Monday, October 21, 2013

The Hidden Issues of Bundling vs A la carte marketing - theory

The presumed "debate" over bundling vs a la carte marketing and pricing models for multichannel and online video delivery seems to be heating up over the last year, and looks to become an increasiningly critical question with the rapid increase in rights fees for channels and programs. (For  those not up on the jargon, bundling refers to the approach by cable and other multichannel distributors to offer packages of channels at a set price to consumers, while "a la carte" means that channels are offered, and priced, seperately).

The problem is that some of the criticisms of bundling are misleading and problematic, and almost none have taken a look at the downstream implications of a switch to a full "a la carte" model.

Taken in extremis, the critical argument is that bundling is a nefarious (possibly illegal) strategy employed by the giant multichannel operators to force subscribers to pay for channels that they don't want.  There's several problems with that position.  First, bundling is a well-established marketing and pricing strategy in information economics that is, in some contexts, socially optimal and can maximize consumer welfare.  For example, newspapers are bundles of news stories, features, ads, etc., as are magazines, and even TV networks.  In a slightly different way, Netflix and Hulu are bundlers, offering access to a range of content offerings for a fixed monthly fee.  On the other end of the continuum is what the media industry is calling "a la carte", or in economic terms, single use pricing models. (There is actually a wide continuum of options between a single bundle and single unit pricing models, but I'll focus on the extreme cases).

The field of information economics has long indicated that bundling is a valid pricing/marketing strategy, and in fact can be socially optimal under certain conditions - when the bundled offerings have uncertain or highly variable value to consumers, and when the consumers cannot be easily differentiated.  This is important, because when the audience can be easily differentiated, then the supplier can charge some more than others for the same set of goods.  When it can't, then the social surplus (the difference between what a consumer gets in value above the price paid) goes to the consumer.  When the supplier can differentiate access, then they get to capture some or all of that consumer surplus through differential pricing.
  There are two other important social advantages with bundling - it allows consumers to sample and establish values for content (which gives unknown, low-interest, and/or low-value content the potential to establish a market), and it allows the benefit of serendipity (finding important or valuable content unexpectedly).
  As for the argument of forcing people to pay for channels they don't want, that's hogwash.  When content is bundled, consumers base their purchase decision on their individual aggregated expectation of value.  That is, consumers look at the likely content offerings, and aggregate their expected values for the content they want.  If their aggregated value is higher than the price, they buy; if not, they are free to not buy the bundle.  The advantage of bundling is that it can accommodate a wide range of value choices and ways to hit that aggregate value target - for one consumer, access to sports channels and content may create that aggregated value, to another, it may be a combination of access to news, science, and history channels; to another, it could be PBS, Nickelodeon, Cartoon Network and Disney.  In all of these cases, the consumers base their purchase decision on getting the content they want, and everything else just comes along with the bundle.  No one is forcing anyone to "pay for" channels they don't want.  Bundling can also be looked at as the high-value channels cross-subsidizing low-demand channels.

In the early days of cable and multichannel distributors, the content was pretty clearly the kinds of new channels and content that makes bundling the best strategy, for distributors as well as consumers.  It was also a good strategy for the various cable networks/channels - enough so that in the early days most paid cable operators to get into that basic bundle.  Getting into the bundle was particularly important for networks/channels that used advertising as a primary revenue source - being included in the basic bundle gave them access to the largest potential audience, while letting those in the audience sample their programming without added cost and letting networks build the demonstrable audience base that provided value to advertisers.  And the payments from channels to cable operators helped to subsidize the price of the bundle, again helping them grow the market.  Another advantage of bundling is that, in maximizing potential audience, it spread distribution fixed costs (which tend to be quit high among multichannel distributors) over larger numbers of subscribers and reducing the per-subscriber cost of distribution.

However, the cable/multichannel market has changed, increasingly moving away from the type of content that bundling is the optimal strategy for.  Most networks have now established their expected value to consumers. In addition, technology now permits greater ability to control which channels are accessible by which subscribers, allowing more differential marketing options.  Technology has also expanded video delivery options, some of which face significantly lower costs. The most significant shift, though, is in the rights fees paid for content.  Rather than subsidizing the price of the bundle, the shift to the multichannel distributor paying rights fees, and the rapid rise in the amounts of those fees, are pushing the price of the bundle to a level where consumers are taking a second look at their willingness to pay.  Particularly when the Internet is providing a range of content alternatives at substantially lower prices.

The industry and market may be approaching the point where offering a single bundle, or a few tiers with dozens of networks/channels, may not be the best marketing strategy for either the multichannel distributor or the TV consumer.  But are we at a point where a pure "a la carte" strategy is optimal for either the distributor or consumer of TV networks?

The economics of information suggests that single-unit pricing (pure "a la carte") works best when there is a group of consumers that has established a reliable, and relatively high, set of expected value for the specific set of content - and where distribution of that content can be restricted to only those consumers.  The technological capabilities for differentiation are increasingly there.  Further, some channels/networks that have done a good job of establishing a relatively high set of expected values for their content through branding (ESPN, Nickelodeon, Disney, etc.),  at least for some portions of the audience.  For those, going a la carte, or minibundling (a small group of networks with similar content or brands), may be marketing/pricing strategies worth exploring.  However, for other channels, going a la carte alone may not be a viable option.
   For example, during the recent CBS/TimeWarner rights fee squabble, TimeWarner offered to let CBS market its network "a la carte" at whatever price it wanted.  An offer that CBS rejected out of hand, suggesting that it felt that going solo might not be a great business strategy at this time.

The CBS reaction points to another issue, which I'll address more fully in a separate post; that most networks/channels get funding from multiple sources, some of which are tied to audience size.  The problem with going "a la carte" is that consumers would then apply their purchasing logic to the individual sets of channel(s) being offered separately.  That is, TV consumers will pick which channels they'd be willing to pay the market price for, and which they wouldn't - and viewing habits suggest there are few channels that wouldn't face huge drops in audience if they went a la carte, particularly if the price was more than minimal.  With  the potential of significant declines in audience-based revenue streams, that could create a pricing death spiral for many channels.

Let me close this piece by referring back to the social side-benefits of bundling.  With bundling, the consumer retains most of the consumer surplus value, instead of it going to the distributor (with minibundling) or the network (with a la carte).  Bundling maximizes consumer access to the broad range of content choices; giving new content and channels the opportunity to establish value with consumers, and allowing for viewers to benefit from serendipity or to access the occasional content a channel might present.  Finally, bundling maximizes potential audience for channels, allowing them to benefit from audience-based revenue sources, and lower per-subscriber distribution costs.

Bundling can be a reasonable and consumer-friendly pricing strategy in theory, at least in some circumstances.  Still, circumstances can change, and there are also other economic issues to consider.

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