Bundling has been a widespread business phenomenon. From computers to stereo systems to vacation packages offered by travel agencies, one can see bundling everywhere in our daily life. Firms use bundling strategy for a variety of reasons. Supply-side and demand-side factors play an important role in bundling decisions. It might be cheaper for a firm to offer two products as a bundle rather than sell them separately. Car manufacturers can assembly components of a car much more efficiently than a customer. Alternatively, consumers might value the bundle more than they value individual products. For example, software packages are meaningless without hardware on which to be installed. However, in some markets it is not so clear whether bundling involves either supply-side or demand-side benefits.
In this paper, I focus on those markets where firms use bundling discounts, which represent one particular type of bundling in order to encourage customer loyalty. In the markets I consider, firms offer multi-products that are not substitutable. As an early example, credit card companies such as Visa take advantage of this strategy by offering free miles, hotel rate discounts etc. Retailers, which are my motivating example in this research, have also successfully experimented with bundling discount strategy.
Supermarket chains in various parts of the world offer their customers vouchers that can be redeemed when purchasing particular products from specific firms. Recently, some chains have offered their grocery customers vouchers that can be used when they purchase gasoline from specific gasoline retailers. When customers purchase groceries above a threshold, they are entitled to receive fixed per gallon discounts. In Australia, for instance, while Coles, one of the largest supermarkets, offers discount vouchers for Shell gasoline, Woolworths and Safeway supermarkets offer discount vouchers for Caltex gasoline. If a customer purchases more than $30 worth of groceries at a Coles supermarket, then she is offered the 4 cent discount per litre to be redeemed at any Shell retail station. However, in addition to the amount they pay for their purchases, customers incur an extra cost when they make two-stop shopping rather than one.
In order to purchase a product, consumers spend time and energy on visiting the store, searching for the product, waiting in line etc. There is also an empirical regularity that people overestimate their cost of time. Hence, the opportunity cost of time matters in understanding the economic phenomenon regarding the bundling discounts above. Besides, when firms offer bundling discounts, they essentially give consumers an “endogenous discount-induced” shopping cost. They pay an additional amount for individual products than the bundle. Thus, it would be interesting to see how the presence of exogenous shopping costs affects the incentives of firms which offer the bundling discounts mentioned above. I consider the shopping cost as the cost of additional time, money and energy required when the consumer shops at multiple stores. There are other features of the bundling discounts which are incorporated in the model.
The strategy firms employ in the above schemes involves exclusive brand Specific relationships. In other words, consumers cannot redeem discounts at an arbitrary retailer which they find convenient. Also, it is important to note that supermarkets and gasoline retailers set the discount rates irrespective of interest rates or gasoline prices which vary on a daily basis. In contrast, bundled discounts remain constant for months no matter what happens in the economy. In a sense, firms which offer bundling discounts commit themselves to a discount rate before price competition takes place. Another important feature of recent use of bundling discounts is that both merged and non-merged firms practice that strategy. For example, in the United States, Handy Foods which is an independent retailer based in Illinois, has partnered with Partridge’s Marathon, a gasoline retailer to offer card-based fuel rewards. Walmart, on the other hand, has employed the same strategy by providing gasoline at its own parking lots.
Download
PDF Ebook The Equilibrium Bundling Discounts with Exogenous Shopping Costs
