How to Make a Bundle on the Net

The Internet gives consumers access to a vast universe of digital products. Among them: news stories, photographs, songs, research reports, software games, and business programs. But how should sellers package and price these products? Is combining a group of digital products for a single price a smarter strategy than selling each item separately?
       Erik Brynjolfsson, visiting associate professor of operations, information, and technology at the Business School, finds that in many circumstances bundling is significantly more profitable. That is because more digital information reaches more people when the information is packaged in a bundle. Working with Yannis Bakos, associate professor of information systems at the University of California at Irvine, Brynjolfsson arrived at his conclusions by developing formulas to simulate a variety of pricing scenarios on the Internet. "Our theory predicts the benefits of bundling tend to increase as the per-copy costs of the components decline," says Brynjolfsson.
      First, they found that because copies of information goods can be made and distributed so cheaply, some of the intuitive rules people commonly use to price physical products no longer apply. The maxim that price should equal marginal cost, for example, is not very useful when virtually anything that can be digitized can be reproduced at nearly zero cost.
      Second, Brynjolfsson and Bakos show that bundling can increase the seller's profits. That is because it is usually easier to predict the value that a consumer will place on a large bundle of goods--whether it be a site license, an electronic subscription, or a suite of software programs--than on any single good. Brynjolfsson explains that when someone subscribes to America Online, AOL doesn't know if that person is most interested in horoscopes, stock quotes, or chat rooms. It's difficult to price each separately. But when you combine them, it's easier to predict consumer behavior and price the bundle correctly.
      Looming on the horizon, however, is a problem Brynjolfsson calls "featuritis," or overbundling. "It's possible that we're all made worse off by this glut of features and products," he says. In fact, he has uncovered a paradox. Even if featuritis is a negative, he finds that the company that sells the biggest bundle is still more likely to sell the most.

By BARBARA BUELL

Chapter 4 in "The Economic and Social Impacts of Computing and Telecommunications: An Introduction and a Research Agenda," Erik Brynjolfsson, National Academy of Sciences, December 1997
      "Aggregation and Disaggregation of Information Goods: Implications for Bundling, Site Licensing, and Micropayment Systems," Yannis Bakos and Erik Brynjolfsson, in D. Hurley, B. Kahin, and H. Varian (eds.), Internet Publishing and Beyond: The Economics of Digital Information and Intellectual Property, MIT Press, in press