Essays on marketing strategy in technology-intensive markets

Tilburg University

Essays on marketing strategy in technology-intensive markets

Stremersch, S.

Publication date:

2001

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Stremersch, S. (2001). Essays on marketing strategy in technology-intensive markets. CentER, Center for

Economic Research.

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-. -.

Essays

on

Marketing

Strategy in

Technology-Intensive

Markets

,//

Dit_{werk terug te}bezorgen uiterlijk op:

1 3 IUN! 2002

1

01.07-·oz

Bibliotheek - _{Katholieke Universiteit Brabant}

Postbus 90153 _{5000 LE Tilburg}

Essays

on

Marketing

Strategy in

Technology-Intensive

Markets

Proefschrift

ter verkrijging van de graad van doctor aan de Katholieke Universiteit Brabant, op gezag van

derector_{magnificus.prof.dr. F.A. van der Duyn} Schouten, in het openbaar te verdedigen ten

overstaan van een door

het

_{college voor}

promoties aangewezencommissie in de aula van de Universiteit _opvrijdag 7 december 2001 om

11.15 uurdoor

StefanStremersch

Geboren op29 maart 1972 teSint-Niklaas. Belgie.

, / / ..=,Mk

Preface

It is customarytodirect a word

of

gratitude to people thathaveshown enthusiasm and support over thecourse

of

writing

a dissertation. in my case, this acknowledgement is not merely the

continuation of

such custom, but

rather it is

a sincere expression of the warm feelings, professionally and personally, 1 havedeveloped forthepeople 1 wish to mention at this crossroads of myacademiccareer. Firstandforemost, I wishto thank my advisors, Ruud Frambach (FreeUniversityAmsterdam)and_{Gerry Tellis (University}

of

Southern California), for theirenthusiasm, support, commitment and high standards. As for Ruud, 1 look back on valuable intense debates on mydissertation and research in general. 1 have shared an open

mind with him

for almost four years and always found our interactions very

fruitful and

rewarding. As for Gerry, Iam grateful thathetrained me in his research approach and have tremendous respect forhis productivity and enthusiasm. On a personal note, Gerry. Cheryl and the kids often welcomed meintheir home and made me feel part ofthe_{family. This has}

been an_{important support for}meduring the year and a half 1 visited with USC.

I am also grateful to the _{people 1} have worked with in the pastyears. Allen Weiss

(University

of

Southern California) strongly inspired my thinking on technology-intensive markets. 1

will

always remember the long and

fruitful talks we had

on research and philosophy

of

science,during my visit at USC. 1 also look back andforward ontheexcellent co-operation with Benedict Dellaert (Tilburg University), Shantanu Dutta

(University of

Southern California), Philip Hans Franses (Erasmus University Rotterdam), Stefan Wuyts (Erasmus University Rotterdam) and Eden Yin (Cambridge University). The interest and commitmentthey showed in our

joint

projects as wellastheir intelligencereally amazed me at times.

A

very special and warm word

of

gratitude goes to Harry Commandeur (Erasmus University Rotterdam) who has shown amazing support

without any sign of

self-interest.

When providing me with

his wisdom and sympathy over the course of the past years, he always had mybest interest in mind. Harry, 1 do hope that at some point 1canreturn some of the favors you granted me! I alsothankJacquesDe Rijcke (University

of

Ghent) who was the firsttoawakenmyacademic interest.

I thank Philip Hans Franses, Hans Pennings, Jan-Benedict Steenkamp and Michel Wedel for

joining

the committee. 1 thank Stefan

Wuyts and Eden Yin

for

being my

"paranimfen". I am_{grateful to}the_high-levelacademic setting thatthemarketingdepartment

addition. I would wantto thanktheIntercollegiateCenterforManagement_{Science (ICM) for} generously providing financial supportduring the years of my PhD education. I alsowould liketo acknowledge the many otherinstitutesand companies that provided financial support to my research, more in particular The Marketing Science

_{Institute, The Institute for the}

Study

of

Business Markets, the CentER

for

Economic Research (Tilburg University), The Goldschmeding Center

of

Economics

for

_{Increasing Returns (Nyenrode}

_{University) and}

AlcatelTelecom. I also wishtothank Rajesh Chandy(University

of

Minnesota),PeterGolder (New

York

_University), Debbie_{MacInnis (University}

of

Southern California),R. Venkatesh (University

of

Pittsburgh) and Eden

Yin

_{(Cambridge University), among}

_{others, for}

providing me withvaluable commentsonearlierdrafts

of

_{chapters 2-5.}

In addition tothe academiccommunity, many managersprovided support in one way or another tomy research. I owe many thanks to DerrickGosselin _{(Alcatel Telecom) for his} support to_{this dissertation. Despite a busy schedule,} he always was

willing

to answer some of my questions andhe posedastronginterest inmycareeringeneral. 1 alsoowegratitude to Henk Speijer(PhilipsConsumer_Electronics) and _{Derek Baine (Paul Kagan Assiociates) for}

sharing their insights and for

helping me

with gathering data on consumer electronics (Chapter 5).

Finally, only a fool thinks he can separate work fromhis private life. My stay of 18 months in LosAngeles hastaught me a lot ontheimportance

of

quality family time. Els, to you go mygreatest feelings

of

gratitude. We both know that 1 would not be what Iam today without you nurturingand_{comforting me. Tomy parents, I owegratitude forthe interest and}

support they showed. They gave me a strong work ethic and the

feeling that you can

accomplish

_{anything if you go for it.}

_{Many things}

_will

_{change in the}

_{future, but this will}

always remain the same.

Contents

Chapter 1: Introduction and Outline 1

1.1 _{MarketingStrategy inTechnology-Intensive}

Markets 1

1.2Motivation,Objectives andOutline

of

Dissertation 4

I.2.1 Motivation 4

1.2.2 Objectives 5 1.2.2.1 _{SpecificObjectives}

of

_{Chapter 2 5}

1.2.2.2_{SpecificObjectives}

of

Chapter 3 6

I.2.2.3_SpecificObjectives

of

Chapter 4 6

1.2.2.4_{SpecificObjectives}

of

Chapter 5 6

1.2.3 Outline 7

Chapter

2: _Strategic

_{Bundling of}

Products andPrices: ANew_Synthesis

_{fur Marketing}

10

11.1 Abstract 10

II.2 Introduction 11

11.3 A Primer on_{BundlingStrategies 13}

II.3.1 Definitions 13

II.3.1.1 ConfusioninLiterature 13

II.3.1.2

_{Bundling 14}

II.3.1.3 BundlingFocus: Product versus PriceBundling 14

II.3.1.4 Bundling Form:Pureversus

Mixed. 15

II.3.2 Classificationand_Legality

of

BundlingStrategies 16

11.3.2.1 Classification

of

_Bundling

Strategies 16

Il.3.2.2 Legality

of

Bundling 18

Il.3.2.3 Legality

of

Various BundlingStrategies 20

11.4 Optimality

of

BundlingStrategies 21

II.4.1 Simulation 22

II.4.2Consumers'ConditionalReservation

Prices 25

II.4.2.1 Heterogeneity

of

Conditional ReservationPrices 25

11.4.2.2Price

Bundling 27

Il.4.2.3Product

_{Bundling 30}

II.4.3_Objectives

ofthe Firm 33

II.4.4 Competition 36

Il.4.5 Costs 38

II.4.6Consumers' Perception

of

Bundles 40

11.5 Conclusion andDirections

for

Further

Research 43

II.5,1 Implications for Marketing Management 43

11.5.2 Limitations and FurtherResearch 45

Chapter

3:

Buying Modular

Systemsin Technology-Intensive

Markets 47

III.2 Introduction 48

Ill.3

Conceptual

Framework 51

III.3.1

Know-how 52

III.3.1.1 Transferability

oftacit know-how 52

III.3.1.2Presence

of

know-how 54

111.3.2Technological

environment 56

III.3.2.1 Technological

uncertainty 56

III.3.2.2Interactions between_{Technological Uncertainty}and Know-How 58

III.3.3 Control

variables 59

III.3.3.1 Transaction-specific

assets 59

III.3.3.2Supplierconcentration inthesystemintegration market 60

III.3.3.3 Importance ofthesystem 60

III.3.3.4Expertiseon

suppliers 61

III.3.3.5_{Componentsupplier}

_{specialization 61}

III.3.4Other Interaction

effects 61

111.4 Method 62

III.4.1 Research

context 62

Ill.4.2

Research

_{design 62}

III.4.2.1 Benefits

ofa

_{conjoint study over}a_{retrospectivestudy 64}

111.4.2.2Benefits ofarating task overaranking/choice task 65

III.4.3 Measuresfor_{non-manipulated}variables 66

111.4.4 _{Pre-testing and}data

collection 67

Ill.4.4.1

Pre-testing 67

Ill.4.4.2 Data

Collection 67

III.5 Analysis and results 69

III.5.1 Model

_{specification 69}

III.5.2

Results 71

111.6 Discussion 76

111.6.1 Theoretical

Implications 76

III.6.2 Implications formarketing

management 78

III.6.3 Limitationsanddirections

for

future

research 79

Chapter

4: _{Buying Behavior}in_{Technology-Intensive}

Markets: The Role of

Embeddedness 81

IV. 1 Abstract 81

IV.2 Introduction 82

IV.3 _Conceptual

_{Background 84}

IV.3.1 Relational

Embeddedness 86

IV.3.2Structural

Embeddedness 87

IV.3.3 Direct

access 88

IV.3.4 Know-How 90

IV.3.5 Pace of Technological Change 90

IV.3.6 Other variables 92

IV.3.6.1

Valence 92

IV.3.6.2 Number

of Third Ties 93

IV.4 Methodology 93

IV.4.1 Research

Design 93

IV.4.2 Sampling andData

Collection 94

IV.4.3 Development

of

_{Questionnaire 95}

IV.4.5 Test

of

_{Hypotheses 98}

IV.5Discussion 100

IV.5.1 Theoretical Implications 100

IV.5.2 Managerial Implications 102

1V.5.3 LimitationsandFuture ResearchDirections 103

IV.6APPENDIX:ScaleMeasures 104

IV.6.1 DirectAccess to Component Manufacturers 104

IV.6.2 Know-How onComputerNetwork 104

IV.6.3 Pace

of

Technological Change 104

Chapter 5: Does it Really Take Two To Tango? Modeling

Indirect Network

Effects in

Hardware

andSoftware

Growth

105

V. 1 Abstract 105

V.2 Introduction 106

V.3 The Role

of

indirect Network Effects in NewProductGrowth 109

V.3.1 The Effect

of

Software

_Availability

onHardwareSales 111

V.3.2 Determinants

of

Software

_Availability

113

V.3.3 WhichComes First, the

Takeoff

in Hardware Sales or the

Takeoff

inSoftware

Availability? 115

V.4 Modeling Indirect Network Effects 117

V.4.1 _{Multivariate Regime-Switching Model for Indirect Network}Effects 117

V.4.1.1 Model Structure 118

V.4.1.2 Interpretation

of

StructuralParameters 120

V.4.1.3Model Advantages 121 V.5 Data 121 V.5.1 DataCollection 121 V.5.2 Sampling 122 V.5.3 Measures 123 V.6 Model Results 124 V.6.1 Estimation 124 V.6.2ParameterEstimates 125 V.6.2.1 TakeoffParameters 125 V.6.2.2 Structural Parameters 126 V.6.3 Model Evaluation 127 V.6.3.1 Fit 127 V.6.3.2 Forecasting 129 ProductMarket 130 V.7Discussion 130 V.7.1 Summary

of

Findings 131 V.7.1.1 Takeoff 131

V.7.1.2 IndirectNetworkEffects and SoftwareProvision 131

V.7.1.3 Modeling indirect Network Effects 131

V.7.2 _Implications 132

V.7.3 Limitations andFurtherResearch 133

Chapter

6: Conclusionsand

Directions for

Future

Research 135

VI. 1 Introduction 135

VI.2.1 _{Bundling(Chapter 2)} 136 VI.2.2 Buying ModularSystemsin Technology-Intensive Markets(Chapter 3) 137 Vl.2.3 Buying BehaviorinTechnology-Intensive Markets: The Role of

Embeddedness (Chapter 4) 138

VI.2.4 NewHardware_Looking

for

Software: _{Modeling Indirect Network}Effects

(Chapter 5) 139

VI.3 DirectionsforFuture Research 141

References 144

Chapter 1

Introduction

and

Outline

In this section, 1

briefly

review the field this dissertation aims tocontribute to. This review is notmeant to be acomprehensiveoverview ofthe literature. Rather it is apersonal perspective on the literature, relevant to marketing, on Technology-Intensive

(TI)

markets and its gaps. Next, 1

will

developthe_{motivation, objective}and

outline of

thedissertation.

I.1 Marketing Strategy in Technology-Intensive Markets

Marketing scholars onlyrecently started to explore the strategicmarketing challenges firms in technology-intensive markets face. At the time 1 started this dissertation in 1998, there probably were not even a dozen

of

articles in the major marketing journals, which focused on hightechtopics. But by the turn ofthe

millenium -

inwhichperiod Nasdaq first rose from 1000 to 5000points in3 years and then camedownagain to 2000 points in 1 year -hightech marketscan count ona_{rapidly growing}attention from marketingscholars, which

can benoted from _{the increasing numberof journal articles}and _{conference presentations on}

high tech topics. The

uprising and fall

of

Nasdaq definitely created a buzz on high tech. Managers at tech companies were

living the

new American Dream, which before was exclusivelyreserved to pop stars, moviecelebrities and

TV

personalities. Marketing scholars aregrowinglybecomingaware ofthe specific challenges high tech companiesface,about 20

yearsaftereconomists did and only after many high tech companies added many

billions of

dollars totheir market valuation.

Technology is scientific knowledge applied to useful purposes (Quinn, Baruch. and

Zien 1997). Technology is at the core of many contemporary markets and is a powerful

engine

of

today's and

of

tomorrow's economic progress (John, Weiss and Dutta 1999). Although they span adiverse range

of

industries, such as homeentertainment (TV, VCR and

stereo _system), telecommunication (transmission, switches, routers). computing (PCs,

computer networks, software) and medical systems (optical systems, laser), technology-intensive

(TI)

markets share similarities that make them into unique environments with unique challenges toour_{understanding (Glazer 1991).}

2 Introduction and Outline

problems because

of

their knowledge-intensity and technological

turbulence. Not only is

knowledgeaprimeassettowards strategic advantage inthesemarkets (Glazer 1991), but also technologies are changing continuously making the associated knowledge bases obsolete (BourgeoisandEisenhardt 1988).

What are the theoretical problems that knowledge intensity and technological turbulence bear? We recognize two main theoretical domains. First, technology changes monolithic products into systems that typically consist

of

'technologically

divisible'

components,joinedtogether by a set

of

interfaces thatallowsthecomponents to work (Katz and Shapiro 1994, Wilson. Weiss and John 1990). Second, in view of the importance and rapid obsolescence

of

knowledge, managing knowledge and information

flows is key to

companies inTI markets, forboth vendors and buyers (John, Weiss and Dutta 1999).

The recognitionthattechnologyturnsmonolithic productsintosystemshasnourished

most of

the research in economics on

Tl

markets. Three interrelated literature streams flow fromthis insight.

A first stream

of

literature focuses on standardization ofthe interfaces between the different components ofa system and competition between different standards (e.g. Besen

and Farrell 1994; Economides 1989: Einhorn 1992; Farrell, Monroe and Saloner 1998; Farrell and Saloner 1985,1986,1992; Matutes and _{Regibeau 1988).} Standardization is an explicit or

implicit

agreement todo certain keythings in auniform way (Farrelland Saloner 1992).Thisliterature provides insights in issues such as: When isstandardization _{optimal for} companies? What is the effect

of

standardization on _{consumer surplus and social welfare?}

What is the influence

of

standardization on the industry structure and competition? This literatureis_{largely of}an_analyticalnature.

A second stream

of

research discusses

network

effects, which

relates to the

increasing utility of the _system with _{increasing adoption} of _system components (e.g. Brynjolfsson and Kemerer 1996: Church and Gandal 1992, 1993; Economides and _Salop

1992, Gandal 1994; Gupta, Jain and Sawhney 1999: Katz and Shapiro 1985, 1986, 1992,

1994: Majumdar and _{Venkataraman 1998; Saloner and Shepard 1995). In case}

of direct

network

effects,theexpected

utility

of

hardwareincreases directly withthenumber

of

other

users there are. Examples ofsuch products are the telephone. fax and E-mail (Shapiro and

Varian 1999). In case

of

indirect network

effects, the expected

utility of

the hardware increasesas_availability

of

_{software increases (Economides 1996).Examples of}such_products aretheCompact Disk Player, RadioandTelevision. Thisliterature providesinsights in issues

Chapter 1 3

effects affect the choice betweenincompatible technologies? What isthe impact

of

network effects on standardization? Howdo firmscompete in networkmarkets? Cannetwork effects lead to socially undesirable outcomes (e.g. the

adoption of

an inferior standard)? This

literature is of

an analytical nature, with rare empirical testing mostly through casual

observation.

Finally, a _third,

although by far

the least developed, literature stream on systems

studies the bundling

of

interdependent products (Bakos and Brynjolfsson 1999, 2000. Matutesand Regibeau 1992; Wilson, Weiss and John 1990). Bundling is the sale of two or more products ina_{package (Stremersch}and_{Tellis 2002). This literature provides insights in}

issues such as: Whenis which bundlingstrategyoptimal? What istheimpact

of

competition

ontheoptimality

of

bundling? Alsothisliteraturestreamis

mainly of

ananalytical nature. A secondtheoreticaldomainrefers tothe

focal role of

themanagement

of

knowledge and information in

Tl

markets. Scholarshavegeneratedconsiderable research in this domain, which consistentlyrelatesto organizationaldecision-making in

TI

markets(e.g._{Acllrol 1991,}

Bourgeois and Eisenhardt 1988, Caponand Glazer 1987; Dutta and Weiss 1997; Eisenhardt

1989; Glazer 1991; Glazer and Weiss 1993; Hansen 1999; Heide and Weiss 1995; John,

Weiss and Dutta 1999; Judge and

Miller

1991; Tushman and Anderson 1986, Weiss and Heide 1993). This literature provides insights in issues such as: What are optimal decision procedures in

Tl

markets? What is the role ofthe marketingfunction in TI markets? What kind

of

interfirm partnerships between companies are optimal in technology-intensive markets? What are the determinants

of

search. consideration and choice behaviorforbuyers in TI markets?Most_{papers in this literature stream}areeither_{conceptual orempirical.}

In sum,aspresented inFigure 1.1, I distinguish twomaintheoreticaldomainsrelevant tomarketing, namely hightechsystems andknowledge andinformationmanagement.Within

thefirstdomain, we recognize threeliteraturestreams thatarerelevant to marketing, namely on standardization, onnetworkeffects and on_bundling.

Within

the second_{domain, we only} recognize one consistent research stream that is relevant to marketing,

namely on

4 Introduction and Outline

Research on Marketing Strategic

( Issues in Technology-Intensive

\ »» Markets

2

THEORETICAL DOMAINS

Knowledge and

High

Tech

Information

Systems Management

4

RESEARCH

STREAMS

-,A Standardization _{Bundling v} Organizational V Decision-Making NetworkEffects

Figure 1.1 Research on Marketing Strategic Issues in Technology-Intensive Markets

I.2 Motivation, Objectives and Outline of Dissertation

I.2.1 Motivation

My

overallmotivationwasdriven bythegrowingrelevance

of

technologyto today's society.

TI

markets contributed an estimated

full

percentagepoint to the

growth of the US

industry in 1998. And its share in the USeconomycontinues togrow.sinceTI markets grow at twice the rate of the US economy overall (John, Weiss and Dutta 1999), continuously increasing the impact technology has on today's economy. Also technology is growingly

Chapter 1 5

It is

thisgrowing presence in andrelevance totoday's society and therecognition that high tech isdifferentthat

initially

motivatedthis research more than three years ago.

Surprisingly, incontrast with thishigh relevance thereisscarceattention forthetopic in marketing literature. Economists started to debate the particulars of high tech systems, standardization and standard

battles in the 60s and

70s. Economics researchers such as Michael Katz, Joseph Farrell, Stan _{Liebowitz, and} Carl Shapiro, to name a few,

built

their fame on technology topics,while the

first

high-quality article on technology and marketing appeared in

Joitrnal of

Marketing

_{only in 1987. The mix of high relevance and scarce}

attention proved to be atrueopportunity. Overthe course of myPhDeducation, I gradually have seen an _{increasing number}

of

peers, as well as research institutes and_{journals, move} intoandencouraging research in this area.

I.2.2 Objectives

The different chapters clearly delineate the shortcomings of the literature, their objectives and contribution. Nonetheless, it is important to portray the overall

objective of

this dissertation and how the specific objectives ofthe different chapters are related to the centralobjective.

This dissertation

posits that the

most important

shortcoming of

the marketing literature on technology is that papers in marketing do not use the focal

insight that in

technologymarkets,monolithicproducts changeintosystems.This insighthasdriven most of the economics literature on technology, bus is almostcompletely neglected in themarketing literature. Therefore,thegeneralobjective ofthis dissertation is "_{to show how transactions of'}

high tech systems are different from transactions of monolithic products and what the

implications of these differences are towards strategic marketing of such systems". As shown before. this "systems" approach has been the dominant research stream on technology in economics. To introduce this ideainmarketing literature is a verysubstantialcontribution to the technology in marketingresearch area. In addition,we develop more specific objectives forthedifferentchaptersalong our generalobjective.

1.2.2.1 Specific Objectives of' Chapter 2

6 Introduction and Outline

substantial differences. The specific objectives of chapter 2 are to: (1)clearly delineate price from product bundling: (2) discuss legality differences between the two', and (3) develop propositions on their optimality.

I.2.2.2 Specific Objectives of Chapter 3

Chapter 2 leads us to recognize the

focal role

of

integration

to distinguish the bundling

of

systems from mere price bundling. This insight leads toa _{theory on}

_{buying of}

modularsystemsasdeveloped in Chapter 3. in thischapter, we recognize that buyers have to

makedecisions towards the system components and towards the system's integration, when they buy a high tech system. Specific objectives of this chapter are to: (1) clearly discern the different bitying aspects of high tech systems. namely outsourcing of system integration and purchase concentration of the system components: 0) develop a consistent theory, grounded in technology literature. that explains buyers' preferences towards these two decision dimensions.

1.2.2.3 Specific Objectives of Chapter 4

In Chapter 3, we studyoutsourcing

of

systemintegration. What we donot study is the

choice of

a_{specific system integratoror vendor. Since we posited in Chapter 3 that system} integration isa process

of

generating and exploiting know-how,economicsociologyteaches us that the attractiveness

of

system vendors

will

depend to a large extent on thestructure of relationships (embeddedness) between system vendor and component manufacturers.

Consequently, the specific objectives of Chapter 4 are to:

(1) argue atid

show that the

structure of relationships between system vendor and component manufacturers determines a

system vendor's attractiveness to btiyers. (2) examine how factors that are focal to TI

markets, such as the know-how buyers possess and the pace of technological change they perceive, injluence the relationship postulated under (1).

I.2.2.4 Specific Objectives of Chapter 5

Chapter 1 1

1.2.3 Outline

We explore four distinct theoretical issues in chapters 2 to 5 _(see Figure I.2).

A

first

issue we explore extends upon the literature on the bundling

of

systems _{(Matutes and}

Regibeau1992; Wilson,Weiss and John 1990). Since systems are a set

of

componentsjoined by an interface, theoptimality

of

bundlingbecomesanimportantconcern. Chapter2provides

an overview of

the bundling _{domain, and consequently} discusses legality and economic optimality

of

strategies within this domain. More in particular, while the distinction this chapter makes between price and_{product bundling} is_{quitegeneral, it} is _especiallyvaluable

to Tl

markets.Price bundling is the sale of two ormore separateproducts asapackage at a discount without any integration ofthe products.

Product bundling is

the integration and sale of two ormore separateproducts at anyprice.

TI

companies often canchoosebetween unbundling,pricebundlingand_{productbundling or}acombination

of

these_strategies.

Conceptual

I

ECONOMICS

/4'ho does sys,I>\

Whenis_bundling

(integration' Extent of'I

ofsystems

_{,omponent purchasej /}

optimal?

_{Jiconcentration 5/}

1/lit.-Ill-****.-dv

High

Tech

Systems

'

..7

/ 'fo which extent'ar

_driveWhich factors_abuyer's

// iii..1 system components: )

\ interdependent? / preferences for a

/-

system vendor?

ECONOMIC SOCIOLOGY

1

NetworkEffects _{Organizational Theory}

ArchivalData _{Experiment/Survey Data}

TimeSeries Limited_{dependent variables}

8 Introduction and Outline

Chapter3 elaborates on thisnotion

of

integrationbetween system components that is so typical to product bundling. It also studies purchase concentration towards the system components to create a theoretical

framework on

the organizational buying

of

modular systems in TI markets. Buyers thatconsider buying modularsystems need to consider two distinct decisions. The first decision

relates to who does

the

integration of

the system components into a

_fully

_integrated

_{system. A firm}

_{may prefer to}have another organization integrate the components ofthe system or it may preferto integrate the components itself. The second decision relates to from whom the buyer purchases the components that will ultimately comprise the system. The buyer can purchase all system components from the same vendor or _{from multiple vendors. In this study, we identify}

drivers of

both decisions. Interestingly, we findthatfactors thatare focal to TI markets, such astransferandpresence

of

knowledgetogetherwith technologicalturbulence determinebuyers'preferences.

Chapter 4 continues upon Chapter 3 in that itconsiderswhichfactorsdrive a_buyer's

preferences forasystemvendor in

Tl

markets. Thefocal argument inthis chapter is that TI markets are embedded and thus that _{buyers' preferences for} a _{specific system}

vendor will

depend upontheembeddedness of thevendorin systems

of

social_{relations, both in time and} structure. Of particular interest in this chapter is the finding that the relations ofa system vendor

with

component manufacturers

will

significantly affectabuyer'spreferences towards that vendor. We also show that abuyer's preferences fortheembeddedness ofavendor are dependent upon the knowledgethey possess and thetechnologicalchange they perceive.

Underlying chapter 2

_{through 4 is}

_{the understanding that system components are}

interdependent. in Chapter 5 we further

build upon

this insight. More in particular, we examine towhat extent system componentsareindeed interdependent. Thetheory

of

indirect network effects argues that the

availability

of

complements -

in

general referred to as

software- increases the

utility of

theprimary

product -

in general referred to

ashardware. The objective ofthis chapter is tounderstand the role ofsuch indirect network effects in the

growth of

new hardware.

Chapter 1 9

underdevelopedareas

of

research. Also, in dissertation research itconfronts the PhD student with differenttheoretical andmodeling traditions, whichenricheshistraining.

Chapter2 contributes to the research stream onbundling, while Chapter5 continues the ongoing researchstream onnetworkeffects. Both Chapters 2 and 5 thusstrictlybelong to thetheoretical domain of hightech systems. Chapters 3 and 4, in contrast, continue the work onorganizational-decision making,related toknowledgeandinformation management, in Tl markets, although theystrongly link this research stream to the researchstream on high tech systems.

Regarding the theoretical backgrounds ofthe different chapters, we note that they specifically build upon economics and economic sociology. Chapter 2 alrnost _exclusively builds _{upon economic}

_{theory, more}

in _{particular microeconomics. Chapter} 4 almost exclusively builds uponeconomic sociology, in that itexaminestheeffect

of

social networks

on _{buying behavior. Chapters 3 and}5 combine_{insights from}both economics andeconomic sociology. Chapter3 combines _{insights from}economic sociological literatureon _knowledge

transferandlearningwith insights from institutionaleconomics. Chapter5combines insights from network economics with insights fromeconomic sociology regardingcollective action and diffusion ofaninnovation throughasocial system.

The different chapters are alsodifferent in the methods they employ. Chapter 2 is a conceptual chapter, in which theoretical deduction, logical reasoning, and numerical illustration is used to develop an innovativetheoretical frameworkand specifypropositions. Chapters 3,4 and 5 are _empirical studies. In _{Chapters 3 and 4. we} use _{quasi-experimental} data from a _{conjoint design, gathered through survey research, in} a limited dependent variables model. Chapter 5 usesarchival data inanon-linear timeseriesmodel.

Chapter 2

Strategic Bundling of

Products and Prices: A New

Synthesis

for Marketingi

II.1 Abstract

Bundling is pervasive in today's markets. However, the bundling literature reveals inconsistencies in the use

of

terms and ambiguity about basic principles underlying the phenomenon. The literature also lacks an encompassing

classification of

the various strategies, clear rules to evaluate the

legality of

each strategy, and a unifying framework to indicate when each is _{optimal. Based on} a

review of

the _{marketing, economics, and law}

literatures this chapter develops a new synthesis ofthe field

of

bundling, which provides three important _{benefits. First,} it clearly and consistently defines bundling terms and

identifies two

key dimensions that enable a comprehensive classification

of

bundling strategies. Second,itformulates clear rules to evaluate thelegality of each

of

thesestrategies. Third,

it

proposesaframework

of

twelve propositionsthat suggestwhich bundlingstrategy is optimal in various contexts. The synthesis provides managers with a framework with which to understand and choose _{bundling strategies. lt} also _provides researchers _{with promising} avenuesforfutureresearch.

'

This chapterisbased_{upon Stremersch, Stefan and Gerard}J._{Tellis (2002). "Strategic Bundling of}

Products and Prices: A New Synthesis forMarketing," Journal of Marketing, 66(January)

(forthcoming).Rajesh Chandy,HarryCommandeur, Ruud Frambach, PeterGolder,R.Venkatesh,

EdenYin,theJMeditor andfour anonymous./Mreviewersprovidedmanyhelpfulcomments on

Chapter 11 11

II.2 Introduction

Bundling is the sale of two or moreseparate products in apackage. This strategy is pervasive in markets today in one form oranother. In the last decade, bundling has received growing attention in themarketing_{literature. However, the} publishedstudiesarefuzzyabout

some very basic terms and principles, do not discuss the legality

of

bundling, and do not provide a comprehensive framework on the economic optimality

of

bundling. As a result, marketing researchers may not appreciate the

full

meaning

of

bundling and the

variety of

strategies encompassed by the term. Marketing managers may not appreciate the hazards

involved inthis strategy and

fully

exploittheadvantages

of

bundling in various markets. Examples

of

bundles that come to mind readily are opera season tickets _{(tickets to} various events sold as a_{bundle), luggage} sets_{(various luggage} items sold as abundle) and Internet service_{(bundle of}webaccess,web hosting, email, personalized content, andInternet

search). Lessstraightforwardexamples includemultimediaPCs,fixedprice menus, executive

MBA programs and premium brokerage accounts. The multimedia PC is a bundle of the traditional PC plus speakers, a_CD-ROM,andothermultimediagadgets. A fixed price menu is a bundle ofachoice

of

_{appetizer, entree, and}dessert. Theexecutive MBA isa bundle of

selectedbusinesseducation modules that managers couldotherwiseget separately at various

conferences and _{educational organizations.} A premium brokerage account provides stock trades, stock research, margin trading, retirement planning, and free check

_{writing in one}

account.

The above examples show the _{pen'asiveness} and _{strategic importance}

of

bundling. Firms need to resort to bundling cautiously because of the legal pitfalls involved. For example, the landmark antitrust case against

_{Microsoft is, at the core, a}

case against its bundling

of

Windows andExplorer. Indeed the US Congress has a longhistory

of

legislating

on bundling issues and the US Department

of

Justiceextensively monitors its use by firms. Recentlythe _Department has _{prosecuted substantially more}cases. _{For example, the number} o fantitrust cases ithandled between 1996 and 1999 is _{approximately}double the number of cases thatithandled between 1890 and 1996.

12 Strategic Bundling of Products and Prices: A New Synthesis for Marketing

Weinberg 1996; Ben-Akiva andGershenfeld 1998; Hanson and Martin 1990; Mulhern and Leone 1991; Venkatesh and Mahajan 1993). Economists have focused mainly on the optimality

of

bundling for monopolists (AdamsandYellen 1976;Burstein 1960; Carbajo, De Meza and Seidman 1990; Long 1984; McAfee,

McMillan

and Whinston 1989; Pierce and Winter 1996; Schmalensee 1982 and 1984; _Stigler 1963, Whinston 1990), equilibrium theories

of

bundling (Chen _1997; Kanemoto 1991; Matutes and Regibeau 1992), and the

welfare implications

of

_{bundling (Dansby} and Conrad 1984; Martin 1999; Salinger 1995; Whinston 1990).

We identify the

following

three shortcomings in the literature. First, the

domain of

bundling is

ill

defined and terms thatreferto distinct phenomena are used interchangeably. Second, there is noclear, comprehensive, andcoherentdiscussion ofthe_legality

of

bundling. Third,there is no integrative frameworkthat explains the optimality

of

bundling conditional

on various factors. On the contrary, the literature contains ambiguity about some key conditionsforoptimality, whiletheoryon othersisincompleteorabsent.

This _{chapterprovides a} new _{synthesis of}the field

of

_bundling based on a critical review and extension ofthe marketing, economics, and law literatures. In particular, this synthesis makes three important

contributions to

the literature. First, it

clearly and

consistently defines bundling terms and principles. It

identifies two

key underlying dimensions

of

bundling that enable a comprehensive classification

of

bundling strategies. Second,

it

formulates clear rules to evaluatethelegality of each oftheabove strategies. Such rules mustcomplement any discussion

of

economic optimalityto ensure that economically optimal strategies are _{optimal in practice, aftertaking into account legal proscriptions and}

risks. _Third, it proposesa framework of12propositionsthat prescribe theoptimal bundling strategy in various contexts. The framework is a logical one that uses uniform terms and assumptions. The propositions incorporate all the important factors that influence bundling optimality. These propositions synthesize a body

of

knowledge that is

at least partly supportedby either verballogic,ormathematical proof,or_empiricalevidence.

Chapter H 13

II.3 A Primer on Bundling Strategies

Thissectionfirstdefines terms usedin bundling. ltthen classifiestheentiredomain of bundlingstrategies andclearlydemarcatestheir legality.

Il.3.1 Definitions

This subsection firstexplains the current confusion in thebundling literature. It then proposes cleardefinitions ofkey terms thatareparsimoniousandrooted in thelaw literature.

II. 3.1.1 Confusion in Literature

The confusion in

the literature arises from inconsistent use

of

terms, ambiguous distinctionsbetween_importantconstructs, andan unclear domain

of

_{application. We explain}

each

of

these_problemswithrelevant examples.

First, bundling does nothave consistent, universallyaccepteddefinitions. Adams and Yellen (p. 475,1976)definebundlingas_{"sellinggoods inpackages."} Guiltinan (p. 74,1987) defines bundling as "the practice

of

marketing two or

more products and/or services in a singlepackage fora_{specialprice."}YadavandMonroe_{(1993)define it as "the selling of two} or more products and/or services at a single price." Without consistent definitions, the legality

of

bundlingbecomes fuzzy and itspracticalimplicationsbecome imprecise.

Second, the distinction between a _{product and} a bundle is not clear. For instance, Salinger _{(1995) treats a pair}

of

shoes as a

bundle of a left and

a right shoe. Telser (1979) considers a car asabundle

of

different_{parts, such as the engine,}wheels, etc. As such, every product

would be

a bundle

of

parts, and the

term

would lose

its strategic and legal importance.

Third, the domain

of

bundling strategies is not clear. Mulhern and _{Leone (1991)}

introduce the concept

of

implicit

price bundling as "the pricingstrategy whereby the

price of

a product isbased on the multitude

of

price effects that arepresentacross products without providing consumers withan explicit

joint

price" (p. 66). By this termtheauthors imply that retailers who decrease

_{price in}

one category must consider potential sales increases or

decreases _{in other categories. However, this} extension ofthe meaning

of

_{bundling runs the}

risk

of

increasing ambiguity about the concept and its domain without enhancing understanding of the core concepts andprinciples

of

bundling.

14 Strategic Bundling of Products and Prices: A New Synthesis for Marketing

II. 3.1.2 Bundling

Bundling is the sale of two or

more _separate products2 in one package. The term separate has

enormous implications for understanding the legality and optimality of the

phenomenon. So it merits precise definition. We _{define separate products} as _{products for} whichseparate marketsexistbecause at least somebuyers buy or want to buythe products separately. For example, combinedofferings

of

bankingand insurance products arebundles because at least some consumers buy insurance and banking separately.

A

travel package including airandgroundtravel is abundle consisting

of

procedurallyseparate services. Note that products canbeseparate atonelevel in the channel, whilebeing mereparts ofaproduct atanother level.Whileaprocessor and a hard diskareparts in a PC foranend-user, they are

separate products for aPC manufacturer. This_{chapter focuses}on _{bundling from}anend-user

perspective and does not dealwith bundling inachannel context. Il. 3.1.3 Bundling Focus: Product versus Price Bundling

At

present, researchers use the terms product bundling and price bundling

interchangeably without clearly distinguishingbetween the two strategies. This study is the first inmarketingto

clarify

this_distinction, articulate theramifications ofeach strategy, and relate the two toeachother.

We define_{price bundling as the sale of two or}more_{separateproducts in}a_package

at a

discount, without any integration of the products.

_{Because the products are not}

integrated, thereservationprice forthe_{price bundle is,}by_{definition, equal to the sum of the} conditional reservationprices ofthe separate products. 3In other words, price bundling

itself

doesnotcreateaddedvalue to consumers and thusadiscount has tobeofferedtomotivate at

least some consumers to buythebundle. Think of a set

of

luggage items,asix-pack of beer, a combo meal,asoftware suite, oraseason

ticket for

theopera.

We define product bundling as

the _{integration and sale of two or more separate} products or services at any price. Thisintegration generallyprovidesat leastsome consumers withadded value, such as_{compactness (integrated} stereo_systems), seamless interaction (PC systems), non-duplicating coverage (one-stop insurance), reduced risk (mutual fund), inter-connectivity (telecom systems), enhanced performance (personalized dieting and exercise

- The term product in thisdefinition and the rest of thetextrefers to both goods and services.

1 Thereservationprice ofaproduct isthemaximumpriceaconsumeriswilling to pay for the

product. The conditional reservation price is the reservation priceofaproduct,conditional on the

Chapter 11 15

program) orconvenience from an _integrated

bill

_{(telecom calling plans). The greater value}

raises consumers' reservation

prices for

the product bundle

compared to the sum of the

conditionalreservation_{prices of}the_{separateproducts.}

A product bundle can thus be thought of as having an integral architecture

(Ulrich

and Eppinger 1995). It implementsthedifferentfunctions ofthebundled_{products in}a_single productbundle.The multimedia PC hasanintegral architecture, in that itintegrates functions such as connection (e.g. modem), data storage and retrieval _{(e.g. CD-ROM), which were}

separatephysicalchunksbeforetheadvent ofthemultimedia PC.

The distinction between price and product bundling is _important because it entails different _{strategic choices} for_companies

with

different consequences. While pricebundling is a pricingandpromotional tool. product bundling is more strategic in thatitcreates added

value. Managers can thususe_{price bundlingeasily,} atshortnotice, and fora short duration, while productbundling is more ofa_{long-term differentiationstrategy. In the case}

of

_physical

goods,product bundlingrequires a new design, research tooptimizethe design,andretooling to manufacture the product bundle. In the case

of

services, product bundling requires re-definition

of

services,

optimization of

the _{interfaces among the services,} and redesign of

service _delivery processes. Managers frequently approach product

bundling from a (new)

product development perspective,

involving the R&D

and manufacturingdepartments. Price bundlingdecisionsareoften thesoleprerogative ofthemarketingdepartment.

For example, consider the strategic

options of Dell

that markets to consumers who

want to buy

a portable computer system consisting ofabasic laptop, a _{modem, and a CD}

burner. First, it can sell theseproducts asseparate items, such thatthe price of each item is independent

of

consumers' purchase ofthe other item. In this case, consumers could easily

forego purchasing a modem or CD

burner or

they could purchase it from a competitor. Second, Dell can sellthe_{products as}a_{price bundle. For example,}itcould, without physically changing any ofthe products, give a discount to consumers if they buy all three products together. This offer would probably motivate at least some consumers to buy all three products from Dell. Third, Dell can sellthe three items as aproduct bundle. To meetthe latter classification, Dellmust design someintegration ofthethreeseparateproducts.For example, it couldcreateanenhancedlaptop. Not only couldthistriggersomeconsumers tobuying all products from Dell,but throughthevalue added they might even do so atapremiumprice.

II. 3.1.4 Bundling Form: Pure versus Mixed.

16 Strategic Bundling of Products and Prices: A New Synthesis for Marketing

not thebundle. Typically,becausethisstrategy is abasestrategy formostfirms,the strategy

is called _{unbundling only} when

_{contrasting it with}

a _{bundling strategy.} Pure _{bundling is a}

strategy in which a

firm

sells onlythe _{bundle and not (all of)} the products separately. Pure bundlingissometimes also calledtying ineconomicsandlegal literature.4

A

tying product is

a separate product that is bundled

with

other _{separate products.} Tie-ins are _secondary

products thatarebundled withtheprimaryproduct. Mixed bundling isastrategyin which a firm sells both the bundle and all of the separate products in the bundle separately.Table II. 1

presentsatabular view

of

theseterms.

Term

Definition

_Examples

Bundling

Bundling is the sale of two or moreseparate Opera season tickets,

products in one package. multimedia PC

Price

_Bundling Price bundling is the sale of two or moreseparate _{Luggage sets, variety pack}

products asa_{package at}adiscount, withoutany of cereals

integration ofthe products.

Product

_Bundling

Product bundling is the integration and sale of two Multimedia PC, sound

or moreseparateproducts at any price. system

Pure

Bundling

Pure bundling is a strategy in which a firmsells IBM's bundling of onlythe_{bundle and not (all of)}the products tabulatingmachines and

separately. cards

Mixed Bundling

Mixed bundling is a strategy in which a firmsells Telecom bundles boththebundle and (all of)the products

separately.

Table Il. 1 Bundling Terms

II.3.2 Classification

and

Legality of

Bundling

Strategies

II.3.2.1 Classification of Bundling Strategies

To classifyandrelate various bundlingstrategies, we identify two keydimensions of bundling: 1)thefocus

of

bundling, whetheron_priceorproduct, and 2) the form

of

bundling, whether pure or mixed. These dimensions encompass a rich set

of

bundling strategies that have substantially differentcharacteristics and_{implications. Byusing}these twodimensions, focus and form, TableII.2classifies thedomain

of

_bundlingstrategies. The focus

of

bundling is along_{the horizontal axis, i.e.,}oneither priceor product. Theform

of

bundlingis along the vertical axis, i.e., none, pure, or mixed. The table considersageneral case with two products

4 Many economics scholarswillapproachtyingmorenarrowly, aspurebundling

of

products infixed

proportions, e.g.abundle of a car and car insuranceisalwaysthecombinationof one car with one

Chapter II 17

X and Y. Combinations of X and

Y

represent the termsofthe sale. Thus (X,

Y)

represents the sale ofa _{price bundle, (XEBY)} represents the sale ofaproduct bundle, and X and

Y

without parenthesesrepresent the sale

of

separateproducts.

Focus : Form - _ - _ Price Product

0

Unbtindling x

I

e e

Pure (X.Y) (X W Y) Bundling

e e

Mixed

(X.Y) (X * Y)

Bundling x

X Y Y

-Table 11.2: A Classijication of Bundling Strategies

When the products are sold separately, the strategy is unbundling, and remains the same for the price and product columns (cell 1). Sears sells Kenmore home appliances unbundled. Cell 2represents a case ofpure pricebundling. In this case, a

firm

bundles the two products foronefixedprice,without integratingtheproducts orofferingthem separately.

A

classic example would include restaurants that

offer only

a fixed

price menu with

appetizer, entrde,anddessert. Cell3 represents a case o

f

mixedpricebundling, inwhich case the

firm

sells theseparateproducts (unchanged) in aprice bundle, and also sells the products

separately at their regular price.

An

example would be Samsonite's strategy

of

selling differentsizes

of

_{suitcases separately as well}as_{complete sets at}a_{discounted price.}

Cell 4 represents a case ofpure product bundling. 1n this case the

firm

physically integrates the products and sells only this integrated product bundle. An example is Apple Computer's strategy

of

sellingits computers andsoftware asone _{package. Cell} 5_represents

18 Strategic Bundling of Products and Prices: A New Synthesis for Marketing

H.3.2.2 Legality of Bundling

The above classification helps us to sort out the legality

of

various strategies (see Table Il.2). This is valuable in view of the limitedattention devoted to a cleardelineation of the legalrulesonbundling inthemarketing,_{economics, and}lawliteratures. in particular, the marketing literature avoids all discussion ofthe legality

of

bundling although it covers the legality

of

truth in_advertisingor pricediscrimination substantially (alsoseeWerner 1991 and 1993). Yet bundling is _{pervasive in marketing and} as _important as _price discrimination or advertising. _{Moreover, understanding the} legality

of

bundling is crucial to developing successful priceand_{productbundlingstrategies.}

Legal or economic analysts have not made an effort to abstractclearrules from past

cases, despite a body of caselaw. Based on a review of the law literature and case law, we

synthesizetheproscriptionscontained in the relevant Federal laws in two clearrules, the per se rule and the rule

of

reason. This simple distinctionhelps to explain much ofthe apparent

conflict

in court _rulings on various cases over the _{last century. The spirit underlying both} rules is that the bundling strategy ofa

firm

should not hurt buyers by

limiting

competition. The per se rule is the morestringent of the two rules.

We describe the per se rule in terms of four conditions, as follows: Bundling is illegal per se when it concerns (1) pure bundling (2) of separate products (3) by a firm with market power and (4) a substantial amount of commerce is at stake.

We

have already clarified the meaning ofpure bundlingand _{separateproducts} earlier. We here_explain market_{power and} substantiality.

Market

power meansthe

bundling firm

can"forcea consumer to do something that he would not do in a competitive market" with regard to the tying product (Soobert 1995,

footnote 87). Although a _{monopoly is} a clear indication

of

dominant market _{power, a}

company's power does not have to be complete over all buyers in the

market

(Fortner

Enterprises v. United States Steel Corp 1969).

Substantiality

means thattheamount

of

commerce that isatstake should be high. If this amount is not high,thepractice islegal. How high is high? The U.S. SupremeCourt has

noted that as little as $60,800 would be considered

substantial (United States v. Loew's 1962).This small number means that this condition is easily met in most markets.

Note that a firm may trytocircumvent the law by adoptingamixed bundlingstrategy

in which

it prices individual products so high thatconsumers buy only the bundle. In this

case, mixed bundling is _de.facto pure bundling and

will

receive the same legal treatment

Chapter 11 19

We describe the rule of reason in terms of six conditions, as fullows: Bundling is illegal linder the rule of reason. when it concerns (1 ) pure bundling (2) qf separate products (3) by a jirm with market power, (4 j involving a substantial amount of commerce, which (5) poses a threat that the bundling jirm acquires additional market power over at least one of the products that is bundled with the tying product. and (6) no plausible constimer benefits of.fset the potential damage to competition. So, under the rule of reason. each of the four conditions mentioned under the per se rule are

still

necessary, but not

jointly

sufficient, for bundling to be illegal. While assessingthe legality

of

bundling under the per se rule can be relatively easyandobjective, doingsounder the rule

of

reason isgenerally more difficult due to thesetwoadditional conditions, whichwe explainbelow.

Under the rule

of

reason, the mere existence

of

marketpower overthetyingproduct is not sufficientfor bundling tobeillegal.In addition, there should beasubstantialthreat of the bundling

firm

acquiring additional market power over at least one ofthe products that are bundled with the tying product. For example, Sandoz Pharmaceuticals bundled Clorazil, a drug for schizophrenia, with CPMS, Clorazil _{Patient Management System,} a _{system that}

monitored the patient on sideeffects of thedrug_{(Hurwitz 1991).} AlthoughSandozpossessed

market power through the patented Clorazil drug, it could not acquire additional market

power in

the market for monitoring systems because the

specific use

to monitor schizophrenics' reaction toClorazil was avery small part ofthetotal market for monitoring systems. Sothisstrategy was notillegal.

The sixth condition for bundling to be illegal, under the rule

of

reason, is that it

producesno benefits to buyers thatmay offset the potential damage to competition_(Meese 1999). Ifsuchbenefits arepresent. bundling canstill be legal, even though all five previous conditions are met. _{Typical offsetting} benefits are substantial reductions in costs or _major increasesin_{value bybundling}the_{products. By}this_{logic,pureproductbundles may be legal,}

if

theyprovideaddedvalue and are not merelyaboltingtogether

of

products. For example, in

US v. Jerrold Electronics (1961),

the

court used this factor to find an otherwise illegal

bundlingstrategylawful.Jerrold Electronics,anearly producer

of

cabletelevisionequipment, soldcommunity televisionantennasonly bundled withaservice contract. The equipment was very sensitive and customers had no expertise inusing it,thus_warrantinga_{bundlingstrategy}

to assure quality. Recently the DC Circuit (appeals _{court), in} the

context of

the Microsoft

20 Strategic Bundling of Products and Prices: A New Synthesis for Marketing

from second-guessing manufacturers' design decisions

_{(United States v. Microsoft Corp.,}

D.C. Circuit, 1998)

Both

of

theserules, the per se rule and the rule

of

reason, have been used over the

course

of

different legal cases and therefore different applications seem to

display a

"conflicting set

of

rules" (Dansby and _{Conrad 1984, p. 377). The IBM case(1936) showed}

rigid legal scrutiny

of

bundling practices, in that the Supreme Court applied the per se rule avant-la-lettre.The_{first explicit application of the per se rule occurred in} 1947(International Salt Co. v. United States). in this case, International Salt Co. leased patented salt dispensing machines onthecondition thatthelessee purchased salt forthemachines fromthe company. Without_{analyzing evidence}

of

substantial _{anti-competitive} effects nor holding into account evidence presented bythecompany that bundlingwas necessarytomaintain quality control, thecourtfound the company perse

guilty

of

illegalbundling (Soobert 1995)

in 1969, the Supreme Court relaxed the harsh per se rule and moved towards the rule

of

reason_{(Fortner Enterprises v. United States Steel Corp 1969). While it is uncertain which} of these two rules a

court will use in a

specific bundling case, use of the rule

of

reason is growing more common. _{Therefore, the rule}

of

reason is the most suitable benchmark for judging onthe_legality

of

various_{bundlingstrategies.}

H.3.2.3 Legality of Various Bundling Strategies

We apply

the previous discussion on

legality to

our classification

of

bundling strategies (see Table II.2). We discuss only the case in

_{which, a firm}

with market power bundles separate products, because these are necessary conditions for

illegality. All

unbundling (cell 1)

and mixed _{bundling strategies}

_{(cells 3 and 5)}

are _legal. Pure _price

bundling (cell 2) is always illegal, both under the per se rule and under the rule

of

reason.

Pureproduct bundling (cell 4) is legal under the rule

of

reason, ifthe benefits to consumers offset potential damage tocompetition. Note however, that

it

wouldbeillegal under the per se rule. Bolting products together is also illegal. Merely bolting products together does not constitute genuine integration and thus cannotbebeneficialto consumers.

Although we have specified clear rules for legality and applied them to various bundling strategies, ambiguity may still occur in the factual evidence

of

specific cases. A good example is the landmark antitrustcase _{United States v. Microsoft Corp. lf}one takes the position that Microsoft does not possess a monopoly position (as

MIT

economist Richard Schmalensee did), or that the bundling

of

Windows and Explorerprovides consumer value (as MicrosoftCEO Steve_{Ballmer did), then}the bundling

of

ExplorerandWindows islegal.

Chapter 11 11

Explorer with Windows by

Microsoft does not

add value for

consumers (as the US

government did), then

Microsoft's bundling of Explorer

and Windows is illegal. Thus the critical issue inthe Microsoft case is the factualassessment

of

marketpowerand consumer benefits.

First, does Microsoft _{possess market power? The presence}

of

market

_{power is a}

difficult fact

to establish objectively. Especially, the

definition of

the relevantmarket is the subject

of

intenseeconomic and legal debate. In the Microsoftcase, Judge Jackson defined

therelevant market narrowly as "the worldwide licensing of Intel-compatible PC operating systems" (Jackson 2000). In this market, Microsoft Windows indeed has market _power because of its dominantmarket share (95%). One canhoweverdebatethis choice. Would it

be more relevant to also include other desktop operating systems such as Apple orLinux? Howaboutnetwork_{operating systems, such as UNIX or}Novell?

Second, does the bundling

of

Explorerand Windows provide consumers withadded benefits, or were the twosoftware packagesjustbolted together to tempercompetition? As the DC Circuit Court

indicated, it is

very

difficult for

an outsider to second-guess a company's _{design choices,}especially in hightechmarkets. Besides, in this case,what would

be the optimal degree

_of

_{integration between the} two software packages? Who would determine that?

Thus, while our identificationandformulation

of

clear rules reduces the ambiguity in

case law, ambiguity still remains in the empirical evidence to which the rules apply. This problem canbeclarifiedby separating out two stages in the legal process: findings of fact and conclusions oflaw. _{Establishingfindings of fact is}an_empiricalissue,which couldbeclear in

some casesandhighly controversialin others, such astheMicrosoftcase. However,based on

those findings, the

conclusions of

law should become much

clearer with

the rules we formulated.

II.4 Optimality of Bundling Strategies

This section discusses the

optimality of

the various bundling strategies. It explains underwhatfactorswhich strategy becomes dominant. Relative to work done intheliterature this section makes the

following

contributions. First, the economics literature has focused

12 Strategic Bundling of Products and Prices: A New Synthesis for Marketing

consumers' conditional reservation prices, _{objectives of the firm, competition, costs and} consumers' perception

of

bundles. Second, the literature is ambiguous

about the

heterogeneity

of

reservation prices. In particular, most authors focus _{entirelyon asymmetry}

of

_{reservation prices. However, the}distribution

of

_{reservation prices}involves_{asymmetry and} variation, each

of

whichcan affect theoptimumstrategy.Ourdiscussionclearlyexplains the

role of

each. Third, the literature has largely ignored the important distinction between product and price bundling. Product bundling is an _important alternate focus

for

_bundling

strategies, especially in hightech markets. We formulate propositionsthatcover the area of priceand_{productbundling.}

0 f

the_propositionswe advance, most have neverbeendiscussed.

Of

those_previously discussed,atleastone_{(proposition 2)}has_previouslybeen_impreciselystated and a few are at leastpartially supported in the literature (propositions 1,8 and 12). We discussand classify

all

of

these propositions in the interest

of

completeness. Whereverthe literature contains a

partial or

full

_{proof for}

a

_{proposition, we cite}

it. _Although our propositions are

_firmly

grounded in marketing or economic literature, we also develop a simulation that illustrates themechanisms underlying most of ourpropositions. The use

of

simulation to do this kind of sensitivityanalyses is a bituncommon in marketing, although it has been used _successfully

before (Rajendran and Tellis 1994;

Tellis

and Zufryden 1995). Before we go to the propositions,weexplainthesimulationindetail.

11.4.1 Simulation

We illustrate the

logic of some of

our propositions

with

numerical examples (see Table 11.3 and _II.4). These examples give theoptimal prices forasupplierbased onvarious distributions

of

consumers' reservation prices or costs of the supplier. To generate these

examples, we developed aprogram that runs onMicrosoft

Excel:

To determinetheoptimal prices, we useasubroutine called

Evolver'

fromPalisade (see www.palisade.com). This is a powerful optimization routine based on an innovative genetic algorithm.

It

replaces the subroutine, Solver, inMicrosoft Excel,which does not work well whena_{spreadsheet has} "if-then-else"statements such asour program does.

Figure 1 provides a

flow

chart ofour program. It consists ofthe

_following

fivesteps

or components.

A) The user

must first specify the segments, their sizes, and the

distribution of

reservation pricesbysegmentandproduct(Figure l A).

Chapter 11 13

C) Based

on those prices, the program contains formulas to determine consumer surplus forthe various offerings (i.e., product and price _{combinations) (Figure}

1C).

D) Next an _{array computes} unit sales for each _{offering (Figure 1 D). This array}

contains formulas that incorporate the

following

rules.

i)

Sales

occur for a

particular

offering if and only

if

consumer surplus is _{positive and} amaximum among alternatives available. ii)

If

consumers are _{exactly indifferent} between buying and not

_{buying, they buy}

a

_{product. iii) If}

consumers are exactly indifferent between buying a bundle and the separate products in the bundle, they buythebundle.

24 Strategic Bundling of Products and Prices. A New Synthesis for Marketing

A:Segment Sizesand Reservations Prices (Input by user)

SegmentSizes Reservation PricesforProduct

Segments Combinations X Y Bundle A User to jill B User tofill 11 B: Prices to

Offer

(Cells to be changed by Excel-Evolver)

PricesforProductCombinations

X Y Bundle

Excel-Evolver to determine

11

C:_{Consumer Surplus} (Calculated by Excel with use offormula)

Consumer Surplus

Segments X Y Bundle

A Formula:

B Reservation Price - Price Offered

11

D: Sales

of Product to

_{Each Segment}

(Calculated by Excel with use offormula)

Sales toEach_Segment

Segments X Y Bundle

A Formula: If (1) TRUE = bundle sales

If ( 1) FALSE => separate product sales for products with surplus 2

B 0

With (1)=Surplusfrombundle_{positive and 2}Esurpluses from

separateproducts

11

E: Revenues (Objective Function)

Revenues

Excel-Evolver to maximize product of (Sales, Segment Sizes and Prices

Offered)

Figure II.1: Flow Chart Of Excel Optimization Program for determining optimal pricing of bundles (displayed here to generate a 2-segment, 2-product example)