How to disrupt an industry through unbundling

Aug 28, 2013

Table of contents:

1. What are complementary products?
2. Competitive advantage in complementary products
3. The problems with controlling complementary products
4. What is bundling?
5. Competitive advantage of bundling
6. The opportunity in unbundling
7. Opportunity for disruption through unbundling
8. Conclusion

An important part of any product are the complementary products that are associated with it. For example, when you buy a new car, you are not just buying the car, you also need a vast array of complementary products and services to make sure your car keeps running over the course of its ownership.

Complementary products are a very important aspect of gaining and maintain competitive advantage in an industry. If you can control or influence the complementary products that are associated with your product, you can control your position and maintain higher margins.

However, unbundling can present an opportunity to disrupt an industry by a new competitor. Unbundling is an extremely important tactic for taking on an incumbent industry, and is often largely ignored before it is too late.

In this post I’m going to be looking at Complementary products and how you can disrupt a market through unbundling.

What are complementary products?

Firstly, what are complementary products? Complementary products are additional products or services that are usually required to get the full use of the base product. For example, when you buy a car, you must also buy petrol, new tyres and you usually have to pay to get the car serviced or repaired. Nearly every industry will have complementary products in one way or another.

Complementary products often have a large effect on the overall perceived image of the product. For example, the performance of razor blades will have a direct effect on the perceived quality of the razor.

It is up to the company to decide if they wish to supply complementary products or not. Being the supplier will often create a bigger competitive advantage, but it can also have a negative effect on the company’s performance and margins.

Competitive advantage in complementary products

Companies can gain competitive advantage by also supplying complementary products in a number of ways.

Improve buyers performance

The first big competitive advantage is that you can ensure the high quality experience of your product if you also control the complementary products. This is the strategy that has been chosen by Apple to control the end-to-end experience of their products. Apple not only makes the hardware, but they also completely control the software as well as any intermediary marketplaces.

This results in differentiation and an overall improved user experience because the product and it’s complementary products and services should all hold the same high standard.

Improve the perception of value

Similar to improving performance, a company can improve the perception of value by ensuring complementary products are also of high quality. Again, going back to the Apple case study, Apple produce a number of complementary products like mouse and keyboards, external storage and headphones. By also supplying these complementary products, they raise the value of their main products.

Of course, Apple does not control the supply of complementary products like the ones listed above and they do not create any competitive advantage. But by also supplying these complementary products, Apple is able to force other manufacturers to raise their standards.

Optimal pricing

Usually when a consumer buys something, they evaluate the purchasing decision based on the entire cost of the product and the complementary products as a whole and not individually. By also controlling the complementary products, a company is able to optimally price their offering.

For example, Apple makes a killing on selling MacBooks and iMac computers. However, when Apple released their latest version of the OS X operating system, it was priced at just $19.99.

By controlling both the hardware and the software, Apple is able to price the entire package by making a huge loss on the software.

Optimal pricing can often force other suppliers of complementary products to follow your price cuts. This is good if you don’t control the complementary products, because you can force the industry to follow your prices.

Reduce marketing and selling costs

The cost of marketing and acquiring new customers is usually a significant outlay for just about any company. Due to complementary products being so tightly coupled with each other, selling both the base product and complementary products can be significantly cheaper because the marketing spend can be amortised over a larger sale.

This is particular important when the base product requires significant marketing effort, but the complementary products do not require any marketing spend because the customer has already been acquired.

The problems with controlling complementary products

Of course, there are also significant problems with also supplying complementary products. Firstly, it is usually the case that complementary products are no where near as profitable as the main base product. By supplying the complementary products without any significant expertise advantage, you run the risk of losing money on the supply that nullifies the perceived advantage of supplying it in the first place.

Secondly, if your company is unable to supply the complementary product without a big investment in reconfiguring your organisation, it is usually not worth it.

What is bundling?

Bundling is where you sell separate complementary products only as a package. For example, Apple sells it’s iPhones with iOS only and you can only run iOS on an iPhone. Bundling is extremely common in many different types of industries and with many different products or services. For example, after-sales support, delivery or bed and breakfast are all extremely common examples of bundling where it has become standard to supply both products or services together.

Bundling essentially means that all customers get the same package, no matter what their exact needs are. This inevitably leads to a case where some customers would rather not have certain aspects of the package in order to reduce the cost. For example, many hotel chains offer just a room and no complementary services like a restaurant or leisure facilities. If a hotel offers everything as a package, the offer will be suboptimal for travellers only looking for a room.

Competitive advantage of bundling

The competitive advantages that arise from bundling are all related to the benefits of supplying a single package without much individual customisation.

Lower costs

By supplying the entire package as a bundle, there are considerable cost savings to be had. Firstly the significant cost of acquiring new customers can be reduced because you no longer have to acquire the customer for each individual component. Manufacturing, distribution and customer service can all be amortised across the entire package to reduce costs, and after sales support can be completed by a single representative.

Differentiation

A company may be able to differentiate it’s products when sold as a bundle in a number of ways. For example, the company can allocate a single point of contact for after-sales support or customer service, it may be able to guarantee greater reliability or performance when all of the individual components are sold together or it might be able to show how a single supplier can make disparate technologies work together when there is no common interface.

One stop shopping

The ability to offer sales, support and customer service could be a significant competitive advantage where the customer is buying into a complicated or new technology. By having a single point of contact that can satisfy all of the consumers requirements, it makes the purchasing decision a lot easier.

Price discrimination through mixed bundling

It may be possible to earn higher revenues if you employ a mixed bundling strategy. For example, if you sell a bundle of individual components at a price that is less than if the individual components were bought separately. This might encourage customers to purchase the bundle when in fact they have no immediate desire for each of the components.

This is also effective at being able to earn higher than normal revenues on the individual components. If a customer is willing to pay a higher price for a single component, it allows the company to charge higher individual prices whilst still selling the bundle at a reduced price.

This strategy only works when there is a distribution of buyer needs in the industry. For example, this will only work if buyers have different price sensitivities for the various individual components. Mixed bundling is a strategy to capture different price sensitivities without charging different prices to different customers for the same product.

The opportunity in unbundling

Now that we have a firm understanding of complementary products and how bundling works, its time to look at the opportunity to disrupt industries through unbundling. Unbundling is one of the key methods for finding disruptive opportunities.

Stripping away the components of a bundle

As mentioned above, bundling is only effective when the majority of all customers require the entire package. When a significant amount of customers only require individual components, or they are paying a suboptimal price because they are forced to purchase the entire bundle, then there is an opportunity for disruption.

For example, low cost airlines have taken this strategy by removing all “frills” from the experience of flying. By removing free meals, baggage handling and by flying from second-tier airports, they can significantly reduce the cost of flying for customers who are price sensitive.

Bundle self assembly

When a consumer has the ability to self assemble the bundle for themselves, they will usually prefer to do so rather than being sold an entire package. This is usually the case in mature industries where the technology or administrative requirements of assembling the package are well known.

Once again, this can mean a significant reduction of price for the consumer, particularly if they do not require after-sales support.

This is also better for the consumer when they can source the individual components of the bundle from specialist suppliers. A specialist supplier will usually be able to produce a superior product and can avoid the costs of coordinating the entire bundle or the hit on margin of supplying after-sales support.

Opportunity for disruption through unbundling

The internet has created a huge opportunity to unbundle many traditional industries, products and services. In the same way that the Internet disrupted publishing, the Internet has given unprecedented access and opportunity to individual consumers.

Spotting opportunities to unbundle traditional industries is really quite easy when you know what to look for. Typically mature industries are ripe for disruption because the benefits and merits of the individual components are well known and understood. When you notice that either individual components would be better sold separately, or there is no longer a need for expensive customer support or the entire package, there is a good opportunity to unbundle the industry.

Here are 5 things to look for when searching for disruptive unbundling opportunities.

1. Use of the Internet has enabled SaaS

The rise of Software as a Service has completely revolutionised the stagnant industry of traditional software. Software can be be marketed, sold and distributed entirely online. It is now much cheaper to get software into the hands of consumers and so a whole new pricing model revolving around low monthly subscription has taken over from the one time large investment that was once a common occurrence.

Whilst SaaS is by no means a new opportunity, there are still plenty of incumbent enterprise software packages that are still sold as an expensive bundle. Can you see an opportunity to slash the costs of enterprise software to open access to a whole new wave of price sensitive consumers?

2. Is your target market now better educated?

Bundling is a competitive advantage when the technology or the combination of individual components is required because the consumer is unable to create the bundle for themselves. However, as an industry matures, this becomes no longer the case.

The Internet has again been a driver of the increased education of consumers. It is now fairly common to be able to search Google for information on just about any topic and find a high quality answer or information.

What industries or products now no longer need to be bundled because consumers have recently become better educated? For example, specialist services like accountancy or some legal services are sold as a package because of the expertise of the accountant or lawyer. Is there an opportunity to create a product that unbundles these services because you can educate the consumer at a much lower cost than a trained professional?

3. Standardisation

When complementary products become standardised, or a common exchangeable format becomes accepted, the opportunity for unbundling disruption increases. For example, traditional accountancy services might offer a bundle where they take your accounts, handle dealing with the banks and submitting your returns to the government. But, this is something that can be unbundled as long as the individual components have a common format for transferring that data.

When you have off-the-shelf accountancy software that is able to submit data to the bank and produce accounts that are formatted to be accepted by the government, you suddenly lose the requirement for a specialist firm to handle all of these things as a package.

4. No need for enterprise support

One of the big opportunities in unbundling is to significantly reduce the overhead of enterprise support. When a large company pays a huge amount of money for a software package they always require on demand 24/7 support. It’s usually the case that large organisations want to pay large amounts of money for a software package to ensure that they have that technical support.

But small companies cannot justify paying those types of costs for support.

Is there an opportunity to bring traditional enterprise software to small businesses by slashing the cost of support? Instead of offering on-demand 24/7 support, you can provide low cost support in the form of on-call representatives, knowledge databases, tutorials and guides that are able to scale much more effectively.

5. In-house assembly

Once an industry reaches maturity, customer are much more likely to want to assemble a bundle in-house. Not only is this more cost effective, but it also enables them to leverage their own resources.

For example, an expensive marketing package that consists of analytic software, consultancy, design services and support can be stripped back to just the software which allows in-house marketers to do the same work but at a much lower cost.

Can you see an example of a traditional bundle where smaller companies are much more likely to want to assemble the bundle in-house using their existing resources?

Conclusion

Phew, that was a long post, thank you for reading to the end. If you made it this far, hopefully you have learned a lot about finding disruptive opportunities through unbundling.

I love the idea of unbundling incumbent industries because it allows a new startup to launch and sell a product where there is already significant customer demand. You don’t need to invent anything new, you just have to split an existing product and only sell the bits of real value to a particular customer segment.