Pricing Strategies for Augmented Products: The Value of Integration and Customization

Posted: 6 Dec 2006

See all articles by Neeraj Bharadwaj

Neeraj Bharadwaj

Independent

Frenkel Ter Hofstede

University of Texas at Austin - Red McCombs School of Business

Date Written: November 20, 2006

Abstract

Although the sale of an augmented product, composed of a core product and supplementary services, has become commonplace in an array of industries, the nuances associated with the pricing of such expanded offerings have not been fully examined in the literature. In this paper, we examine the potential improvement in selling firm profitability from jointly setting the prices for products and supplementary services (i.e., integration) and/or tailoring pricing strategies for products and supplementary services to individual customers (i.e., customization). We develop a model which specifies the interactions between a customer's purchases of products and supplementary services. We investigate the direct effects of pricing products and supplementary services on demand as well as the cross effects between them, at the customer level, and postulate a transfer effect of purchases driving future revenues. We find that changes in prices of core products affect demand for supplementary services and vice versa. We also find support for a service transfer effect: customers who acquire more supplementary services tend to purchase more products in the future. The product margins do not influence purchases of additional services as much as service margins affect purchases of physical products. This asymmetry in margins combined with the service transfer effect suggests that selling firms can achieve growth by accepting lower margins on supplementary services and sacrificing some profits on services to boost the profits made on hardware. Moreover, we conduct a profit analysis which demonstrates that higher optimal profits resulting from jointly pricing products and supplementary services (integration) than from tailoring prices to customers (i.e., customization). The combined profit gain of integration and customization is 18%. Interestingly, customizing pricing of supplementary services greatly improves profitability in relation to customizing the pricing of products.

Keywords: industrial marketing, marketing strategy, pricing research, complementary product pricing

JEL Classification: M31

Suggested Citation

Bharadwaj, Neeraj and Ter Hofstede, Frenkel, Pricing Strategies for Augmented Products: The Value of Integration and Customization (November 20, 2006). Available at SSRN: https://ssrn.com/abstract=949582

Neeraj Bharadwaj (Contact Author)

Independent

No Address Available
United States

Frenkel Ter Hofstede

University of Texas at Austin - Red McCombs School of Business ( email )

Austin, TX 78712
United States

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