A continuation of this post

Introduction

Let's talk about some non-hurdle means of price discrimination. For a definition of price discrimination and hurdles, see the previous post.

Versioning

In versioning, the seller offers different versions of the same product at different prices. Going back to airlines, airlines offer a business-class version of tickets and an economy-class version of tickets.

Now hold on, arguably, “different versions of the same product” could just mean “different products.” A seller offering “different products” doesn't exactly break new ground. In practical terms, versioning involves:

  1. price differences far greater than cost differences, from the seller's perspective
  2. direct substitutability, from the buyer's perspective

With the classes of airline tickets:

  1. Airlines price business-class tickets multiple times greater1 than economy-class tickets. The incremental cost of providing business-class service, e.g. priority boarding, more leg room, better bathroom, comes out to much less than the increase in price.
  2. For a single person on a single trip, I could substitute any class of ticket for any other class of ticket (ignoring price). I don't want a business-class and an economy-class ticket; I want a business-class (x)or an economy-class ticket.

Therefore, the different classes of tickets don't just represent “different products,” they represent “different versions of the same product,” versioning.

Bundling

Before we unbundle, let's first bundle.

Let's say you sell Dolors and Amets. Dolors and Amets cost $0.50 each to make. Only two people care about buying Dolors and Amets: Zeta and Eta. Zeta will pay up to $6 for a Dolor and $4 for an Amet. Eta will pay up to $4 for a Dolor and $6 for an Amet.

If you sold them separately, you could charge $4 per Dolor and $4 per Amet, making (2 * $4) + (2 * $4) - (2 * $0.50) - (2 * $0.50) = $14.

However, if you charged $10 for a Dolor-Amet bundle, you would make (2 * $10) - (2 * $0.50) - (2 * $0.50) = $18. Great!

Bundling works if the differences in people's willingnesses to pay for different products balance each other out, like in the example above.2

Unbundling

However, what if the differences in people's willingnesses to pay don't balance each other out?3

Let's say Zeta will pay up to $10 for a Dolor and $4 for an Amet, and Eta will pay up to $10 for a Dolor and $1 for an Amet.

You could charge $11 for a Dolor-Amet bundle, in which case you would make (2 * $11) - (2 * $0.50) - (2 * $0.50) = $20.

However, if you sold them separately, you could charge $10 per Dolor and $4 per Amet, making (2 * $10) + (1 * $4) - (2 * $0.50) - (1 * $0.50) = $22.50.

If the differences don't balance out, you would make more from unbundling previously bundled products.

Conclusion

We can see bundling in airline pricing. For example, airline tickets often come with a free checked bag. However, I find the trend of unbundling more interesting. We now see some airlines unbundle choosing your seat or getting an in-flight meal. If you know your preferences austere, you can go for the lower “version” ticket and forgo the bells and whistles with an unbundled airline.

  1. Through cursory search, typically 3 or 4 times greater ↩︎

  2. Bundling also works if the value of products offered together exceeds the sum of the value of the products separate, e.g. the value of convenience of buying together. We can call the excess the “incremental value of bundling.” ↩︎

  3. and the incremental value of bundling doesn't end up significant ↩︎