Pricing and Bundling Electronic Access to Information

1. Pricing and Bundling Electronic Access to Information Jeffrey K. MacKie-MasonDept. of Economics and School of InformationUniversity of MichiganOctober 1998

2. Reed Elsevier ($5.75 B) Wolters-Kluwer ($2.75 B) Gannett Co. ($1.3 B) News Corp ($3.2 B) Publishing 1996 US GDP 1997 Sales

3. Selected Publishing M&A Activity • Harcourt General acquires Times Mirror’s Mosby Inc. ($415 MM) (9 Oct 98) • Bertlesmann AG to buy 50% ($200 MM) in Barnes and Noble online (7 Oct 98) • Penton Media to buy Mecklermedia ($200MM) (8 Oct 98) • Wolters-Kluwer acquires Ovid Technologies (30 Sept 98) • Microsoft in discussions with Reed Elsevier? (24 Sept 98, Assoc Press) • Reed Elsevier acquires Matthew Bender and Shephard’s ($1.65 B) (27 Apr 98) • Individual Inc. and Desktop Data and ADP/ISS (24 Feb 98) • Washington Post and Newsbytes News Network (18 Dec 97) • Reed Elsevier and Kluwer propose merger (13 Oct 97; abandoned) • Reed Elsevier acquires Chilton Business Group ($447 MM) (23 June 97) • Reed Elsevier acquires MDL Information Systems ($320 MM) (24 Mar 97) • Reed Elsevier acquires Thomson legal titles (Feb 97)

4. Problems and Opportuntities • Problems: • High first copy costs • Threat from “bypass publishing” • Incremental costs from new delivery media • Development risk for new value-added services • Opportunities with electronic pricing: • Revenue from new service provision • Extracting more value from heterogeneous users

5. What is known about bundling? v2 Bob Alice has strong taste for good 1, not much for good 2 Bob has middling taste for both Alice v1

6. What is known? v2 Unbundled:Sell to those with few extreme values, not those with several low values Alice buys good 1 (v1 > p1)Bob buys nothing p2 Bob Alice p1 v1

7. What is known? v2 pB Bundle: Average across values. Pick up the averages, Lose the extremes Bob Alice pB v1

8. What is known? v2 pB Bob Pure bundling Bob buys bundle. Alice does not. Alice pB v1

9. What is known? v2 Mixed bundling Both buy. Offering choice of two price schemes rather than one increases sales But not a general solution! Buy #2 Buy both p2 Bob Buy #1 Alice v1 p1

10. Early literature • Adams and Yellen (QJE 1976); McAfee, McMillan and Whinston (QJE 1989); Salinger (J Bus 1995) • Limited to 2 goods • drastically limits expression of customer heterogeneity and innovative bundling • Didn’t examine behavior as marginal cost Ô 0 • defining feature of information goods

11. Recent efforts • Chuang & Sirbu (1997), Bakos & Brynjolfsson (1997) • Explore N goods, but still very limited bundling possibilities • unbundled, fully bundled and self-selection between the two • don’t consider partial bundles, or user-chooses bundles • Fully bundled tends to be profit maximizing when • consumers have similar “average intensity” • economies of scale in distribution of info goods • not always beneficial to readers • Outstanding issues: • heterogeneity • dimensionality of product space • publisher competition

12. Word processing Java component “home” config “pro” config suite bundle Stock data by the... quote day exchange With or without access to analyst reports, technical charts, &c. Info goods are infinitely configurable

13. Rebundling is opportunity and curse • Possibilities for 3 items: {A},{B},{C},{A,B},{A,C},{B,C},{A,B,C} • Complexity grows rapidly: • Need principled approach to exploring the design space

14. Our agenda • New mode of bundling for heterogeneity: generalized subscriptions (w/Riveros) • Competition when firms bundle (w/Fay) • Two-sided learning in differentiated product (bundle) space (w/Kephart et al.) • consumers learn about changing price/bundle offerings • providers learn about consumer tastes and competitor strategies • Field research: PEAK

15. Simple bundling • If users have similar average values for info goods, offer large bundle: “seller chooses” • If users have different average values, let them select individual components: “buyer chooses”

16. What we know Users similar Users different Seller chooses:bundle Buyer chooses:unbundle Costslow Buyer chooses:unbundle Seller chooses:bundle Costshigh

17. What we need Sellerchoose Buyerchoose Real world(e.g., buyer choosesw/sub-bundling) Buyerchoose Sellerchoose

18. Consumer preferences • How do consumers value articles from a collection? • For one consumer, each article can have different value w0 Value of best article = w0 N articles; k is fraction user values > 0 kN article n

19. Let w0 and k vary across users w0: most valued article k : fraction with value > 0 Between two consumers, ranking and values can be different Consumer heterogeneity w0 kN article n

20. Bundle options • Fully bundled: N=100 articles at pB • Unbundled: each article at pu • Generalized subscription (“user chooses sub-bundle”):NG=10 articles at pG

21. Bakos & Brynjolfsson • B&B assume (main results): • all individuals draw article values from same distribution as each other • all articles drawn from same distribution (LLN holds: sample average converges to distribution mean) • so bundling is highly favored • Aggregate demand for bundle of size N: p p N=100 articles N=1 article articles sold articles sold

22. Comparison to B&B • Homogeneous consumers • Two consumer types (different max value: wA, wB) • same orderings • but quantity drops from 48,400 to 24,300

23. More heterogeneity: Chuang & Sirbu • Heterogeneity: • different intensity: number of articles with value > 0 random:article values ~ U[0,1] for first ni ~ exp(13.9) articles • heterogeneity not averaged out as N increases • Profits increase by 10% when customers offered self-selection from menu of <GS, unbundled, bundled>

24. Next challenge: Competition • Prior lit has examined bundling by monopoly sellers; what happens with some competition? • Exceptions: Fishburn, Odlyzko, and Siders (Tech Rpt 1998); Matutes and Regibeau (JIE 1992) • Some questions: • How much does competition reduce extraction of surplus? • Can publishers in competition use bundling to recover fixed costs (is equilibrium sustainable)? • What effect on incentives to create new content

25. P2 Buyneither Buy collection1 only V2 VB-V1 Buy collection2 only Buyboth P1 VB-V2 V1 Choice with competing bundles • Assume articles randomly divided between two publishers • Consumers: • all articles are ex ante identical in value • based on expectations, risk-neutral consumers decide among offerings: bundle, per item, or nothing -- want at most one of any article • after purchase, values are revealed and consumers decide which items to read Both firmsoffer bundlesonly:

26. Competing articles • Suppose firms only offer to sell by the article • (One firm bundling, one offering articles lies in-between) P2 Buyneither Buy articles fromcollection 1 only w0 Both firmsoffer articlesonly: Buy articles fromcollection 2 only Buy some articles from both w0 P1

27. Results: Competition with homogeneous consumers • If both firms bundle: • efficient: all articles purchased (same as monopoly) • competition leaves much more consumer’s surplus • only 65% of monopoly profits even when competitor has only 20% share • in a two-stage game with a fixed cost Fi to create Ni articles, incentives to invest efficiently are preserved in the duopoly

28. Competition with homogeneous consumers (cont.) • If neither firm bundles: • Inefficient outcome: P > MC • Lower: • profits (13%) • consumer’s surplus (9%) • welfare (12%) • But if one bundles, one does not: • no pure strategy Bertrand (price competition) equilibrium

29. Heterogeneous customers: Monopoly • When customers were homogeneous (B&B), monopolist always prefers bundling • When heterogeneous (different values of k), offering self-selection mixture of bundles and articles dominates (divide and conquer) • Simple sub-bundling is inferior • since articles are substitutes, creating sub-bundles creates artificial competition • this ignores possibility of clustering by customer types to sort (different journals)

30. Heterogeneous customers: Competition • If both firms bundle: pure strategy Bertrand does not exist • If one or both sell unbundled, pure strategy equilibrium does exist (similar results with Stackelberg) • both have (much) higher social welfare than monopoly • But bundling is strategically advantageous: • firm that bundles earns more per item • when both mix bundles and articles, nearly all revenue from the bundle • larger firms can extract more surplus per item

31. Competition Extensions • Endogenize the bundling strategy • any outcome can result • bundling is not dominant • when mixtures are offered, most of the revenue comes from the bundle sales • Endogenize the collection size • monopoly bundling is inefficient, but captures more of the total surplus • former effect dominates: the duopoly’s greater allocative efficiency makes duopoly investment incentives closer to efficient level than monopoly

32. PEAK Project • Network access to 3.5 years of all 1100 Elsevier journals • Large scale field trial • 12 university, research lab and technical college libraries • over 100,000 authorized users • full text searching • high-resolution screen or print viewing • Over $325,000 in up-front payments • Experimental variation in choices available: • unbundled • bundled • user chooses sub-bundles

33. PEAK Bundles • Traditional subs: $6 / issue • Unbundled articles: $7 • Buyer chooses “gen’l subs”: $548 / 100 articles

34. Clients subscribed to fraction of all print titles • But every authorized individual now has immediate desktop access to every page of every journal (at varying prices)

39. Summary • Low transactions costs enables plethora of disaggregated and reaggregated products • Workability needs more limited design space • We are extending the 2-extremes theory of bundling • We are studying competitive strategy when firms bundle • In PEAK we introduce user-chooses sub-bundles and test the ideas in the field