarly, if all the buyers value the complements in a similar way, i.e. their taste is homogeneous, the randomness required for the individual selling to perform does not exist.
2) Information asymmetry
Sometimes, you can get a higher price by selling a bundle than by selling the individual pieces. We would use this strategy when the value of complements is very little to an “expert”. Then, if you were less experienced you could see a game console + 5 games the 5 games, however, had very little value in the market and it would therefore make sense to include them in the bundle and to attract less-informed buyers. In other words, benefiting from information asymmetries.
Finally, the buyer of a complement bundle needs to be aware of the market price (or the range of it) of each item. Otherwise, he might end up paying more than the value of the sum of individual items.
Finding bundles and selling the pieces individually is a great way for young people to practice business. Luckily, there are always sellers in the market who are not looking to optimize their asking price, but appreciate the speed and comfort associated with selling bundles (i.e., dealing with one buyer). The actors with more time and less sensitivity to comfort can then take advantage of that condition to make some degree of profit.
EDIT: My friend Zeeshan pointed out that a business may actually prefer bundling even when the price is lower than in individual selling, if they assign a transaction cost (search, bargaining) to individual selling and the sum of transaction costs of selling individual items is higher than the sum of differences between the full price and bundle price of complements. (Sounds complicated but means that you’d spend too much time selling each item in comparison to profit.) For us as kids this didn’t matter since we had plenty of time, but for businesses the cost of selling does matter.