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Discount the Parts or the Whole?

September 2013 Pricing 1 Comment

When selling things that go together, should the company offer discounts on the individual parts or the whole shebang?  Which approach brings more attention to the price reduction?  How does it depend on the nature of the things that go together?  And, does the attention translate into sales?  Sourav Ray, Charles A. Wood, and Paul R. Messinger examined these questions across 650,000 daily price listings and through customer and manager surveys in a recent Journal of Marketing article.  Their results have broad price-management implications for many manufacturers and systems solutions providers in both business-to-business and business-to-consumer markets.

Multicomponent Systems

Specifically, Ray et al. examined price reductions on multicomponent systems.  Multicomponent systems are composed of products that work together to enable the whole system to function, yet the products are usually priced individually.  For example, a laptop computing system might contain a laptop, monitor, printer, back-up drive, docking station, and other peripherals.  Similarly, a camera system might contain a lens, flash, and camera body.  Hair-washing products could even be called a multiple component system since consumers often purchase shampoo in combination with conditioner.

Multicomponent systems can be classified into two categories—tightly coupled systems and loosely coupled systems. Tightly coupled systems are products which offer only limited component-level choice to the customer. For example, a Canon camera body may work best with Canon lenses, and therefore cameras would be classified as a tightly coupled multicomponent system.  In contrast, loosely coupled systems offer greater component-level choice to the customer operationally.  For example, a Dell desktop computer works equally well with a Dell, Acer, LG, Samsung, Apple, or HP Monitor, making computers classified as a loosely coupled multicomponent system. A short list of potential examples can be found in the table below into which we encourage executives to categorize their own offerings as appropriate.

table1

Price Reductions and Multicomponent Systems

Deep price reductions generally generate more customers than shallow discounts, but the increased sales volume might be at the cost of lost profits.  In contrast, small price reductions might preserve profit margins but not be appreciated by customers, resulting in negligible sales volume impact.

Multicomponent systems pricing provides a strategic method for managing price reductions. Generally speaking, customers tend to be always attracted by deep price reduction, but what about small price reductions?  Ray et al. demonstrated that customers have different responses to small price reductions depending on the coupling within the multicomponent system: tightly or loosely.  These observations led to an understanding of how to maximize the attention with the smallest reduction.

For products in tightly coupled systems, Ray et al. showed that small price reductions on the entire system are both more common and generate larger customer attention than similarly sized price reductions on components.

In contrast, for products in loosely coupled systems, Ray et al. showed that small price reductions on the individual components are both more common and generate larger customer attention than similarly small reductions on the entire system.

Thus, managers of multicomponent systems are encouraged to first evaluate whether they are offering tightly or loosely coupled systems, and then offer shallow discounts on either the entire system or on individual components, respectively.

Impact in Tightly Coupled Systems

The following graphs help to explain the concept more vividly.  The two lines represent the relationship between price capture and customer attention.  In the tightly coupled markets, as a price drops, customers of both system and components start to pay attention to the change.  However, if the prices for these two categories of products go down at the same level, the customer attention of system will be larger for system price reductions than that for component price reductions.  Therefore, when setting discount policy for tightly coupled multicomponent systems, managers may want to start by applying shallow discounts at the entire system level.

figure1

Let’s return to our previous example of the tightly coupled model: cameras.  When a customer purchases a new camera system, she typically buys a set that includes a body and lens.  Those components are tightly related with each other since the entire camera does not work with any absence of single part.  Thus, the price manager of cameras is suggested to provide smaller discounts on the system than for every single component within the system.  For the camera market researched by Ray et al., system price reductions are 13% smaller than component price reductions since the discount level has already attracted enough customers.

Impact in Loosely Coupled Systems

For loosely coupled systems, the price-attention curve performs the inverse situation.  In these markets, prices of two products are decreased at the same level while customers pay more attention to the change of components price illustrated by the higher percentage of quantity increased.  Only when deep reductions are applied to a system packaged in bundle format do customers start to realize the significance of the discount.  However, deep reductions in component prices may not have a significant marginal impact on attention because small reductions have already generated sufficient attention.

figure2

Under this product category, managers of computers and monitors are recommended to present smaller discounts on the components than for systems since demand for components is more elastic and customers can more readily perceive the value of price reduction for systems.

Why Multicomponent System Pricing is Useful

So should you discount the parts or the whole?  Ray et al.’s research indicates it depends on how highly coupled the components are.

For loosely coupled systems, small discount in components should lead to a larger customer response than a comparable discount on the system.  In tightly coupled systems, a small discount on the entire system will typically lead to a larger customer response than a comparable discount on the parts.  But does this increase in attention paid by customers lead to sales, and, most importantly, which approach is the most profitable?  That will require more research and analysis, but at least we know where to start looking.

References

  • Ray, Sourav, Wood, Charles A. & Messinger, Paul R. 2012, Multicomponent Systems Pricing: Rational Inattention and Downward Rigidities, Journal of Marketing, Vol. 76, No. 5, pp.1-17


  • Serrena

    This is a great article that you can take and work with what you have discovered. Thank you for sharing.

About the author

Tianyang is student in Master of Science in Finance Program in DePaul University. She is now working with Wiglaf Pricing as a Pricing Analyst Intern. Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

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