In last few days, two headlines grabbed industry analysts’ attention. The first pertained to the doom’s day prediction for Netflix due to the consumer backlash against their spin-off and price-hike decisions (read: Netf***ed : Can the online DVD rental company stop its free fall?) and the other disclosing the DISH Networks’ plan to use the recently acquired Blockbuster’s Movie Pass service to offer a Video Steaming option to its subscribers for an additional charge of $10 per month (Read WSJ Report: Dish to Launch Streaming Service).
Both these media stories have two things in common … of course, both of them relate to the future of video streaming business but they also pertain to the most exploited telecom and media strategy in last few decades – the “bundling” strategy! While, Netflix moved to unbundle its video streaming service from its “legacy” mail-in service, DISH network moved to bundle its legacy Pay TV service with the video streaming service! Rarely would you see such a massive incongruity ; when two leading competitors in an industry segment move in exactly opposing direction than the other on a pivotal strategy!!!
The round one, at least, is lost by Netflix even though the jury is still out whether DISH will win or not! Consumers are on offensive and Reed, the so-far-victorious CEO of Netflix, is apologizing, explaining, and admitting to the arrogance (Read the Netflix Blog: An Explanation and Some Reflections ). But then, we do have an altered landscape where Netflix competes with other over-the-top video streaming services while Qwikster will play the game in the brick & Mortar world against the Red Box and Wal-Marts of the world. Reed, on his blog, takes pride in distinguishing his company from the likes of AOL and Borders who, he categorizes, are “too slow to change” because it may “hurt their initial business”. Here is how he justifies their decision:
“ … we realized that streaming and DVD by mail are becoming two quite different businesses, with very different cost structures, different benefits that need to be marketed differently, and we need to let each grow and operate independently.”
On the other hand, Dish Chief Executive Joe Clayton said his company is offering customers one bill and one connection to stream more than 3,000 movies as well as have the option to rent more than 100,000 titles and thousands of video games by mail, and return them to Blockbuster stores if they choose (source: WSJ Report cited above). DISH dosen’t seem to mind mending “two quite different businesses”!!! The question is – Why on earth are these two competitors behaving as if they live in two completely distinct realities?
Well, there could be many reasons! But do these decisions make sense when measured on the basis of the fundamental parameter of the bundling economics?
(Cont. after the sidebar …)
A Primer on the Economics of the Bundling Strategy: The economics of the “bundling strategy” depends on the interplay of consumers’ “willingness to pay” for different services being offered. Let us take an example of a market with only 4 consumers (A, B, C, and D) and a service provider offering 2 services – (1) the Legacy Service and (2) a Next-Gen Service. Here are the assumed Willingness-to-pay values in this 4-people market:Table 1: Willingness to Pay
| Consumer |
Legacy Service |
Next-gen service |
For Both Services without any bundling premium |
For Both Services with bundling premium of $5 |
| A |
$5 |
$50 |
$55 |
$60 |
| B |
$10 |
$40 |
$50 |
$55 |
| C |
$16 |
$30 |
$46 |
$50 |
| D |
$20 |
$20 |
$40 |
$45 |
It is easy to figure out how many buyers would subscribe to these services if they are sold “individually” at each price-point –
Table 2: Pricing Decision (Without Bundle)
| Legacy Service |
|
|
Next Generation Service |
| If Sold at |
Number of Subscribers |
Total Revenue |
|
If Sold at |
Number of Subscribers |
Total Revenue |
| $5 |
4 (A,B,C,D) |
$20 |
|
$50 |
1 (A) |
$50 |
| $10 |
3 (B,C,D) |
$30 |
|
$40 |
2 (A, B) |
$80 |
| $16 |
2 (C,D) |
$32 |
|
$30 |
3 (A, B, C) |
$90 |
| $20 |
1 (D) |
$20 |
|
$20 |
4 (A,B,C,D) |
$80 |
So, the operator will price his Legacy service at $16 and the Next generation service at $30 – collectively it would give him a revenue of $32+$90 = $122.
Let us see what happens if this operator decides to “bundle” his Legacy and Next-gen services.
Table 3: Pricing and Revenue (with Bundling)
| If Bundled service is sold at |
Number of Subscribers |
Total Revenue without any bundling premium |
| $55 |
1 (A) |
$55 |
| $50 |
2 (A, B) |
$100 |
| $46 |
3 (A, B, C) |
$138 |
| $40 |
4 (A,B,C,D) |
$160 |
All of a sudden, the operator can earn revenue of $160 instead of $122 that he earned without any bundling. The benefit from bundling, in this case, would be even more if we take into account the “bundling premium” that a subscriber might be willing to pay for a bundle of services.
This seems like a Sleight of Hand! Well, not really … all that the bundling does (in most cases) is to make the market segments more homogeneous in terms of the “willingness-to-pay”. The bundling strategy works ONLY when (a) the willingness to pay for these different services moves in opposing direction to each other (or in mathematical language, have negative correlation) and (b) the cost to bundle is less than the benefit arising from it. |
( … Cont.)
As mentioned in the concluding part of the sidebar on bundling economics (above), bundles work only when there are segments of the market that have opposing preferences (and hence, opposing “willingness-to-pay”) for different services. In case of Netflix, there are two distinct market segments that steaming and DVD rental business address. In my judgment, the streaming market is what I would characterize as the “urban high-speed broadband youth” market and the DVD rental market would be mainly rural non-broadband market or the aged population that is not comfortable with the technology adoption. I would rate their willingness to pay as under:
Table 4: Willingness to Pay for Netflix
| |
Streaming |
DVD Rental |
| Urban high-speed broadband youth population |
High |
Low |
| Rural non-broadband OR Older population |
Near Zero |
High |
So, to my mind, it appears that Netflix services have near-perfect negative correlation with each other as far as the willingness-to-pay goes and if one follows the basics of bundling economics, it should make perfect sense to bundle (or, keep bundled) these legacy (DVD mailer) and next gen (streaming) services rather than unbundle. Of course, one needs to keep in mind that the bundling strategy may not always be a cost-less painless strategy. There could be additional costs involved to offer bundled services as compared to offering them separately. However, in case of Netflix, I do not see any significant bundling costs that could offset the bundling benefits. It would be very interesting to know what Mr. Reed thinks about this analysis. He might argue that operational ineffeciencies of running “two quite different businesses” are, in a way, cost of creating the bundle that outweigh the benefits. But then, don’t businesses bundle “different” products and services all the time?
Let us examine DISH Network’s decision to bundle these “quite different businesses” using the same economic principles. DISH, like many others, is facing the brunt of the cord cutters; who are abandoning the Pay-TV gatekeepers for the over-the-top (OTT) services such as Netflix. DISH Network recently acquired Blockbuster for $320 million. BTGI analyst Richard Greenfield, commenting on this acquisition, said, “DISH has a Netflix envy.” (Read: The Hollywood Reporter: DISH Network closes Blockbuster acquisition). In whichever fashion you try to dissect this decision, it is clear that DISH needed to address the shaky market segment of cord cutters. So how would the willingness-to-pay matrix look like for DISH’s market segments?
| |
Streaming |
Pay-TV |
| Urban high-speed broadband youth population |
High |
Low to Near-zero |
| Rural non-broadband OR Older population |
Near Zero |
High |
It seems very apparent from the willingness-to-pay table that bundling Pay-TV and Streaming might make a lot of sense. However, unlike Netflix, DISH might have to incur some bundling costs if it wants to provide these services through its own Set Top Box. Of course, I do not see that as being absolutely essential and the streaming services can be very well made available on the third-party devices through a third-party broadband provider. If the bundling costs are kept to the minimum, this could end up being an excellent defensive strategy for DISH Network.
In the conclusion, I do wonder if Netflix had some other reasons behind the “unbundling” than what has been stated by Reed in this “frank and open” blog post (e.g. content relationships, investors demand, etc.). On the other hand, DISH seems to have equipped itself with a great defensive strategy … not sure, how it will play out when the time comes to go on an offesive. For now, it may help DISH to stem the cord-cutting tide, if the pricing is appropriately determined.
Posted by Business Analytix 
