Unbundling of Industrial Systems

By Lynn 0. WilsonAllen M. WeissGeorge John
1988| Working Paper No. 1027

This paper examines the bundling strategy for a firm which sells an indusrial system. Such a system consists of several distinct components which must be used together in order for the overall system to be operational. Examples include computer, communications, and printed-circuit board assembly systems. In many cases a “turnkey” system can be acquired. However, since most industrial systems are also technologic-ally divisible, the system can be unbundled and the constituent components sold separately. To the degree that open standards exist for the interfaces between the various components, the system components can be sold by multiple vendors. This creates a dilemma for a firm which sells a turnkey system. While appealing to customers who desire the enhanced integration of turnkey systems may be a profitable strategy for the firm, it may derive even more profits by unbundling and letting customers mix and match its components with those of competitors. To provide insights into the optimal bundling strategy, we develop a model which incorporates several characteristics of the market for industrial systems. Systems are characterized by attributes associated with the individual components and by two system level attributes, the ‘integration’ of the system components and the ‘modularity’ of these components. Customers are assumed to have heterogeneous preferences for the components of the system as well as for the manner in which these components are packaged (turnkey or separate). It is further assumed that specialist firms exist which can provide the individual components for customers to mix and match. We derive a general criterion for when a profit maximizing firm should unbundle a turnkey system and sell the components individually, and possibly stop selling some of these components. Our results indicate that market growth resulting from unbundling and the extent of cross- subsidization are crucial determinants of the attractiveness of the strategy. Finally, we use a simple numerical example to demonstrate that the model can account for the observation that systems tend to become unbundled over time.