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Bundling and Pricing Innovation

This was initially posted on LinkedIn December 16, 2013.

Innovation comes in many forms. Many times innovation is thought of as technological improvement or as invention. We can all cite examples of inventions which turned into industries which re-defined civilization. The steam engine comes to mind but there were many others before and after. Inventing something is certainly a way to create value but it’s not as common or as reliable a method as it might seem. Creating Intellectual Property is one thing, finding a defensible market and business model is quite another.

More often companies innovate in terms of processes or the “algorithms” which are used to deploy existing resources. Wal*Mart was immensely innovative in the way it organized itself and laid out a low-cost business model. More recently Amazon has innovated in distribution and fulfillment based on the ability to dispense with showrooms for products and sell directly online. There is little in terms of technology which Amazon “invented”. Rather, it deployed off-the-shelf technology in a novel way.

But what I want to address is a more mundane sort of innovation: marketing innovation, specifically pricing. Few would consider a price model to be an innovation but in fact it’s a core lynchpin to many breakthrough innovations. It was pricing which permitted Henry Ford to build an industrial empire. He could have built cars for those who could afford them as cars were defined in 1907 but he chose to build a car around a price point which was around the median of the population. A car “so low in price that no man making a good salary will be unable to own one.” His business logic began with a price and the product and process followed.

Another aspect of pricing innovation is “bundling” where products which might sell poorly independent of each other sell very well when coupled with complements. Consider the original Microsoft Office. When introduced vis-a-vis Lotus 1-2-3 and WordPerfect as separate products, it handily won the market for spreadsheets and word processors. Bundling is also the way TV is sold. Cable companies don’t offer channels a-la-carte. It even took root in the car business. Automakers are now selling upgrades as “equipment packages”, a method proving far more popular (and profitable) than the menu system of old.

But there are cases where bundling has been rejected by users. iTunes broke the bundle of the “Album” where the only way you could get a single was to buy a dozen other songs. Once broken, the album bundle shows no signs of a come-back. Many are questioning whether TV channel bundling is also ripe for such a break-up.

And there is yet another looming bundle question. For as long as the market existed, mobile carriers sold their service bundled with a device. This harks back to the days when AT&T (known then as the Bell Network) did not permit users to own their own landline phone. They argued that the device is a part of the network and choice in the matter would compromise security and safety of a crucial infrastructure. The argument played well with regulators for decades.

This tie between the device and the service persists today but the connection has been preserved not though regulatory fiat but through incentives in pricing. Arguably, the low price of devices, and hence cost of entry, has meant that penetration skyrocketed. Cellular service now reached saturation in the US in near-record time. The upgrading to smartphones is now about 60% complete and looks to saturate a mere 8 years after reaching 10% of the population.

So in a way, the “innovation” of the carriers has been in bundling and creating a package that was irresistible to consumers. They went from not consuming mobile networks to consuming them universally. The amount being spent by consumers on mobile services is above $1.3 trillion world-wide–a market that did not even exist 20 years ago.

So now the question being asked, even within the industry, is whether this bundling can long last. The way I would answer the question is by following the logic from the consumer’s point of view. If the bundle is valuable, then it’s likely it will be tolerated, even preferred. In the case of software and car options the model works. Even in the case of TV the model is still preferred as few consumers are defecting to the IP-based unbundled alternatives. In the case of music, the consumers prefer the unbundling because there were things in the bundle which they did not need or want. They wanted a song, not a song and others which they might like.

But in the case of network service and device, the split is more subtle. A service is useless without a device and a device is useless without a service. The bundle makes sense from the point of view of co-dependency of modules. The broader question is one of choice. The premise of unbundling might be that users can choose service and devices separately and change them arbitrarily.

There is a fundamental problem with this however. A service that can be switched on or off easily by consumers is economically challenging for network operators. The economics of networks are such that financing them requires steady cash flow and every operator desires stability. So incentives will be put in place for consumers to stick around, and these incentives (read innovations) work. But isn’t the device itself such an incentive?

We end up back where we started. The business model and economics of operators world-wide is such that the device is a critical part of the incentive structure which preserves the network’s economic balance.

It may be an illusion, but a cheap phone (with a long-term contract) is a fundamental innovation devised by telco operators even before the phone became mobile. Operators have come to love it and no matter how many technology generations go by; how many family plans, bucket plans, weekend minutes, rollovers, and data packages; no matter how many tweaks and re-brands the model gets, it will persist. There simply isn’t sufficient win-win value in alternatives.