Netflix to Stream Games: A Strategic Use of Bundling?
In July 2021, Netflix announced its intent to enter the gaming market and begin streaming video games. Founded in 1997 as primarily a DVD-rental-by-mail company, Netflix introduced “video streaming” in 2007. This was a bold move when the low level of broadband penetration in the US made watching movies (or TV shows) online impractical, given its need for dependable high-speed Internet service with low latency and no jitter. With bundle pricing – around $8/month for unlimited consumption of content licensed from the major film and television studios – and additional innovations such as personalized recommendations, Netflix made this streaming service work and enjoyed phenomenal growth in subscribers and revenues.
Netflix maintained a dominant position in in-home video entertainment for many years, beating out the TV bundles from incumbent cable and telecom service providers. But by 2021, Netflix faced a hyper-competitive environment with several new subscription streaming services (e.g., Disney+, Amazon Video, HBO Max, a rejuvenated Hulu+, YouTube TV, Peacock Premium from NBC, and many others), many ad-supported streaming services (e.g., NBC Peacock, Hulu, Discovery+, Pluto TV, Xumo etc.), and a shift in entertainment consumption from movies to games (and to other products such as music streaming services and ad-supported short-form video).
This shift in market potential and consumer trends seems to justify Netflix’s dive into Gaming. There are also some obvious criticisms, including the fact that (compared to its incumbents) Netflix knows little about game production, preferences of gaming users, or the distribution of games. So, will it succeed, and what business strategies can help Netflix?
A Streaming Bundle of Videos and Games?
The simplest strategic opportunity for Netflix is to bundle game-streaming into its video-streaming product. I will illustrate this market opportunity through an experiment using hypothetical (but reasonable) numbers.
Say, Netflix’s video streaming service has a target market of over 100,000,000 (100 million) customers in the US, split across 1,000 different levels of willingness-to-pay (WTP) for a monthly subscription. Suppose this monthly WTP falls between $5 and $25 for most users. We can model this with a Normal distribution with mean $12 and standard deviation $3.5, as shown in the Left panel of the graphic.
If Netflix priced video streaming at $11 per month, then based on the above demand distribution, it would capture 62,100,000 subscribers, yielding $683,100,000 in monthly revenue.
Next, suppose a slightly weaker profile for Netflix’s game-streaming. Since existing gaming services like Twitch and Stadia charge roughly $5-10 per month, and given that Netflix is a newcomer, let’s model this with a Normal distribution with mean $4 and standard deviation $2 (see the Right panel). If Netflix were to price game-streaming at $5 per month, this should yield 31,000,000 subscribers (many of whom also bought the TV service, and others who did not), and monthly revenue $155,000,000.
So, that gives us a total revenue of $838,100,000.
How might bundle pricing help Netflix? The idea is to offer people a slight discount for buying both items. Suppose Netflix priced a bundle of video and game streaming at $13 (below the sum of the two prices, $11 for TV and $5 for Games). Using the same demand distributions, Netflix would capture 76,300,000 subscribers with a $13 bundle price, fetching $991,900,000 in monthly revenue. That is well above the previous, separate-selling, revenue of $838,100,000. The bundle worked!
Why it worked, in this case, is something called the demand-smoothing effect of bundling. In Netflix’s target market and many segments, surely there is someone whose WTP is high for Video (say, $15) but low for Gaming (say, just $1). When sold separately, this person would be content to buy video streaming but not the gaming service. But when offered a $13 bundle, this customer will purchase the bundle, and even spend some time gaming. Conversely, a gaming-intensive group (say, whose WTP for Gaming is $14, but WTP for video alone is $5) would purchase the gaming service but not video streaming when offered separately, yet pay $13 for the bundle. So, what the bundle does is to “smooth out” the differences between different groups: when considering a bundle, potential buyers are less sharply different than they are for individual products. ** could use a nice Cartoon illustration of the above.
Of course, these are just two examples, and there are many other groups with a variety of other price-points at which they would buy none, one, both services, or the bundle. Some customers have high WTP for both services: they would have bought both services when priced separately, hence the discounted bundle causes Netflix to lose out a bit on such customers. But they are not the bulk of the market. Then there are customers with moderate WTP for both products, and they find it easier to purchase the discounted bundle even when they’re unwilling to buy both (or even one) services separately. The bundle really works well for customer groups who have high WTP for one service and lower for the other. These groups might buy one or the other service when offered separately, whereas the bundle discount can motivate them to buy both.
Adding up the effects across all of these groups establishes the higher revenue from bundling. Let’s look at a scatter plot of customers based on their willingness to pay for each service (Video, Gaming, and the Bundle). Superimpose the prices (selling Video and Games separately, vs. selling the Bundle) shows that bundle selling yields more sales (76,300,000 subscribers buy both Video and Gaming, compared with 62,100,000 subscribers for Video alone and 31,000,000 subscribers for Gaming alone).
Bundling as a Competitive Business Strategy
Bundling is employed widely in business. There are many motivations for firms to use bundling, and multiple ways to do so.
Pure bundling: only the bundle is offered, you can’t buy individual goods at individual prices. Often, pure bundling is “invisible” - we don’t realize there was a bundle until the product gets unbundled (e.g., airline travel).
Mixed bundling: you get the discounted bundle but can also buy individual items or subsets of items (e.g., MS Office, camera kits, food+drink+fries at McDomalds, cable TV bundles).
Partial mixed bundling: the bundle is offered, along with one of the bundled items separately, but not the other. For instance, some hotels price include free breakfast in their room price. This is a partial bundle: one can just walk into the hotel restaurant and buy breakfast, but you can’t get the hotel room minus the breakfast for a lower price than the room with breakfast.
Tying: the purchase of item A is tied to buying item B, although item B might be sold separately (i.e., partial bundling) or not (pure bundle). For instance, Sandoz Pharmaceutical tied the purchase of Clorazil (a highly effective drug for schizophrenia, but which caused a potentially-fatal blood disorder in 1-2% of patients) to a compulsory blood monitoring system.
Here are some examples that illustrate the different ways in which bundling delivers competitive benefits.
Demand-Smoothing Bundle demand exhibits less disparity in WTP (relative to mean) among potential buyers, than for the individual components, enabling the seller to capture more revenue. This effect, illustrated for Netflix video and game bundles above, is present in nearly all applications. But it makes business sense only when variable costs are relatively low, among other preconditions. It is rarely the driving factor behind the use of bundling.
Economies of Scope The cost of selling a bundle is often substantially lower than the sum of the costs of selling the component items separately. This is true for newspapers and magazines (bundle of stories in politics, sports, entertainment, global, national, …), telecom bundles (e.g., phone + Internet), telecom+entertainment bundles (e.g., Internet service + TV bundle), music CDs. etc. In some cases, selling a bundle costs about the same as selling an individual item, thereby giving the seller bigger profit margins.
Cross-Market Competition Bundling (specifically tying) is often used by firms that are dominant in one market to gain advantage in a second market, enabling entry of its own product, or forcing exit of a specialist competitor who can’t offer the more convenient bundle. For instance, Amazon Prime (dominant in e-commerce) extends into home video by bundling streaming video into the annual price (and you can’t get Prime-without-Video for less). Microsoft translated its heft in enterprise computing to fall in 2nd place (behind Amazon Web Services) in enterprise cloud computing. This strategy is often applied when the second market is highly lucrative. Indeed, this strategic element may justify Netflix’s entry into Gaming: it might have greater revenue potential than TV and films. With bundling, Netflix can suddenly achieve a user base of millions of Gaming subscribers, becoming a formidable competitor even as a total newcomer in this industry.
Bundling Your Own vs. Outsourced Goods Many firms bundle items that they “own” (that is, they internalize per-unit variable costs of the item), for instance Microsoft Office is a bundle of Microsoft’s Word, Excel, PowerPoint, and Outlook. In others, such as cable TV bundles and even Netflix’s early years in streaming video, the bundle comprises items licensed from dozens or thousands of separate producers. This will surely be true for Netflix’s game-streaming (as is for games streamed on Twitch and YouTube). However, a high license fee (relative to its contribution to the bundle price) can destroy the demand-smoothing benefit of bundling. Further, the bundling firm is a hostage to its producers: its financial success drives them to demand higher license fees. One way out of this is to “make your own product”: Netflix has made a huge move into producing or owning original content, and driving its demand with its own originals.
Netflix’s entry into gaming leverages bundling strategy in multiple ways: the bundle has less variation in consumers’ valuations; it has lower transaction costs; and most of all is a strategic lever for Netflix to enter the lucrative gaming industry. I would expect Netflix to simply add game-streaming into the existing service – at no additional cost – and later shift either to a higher-priced tied video+gaming service, or a mixed bundle which offers a discounted bundle and also prices each service separately.
Web page: https://rpubs.com/hkb/bundling
Sources:
Bhargava, Hemant K. 2013. “Mixed Bundling of Two Independently Valued Goods.” Management Science 59 (9): 2170–85.
Eckalbar, John C. 2010. “Closed-Form Solutions to Bundling Problems.” Journal of Economics & Management Strategy 19 (2): 513–44.
Bhargava, Hemant K. 2012. “Retailer-Driven Product Bundling in a Distribution Channel.” Marketing Science 31 (6): 1014–21.