Bundling Economics in the Connection Economy

Economic bundling is a good idea for both buyers and sellers. It’s efficient. It’s easy. It’s also going to happen less.

People are unbundling goods and services that were previously bundled. Why?

Let’s try to figure this out through four question.

1. Why are people “cutting the cord,” when the a la carte options end up costing the same or more?
2. What are the economics of bundling? We’ll hypothetically merge Netflix and Spotify to explain.
3. What are the four parts that make a good bundle?
4. Why is bundling in decline?

Ready?

Cord cutting.

“Cord cutting” via Google Trends:

There are plenty of articles that explain why and how to cut the cable cord. Like this CNN Money Article, which says:

“Dropping cable TV can be a tough choice: You’ll save money, but you’ll have to work harder to watch your favorite programs when you want to see them.”

Well, I’m not above a little work to save money, what do I need to do?

First, set up an HD antenna. Then add Hulu, Netflix, Amazon, HBO, Showtime, CBS, and SlingTV. Hmm, that sounds like a lot. How much does all that cost?

$78 !?!?

Wait a minute, that only saves me $8 a month. What gives?

The same CNN article has the answer:

“When you call your cable company, make sure an Internet-only plan is the cheapest package it has to offer. Sometimes, cable providers incentivize customers to keep their TV subscriptions by making “double play” or “triple play” phone-Internet-TV bundles cheaper than any single option — at least for an introductory period.”

The bundle isn’t cheaper because it’s a promotion, the bundle is cheaper because of bundle economics. Once the cable company is providing you one service, it doesn’t cost that much to provide more.

Bundles also work because they “elongate the demand curve” which is fancy language for “more people will want it.” Imagine if Netflix and Spotify combined.*

“Netify”

The economics behind the idea go like this. I subscribe to Netflix (69 million subscribers)for $10 a month, but not Spotify (20 million subscribers, and also $10). I’m willing to pay something for Spotify, just  not $10.

I’m not the only one. There are other people in this willing to pay something group. Call us the $5 members.

Now imagine this. What if Reed Hastings — CEO of Netflix — woke up tomorrow and wanted to buy Spotify. He’ll combine the services — now called “Netify” — and offer both for $15 a month.

This is where economic bundling theory makes a prediction. There will be more revenue from the bundled $15 service than there was for separate services at $10 each because more people are willing to pay. 

Add in a host of other savings (salary costs, royalty negotiations, etc), and “Netify” will be cheaper to provide than Netflix and Spotify were as stand alone services.

A quick explainer in terms of food.

Anytime I go to a breakfast buffet I always eat one thing I never order: biscuits and gravy. You see, I like biscuits and gravy, but I don’t want it to be the only thing I eat.

A breakfast buffet has bundled all the food in a single package, so I (over) indulge. And others do too.

One more thing about the economics of bundling.

Economic bundling only works when the marginal cost is practically zero. That means that each additional item cost almost nothing to create.

It takes a lot of time and money for Taylor Swift to write, record, and mix an album. But once the master is done, the costs are almost nothing. A CD costs less than a dollar to make, the digital download less to host. The marginal cost for music is practically zero.

Low marginal costs exist elsewhere too. The cost to build and staff a hotel are up front, each additional guest adds almost nothing. The cost to build Google was up front, each additional user add almost nothing.

This raises the question:

If bundles are great for producers and consumers, and cable packages are bundles, why are people cancelling cable packages?

Why are people cutting the cord if bundling is so great?

It’s not that people save money. The NCTA is happy to note that Spongebob, True Blood, Mad Men, and MLB Season Pass purchased a la carte are more expensive than a monthly plan.

It’s not that the quality is that bad. The Sopranos, The Wire, Breaking Bad, and Mad Men are all great shows.

Ben Thompson at Stratechery has five reasons why people watch TV (or aren’t watching TV). Listen to the podcast (it’s really good) for the specific reasons. For us we only  need the general idea: people aren’t watching TV because those other things do what TV did. 

Entertainment now is Facebook posts and YouTube Channels and blog feeds and craft pins. Those things satisfies desires that TV used to. And they do so at a “good enough level.”

4 things bundles must do “good enough.”

The good news for bundles is that they don’t have to be perfect, just good enough. Netflix is a classic case of “good enough.” Note, Netflix is “good enough” for me. This is a subjective decision on the consumer level.

Netflix have enough okay kids shows, original series, and old shows to catch up on. Netflix does four things “good enough.”

• Bundles have consistent quality. The TV shows on HBO are varied, but the quality isn’t. Girls and Game of Thrones are both different shows, but they’re both great shows. HBO has “good enough” quality.
• Bundles have wide and deep offerings. If I like original programming, Netflix has it. If I like old TV shows, Netflix has it. Netflix has a “good enough” spectrum of options.
• Bundles look like good deals. “I’m going to get my money’s worth” goes the saying. At $10 a month Spotify is a “good enough” deal compared to a la carte pricing.
• Bundles are convenient. Planning a vacation to the beach is more difficult than planning a cruise. A cruise answers questions like; when and where to eat, what to do, and where to stay. It’s a “good enough” vacation bundle.

Bundles don’t have to do all these things well, only well enough. The ultimate bundle of bundles does this well.

The ultimate bundle, Walt Disney World.

Here’s what’s great about Walt Disney World. Upon landing at the Orlando airport you take a Disney bus to a Disney hotel. From there a Disney shuttle takes you to a Disney park where you see Disney shows with Disney characters and eat Disney’s food.

Disney bundles; transportation, lodging, food, shows, thrills, souvenirs, and picture packages all into a single vacation. They call it “my Disney experience.” There’s an app you can use. It’s the ultimate bundle because Disney nails the 4 things:

• Bundles have consistent quality. You know with Disney that the entertainment will be good, not great. It’ll be clean, with some humor, and not too deep.
• Bundles have wide and deep offerings. Walt Disney World has thrill rides, peaceful rides, and children’s rides. There are comedy shows, singing shows, and 3D shows. There are cutting edge attractions and old favorites.
• Bundles look like good deals. Here’s where Disney branding comes in. Parents don’t know if their kids will have a good time at a generic beach vacation, but are almost sure they will on a Disney one. A good deal can cost a lot if you get a lot in return.
• Bundles are convenient. Disney is an easy vacation to plan. Pick a hotel budget. Pick what things you want to do. Done.

Compare the Disney bundle with the worst bundle, compact discs.

The worst bundle, compact discs.

Some CD’s are great bundles. I’ve listened to Blood on the Tracks by Bob Dylan for hundreds of hours — and it only cost me ten bucks.

The problem with compact discs was that most weren’t a good bundle of songs. They failed in the same way HBO would fail if they only had one good show.

In How the Music Got Free, Stephen Witt writes about the confluence of conditions that led to changes in the music industry. There were many factors, but one of them was bad bundling. Quotes are from Witt.

• Bundles have consistent quality. Bob Dylan aside, most albums weren’t very good. “For years the industry had been selling songs that even their creators acknowledged were not very good. Now they were paying the price. In economic terms, album sales were an example of ‘forced bundling’”
• Bundles have wide and deep offerings. CD options were limited in a way that the mp3 — it’s successor — was not. You needed a nearby store to have an album in stock. There was no streaming, no digital download, no two day shipping.
• Bundles look like good deals. Most albums never came down in price and didn’t warrant repeated listening. “Seeing something for efficiency gains in compact disc manufacturing brought the per-unit cost of goods below a dollar — a savings that was not passed on to the consumer, who was charged $ 16.98 retail.”
• Bundles are convenient. Compact discs weren’t convenient to listen to.  The mp3 was much more convenient.

Bad bundling wasn’t the only thing that caused the shift in music, but it was one part.