The incremental revenue-allocation method ranks individual products in a bundle according to criteria determined by management and then uses this ranking to allocate bundled revenues to individual products. The first-ranked product is the primary product in the bundle. The second-ranked product is the first-incremental product, the third-ranked product is the second-incremental product, and so on.
How do companies decide on product rankings under the incremental revenue-allocation method? Some organizations survey customers about the importance of each of the individual products in their purchase decision. For example, if one product in the bundle is an established product and the second product in the bundle is a new product, managers would rank the established product as the primary product and the new product as the first-incremental product. Other managers rank products on the basis of the recent stand-alone revenues of the individual products in the bundle. In a third approach, top managers use their knowledge or intuition to decide the rankings.
Consider again the Word + Finance Suite and assume Dynamic Software sells equal quantities of WordMaster and FinanceMaster. Assume WordMaster is designated as the primary product and FinanceMaster as the first-incremental product. WordMaster is allocated 100% of its stand-alone revenue of $125 and FinanceMaster is allocated the remaining revenue of
The table depicts revenue allocated and cumulative revenue allocated for WordMaster and FinanceMaster, plus the total. The details of the table are as follows:
1. WordMaster
2. FinanceMaster
3. Total revenue allocated: 280 dollars
If the suite price is less than or equal to the stand-alone price of the primary product, the primary product is allocated 100% of the suite revenue. All other products in the suite receive no allocation of revenue.
Now suppose FinanceMaster is designated as the primary product and WordMaster as the first-incremental product. Then the incremental revenue-allocation method allocates revenues of the as follows:
The table depicts revenue allocated and cumulative revenue allocated under the incremental revenue-allocation method for FinanceMaster and WordMaster, plus the total. The details of the table are as follows:
1. FinanceMaster
2. WordMaster
3. Total revenue allocated: 280 dollars
The Shapley value method allocates to each product the average of the revenues allocated as the primary and first-incremental products:
The table depicts the allocations under the Shapley value method. The details of the table are as follows:
1. WordMaster: The quantity 125 dollars plus 55 dollars divided by 2 equals 180 dollars divided by two equals 90 dollars
2. FinanceMaster: The quantity 225 dollars plus 155 dollars divided by 2 equals 380 dollars divided by two equals 190 dollars
3. Total: 280 dollars
The incremental revenue-allocation methods can be adapted if Dynamic Software sells manymore units of one product relative to another.*
When there are more than two products in the suite, the incremental revenue-allocation method allocates suite revenues sequentially. Assume WordMaster is the primary product in Dynamic Software’s three-product suite, FinanceMaster is the first-incremental product, and DataMaster is the second-incremental product and Dynamic Software sells equal quantities of WordMaster, FinanceMaster, and DataMaster. The suite sells for $380. The allocation of the $380 suite revenues proceeds as follows:
The table depicts revenue allocated and cumulative revenue allocated for WordMaster, FinanceMaster, and DataMaster, plus the total. The details of the table are as follows:
1. WordMaster
2. FinanceMaster
3. DataMaster
4. Total revenue allocated: 380 dollars
Now suppose WordMaster is the primary product, DataMaster is the first-incremental product, and FinanceMaster is the second-incremental product.
The table depicts revenue allocated and cumulative revenue allocated for WordMaster, DataMaster, and FinanceMaster, plus the total. The details of the table are as follows:
1. WordMaster
2. DataMaster
3. FinanceMaster
4. Total revenue allocated: 380 dollars
The ranking of the individual products in the suite determines the revenues allocated to them. Product managers at Dynamic Software likely would have different views of how their individual products contribute to sales of the suite products. In fact, each product manager would claim to be responsible for the primary product in the " * Because the stand-alone revenue-allocation method does not require rankings of individual products in the suite, this method is less likely to cause debates among product managers.*
Revenue allocations are also important for tax reasons. For example, Verizon Communications Inc., the second-largest provider of telecommunications and cable services in the United States, sells each of its services—telephone, cable television, and broadband—separately and in bundled arrangements. State and local tax laws often stipulate that if a bundle is sold and the price for each line item is not split out on the consumer’s bill, then all services are taxed as telephone services, which generally carries the highest tax rate. To preclude consumers from paying higher taxes on the entire package, Verizon allocates bundled service revenue to its telephone, cable television, and broadband services based on the stand-alone selling prices of these services. Consumers then pay taxes on the amounts billed for each service. Specialized software packages, such as CCH SureTax, help companies such as Verizon to properly recognize revenue according to the laws of each state.*