Managing Customer Search via Bundling

Abstract

Problem definition: Product bundling has been a pervasive marketing strategy, and its success has been largely attributed to its strength in reducing customers’ valuation dispersion. Less is known about the efficacy of bundling in settings where customers are less sure about their valuations for a product, especially when that product is newly launched or has an experience nature, and can conduct costly search to learn the product content and discover their true valuations. In this paper, we investigate the interplay between product bundling and customer search and its implications for a monopolist’s optimal pricing strategy. Academic/practical relevance: The existing search theory has focused on decision making that selects the best among multiple alternatives, with costly search being mandatory for the acquisition of each alternative. In this paper, we introduce a framework of multiproduct demands and nonobligatory search, where customers demanding multiple products strategically decide whether to conduct costly search to resolve valuation uncertainty, while reserving the right to purchase these products without having to search them first. Methodology: We apply a nonobligatory search framework to study two different markets: (1) a market of one mature and one new product, in which valuation uncertainty exists for the new product only; and (2) a market of two new products, in which valuation uncertainty exists for both products. The firm fully anticipates the customers’ search behaviors, determines whether to bundle these products or unbundle them, and optimally sets prices. Results: We show that bundling cultivates search in a market of one mature and one new product, but inhibits search in a market of two new products. This contrast emerges as a result of market structures: Bundling reduces the appeal of search by making the search decisions sequential and path-dependent in the latter market, but is less effective in doing so due to the existing heterogeneity in the former market. Our results thus point to an intricate interplay between customer search, market heterogeneity, and prices and their joint impact on the monopolist’s optimal bundling strategy. We also study mixed bundling and show that its economic benefits only carry through when customers’ search cost is not too large. In this case, mixed bundling can lead to considerable revenue improvement in a market of one mature and one new product, but only tiny revenue improvement in a market of two new products. We also study the joint management of product return and product bundling and show that a positive refund should generally be offered for returned products to stimulate customers’ no-search purchase. Managerial implications: Our paper provides guidance for firms selling multiple experience or new products. We propose product bundling to manage customer search, identifying regimes for its economic benefits and clarifying its implication for customer welfare.