Optimization of Product Bundling Strategy Decisions and Inventory Allocation
with the Integration of the Degree of Contingency and Dead Stock Levels in a
Multiple Time Period Setting
E. J. Franco1, M. C. Santos1, D. E. Suyom1, D. E. Cruz1
1
Department of Industrial Engineering, De La Salle University, Manila, Philippines
edward_franco@dlsu.edu.ph; mikhaela_santos@dlsu.edu.ph; denise_suyom@dlsu.edu.ph; dennis.cruz@dlsu.edu.ph
Abstract – This paper considers a multiple integer non-linear
programming model that aims to optimize the three types of bundling
strategies while considering the selection of components for the
bundles that integrates the degree of contingency and the dead stock
component of the product. The proposed model is validated through
different scenarios with varying incremental input parameters in
order to determine the effects of the variables to the objective function
and the sensitive points in the model. The results were able to show
that an increasing degree of contingency is able to affect the pure
component variable while the interaction of degree of contingency
and the reservation price of a mixed individual appears to have a
significant effect on the number of pure bundles. In addition, the dead
stock level and degree of contingency have produced adverse effects
to bundling optimization. These results have shown that integrating
component selection, dead stock level and bundling strategies gave the
model the flexibility to change through its varying parameters
improving its profitability.
Keywords–Product Bundling, Dead Stock, Degree of
Contingency, Operations Research
I. INTRODUCTION
Product bundling is defined as the practice of selling two
or more products that are combined into one unit [1]. It is
widely used in the manufacturing and service industry where
products and services are bundled together. Manufacturing
firms’ intent on bundling products is to control the variability
of demand between products. One specific scenario is
demonstrated in the overproduction of goods thus incurring
high inventory in the warehouse. In this instance, bundling is
deemed to be a fitting strategy to reduce its inventory levels.
Moreover, bundling is also used as a strategy to push out slow
moving products and reduce the total holding cost incurred in
storing the goods.
Products can be classified according to their degree of
valuation. Some products are perceived as less attractive by the
customer, these are called products with low valuation. By
integrating bundling, products with low valuation may be
paired with products of high valuation. This maximizes
consumer surplus for the bundle because of the high
willingness to pay for the product with high valuation.
Moreover, firms opt to bundle because it is more profitable
than selling stand-along products [2]. This is because firms are
able to reduce the varying preference of the customers by
combining the products preferred by customers [3]. Moreover,
bundling is carried out as a profitable strategy by
discriminating consumers with heterogeneous preferences.
These discriminating consumers are often the most difficult to
please. The strategy is able to exploit the consumer’s
willingness to pay.
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Bundling is also known for reducing customer
heterogeneity. Customer heterogeneity is defined as the range
of the variability in the valuation of various customers. A high
customer heterogeneity would mean a high range of customer
valuation or preference, while a low customer heterogeneity
would indicate a lower rage of customer variation.
In the field of product bundling research, two significant
features have always been discussed as a means of addressing
bundling problems, these are: bundling strategies and
component selection. Product bundling can take the form of
three different bundling strategies, namely: pure component,
pure bundling, and mixed bundling. In pure component, the
products are always sold individually. In pure bundling, only
bundled items are for sale, which entails that a product must be
bundled to be available to the market. Mixed bundling allows
the products to be offered in two different ways, individually
and by the bundle. [4].
Decisions on the most appropriate bundling strategy differ
depending on the situation of the component. The optimal
bundling strategy would vary from different sets of
components depending on their reservation prices and
marginal cost [5] therefore it is constructive to integrate the
two features (component selection and bundling strategies
decision) to maximize the revenue of the system further while
improving customer valuation.
In component selection, the basis of choosing the best
component pairings are based on which pairing would produce
the highest product valuation as portrayed on studies by [1],
[6], [7],[2] and more. However, another purpose of product
bundling is to be able to push out slow to non-moving
products out of the system in order to decrease its costs. In a
study by [8] it makes use of the degree of contingency as a
parameter for bundling multiple products. The degree of
contingency is defined as the association of two variables,
known as the level of complementarity and level of
substitutability [6]. The degree of contingency is used to
impact the customer’s overall valuation of a bundled unit.
Hence, when products are said to be complementary, the value
of the bundle is still greater than the sum of its components’
values while substitute products extracts a lower value for the
bundle.
Fig 1. Degree of Contingency
The degree of contingency may have a value from 0 to 1.
When its value lies between 0.5 to 1, then it is said to be
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 Proceedings of the 2017 IEEE IEEM
complementary while a value between 0 to 0.5 suggests that
they are substitute products. However, evaluating the effects of
the degree of contingency to the overall profit only considers
customer preference. Hence, dead stock components are
accounted in order to consider merchant requirement.
Merchant requirements consider factors that are most likely to
minimize costs during the operations before the product is
delivered to the market. In this case, the dead stock level is an
important merchant requirement because of its impacts on
inventory costs. Dead stocks are components that are stocked
in inventory and are less likely to make sales [9]. Considering
the perspective of the merchant would enable to examine the
trade-off between customer preference and merchant
requirements.
Integrating inventory management will be able to
determine the optimal order quantity for each SKU of the
products. Thus, it is essential to be able to determine the
quantity to order and allocate for each product bundling
strategy to be employed. Inventory management deals with
optimal order quantity of different SKUs by the warehouse
[10]. Determining the order quantity per period would improve
inventory management of the system. Being able to determine
the optimal order quantity would minimize stock-out costs and
holding costs of the system. Ordering amounts that would go
over the demand could lead to more inventories which would
increase holding costs, while ordering amounts that would lead
to unmet demand would lead to stock-out costs. Thus, the
inventory management of the system would be improved as
well by incorporating the use of optimal order quantity. These
order quantities would vary per period because of the
variations as well in different factors such as demand and
beginning inventory [11]. The importance of taking into
account the holding cost of deadstock products, which is
accumulated in multiple periods, to the different inventory
management decisions is essential in determining the
profitability of the system. Thus, employing a multi-period
strategy would have an effect on the revenues generated by the
firm because of the varying valuation thru time.
II. METHODOLOGY/MODEL FORMULATION
A mixed integer nonlinear programming optimization
model (MINLP) was utilized to optimize the overall profit of a
firm. MINLP refers to problems with nonlinear functions with
discrete or continuous variables. The formulated model is
applied to a heterogeneous market with an infinite pool of
products under a finite time horizon.
Assumptions
• Lead time for product replenishment is known and
constant
• Stock out may occur
• Bundling process is instantaneous
• Demand is a function of selling price and degree of
contingency
• Products may be considered as a deadstock
Indices
i = Component i classified for bundling {1, 2, 3… n}
j = Component j classified for bundling {1, 2, 3… n}
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k = Pure component type {1, 2, 3… n}
l = Time period l {0, 1, 2… n}
Parameters
, =Marginal Cost of Component k at period l
, = Holding Cost of Component k at period l
, = Purchasing Cost of Component k at period l
= Upper Bound Reservation Price of Component k at
period l
, = Lower Bound Reservation Price of Component k at
period l
, = Reservation Price of Mixed Component i at period l
, = Beginning Inventory of Component k at period l
, , = Lead time for ordering component i and j
, , = Stock out cost for component i and k and bundle ij at
period l
= Capacity of Warehouse
= Threshold value for Dead stock
THHETERO = Threshold value for Heterogeneity
THPRIOR = Threshold value for Dead stock Priority Bundle
FIT = Priority value
System Variables
, = Heterogeneity Value for component k at period l
= Ending Inventory of Mixed Components i at period l
,
, = Ending Inventory of Component k at period l
= Reservation Price of Bundle ij at period l
, ,
, = Stock-out Quantity of mixed individual component I in
period l
, = Stock-out Quantity of pure component i in period l
, , = Stock-out Quantity of bundle ij in period l
Decision Variables
= Selling Price of Component k at period l
,
, = Selling Price of Mixed Product i at period l
, , = Selling Price of Bundle Product ij at period l
= Quantity Sold of Component k at period l
,
= Quantity Ordered for Component k at period l
,
, = Quantity of Mixed Component i at period l
, , = Quantity of Bundle Products ij to be formed at period l
, , = Quantity Sold for Bundle Product ij at period l
, - = Quantity of Deadstock Component of Mixed Component
i at period l
1, = Quantity Sold of Mixed Product i at period l
,, = 1 if component k at period l is to be used as pure
component, 0 otherwise
, , = 1 if bundle ij at period l should be sold as Bundle, 0
otherwise
, = 1 if component i at period l is to be used as a mixed
component, 0 otherwise
, = 1 if mixed component i at period l qualifies as a dead
stock, 0 otherwise
Objective Function
The objective function aims to maximize the profit of the
mathematical model by considering the corresponding costs
and selling price of the sold components. Since the products
can be sold in three types, component, bundles, and mixed
components, the revenue for each is derived from the selling
price of the products. Furthermore, the corresponding cost
components and penalties were considered in maximizing the
profit.
EQUATION 1 OBJECTIVE FUNCTION
 Proceedings of the 2017 IEEE IEEM

, ∗ , EQUATION5
∑ , ∑ , ∀, ,
, ,

Heterogeneity Constraint –This constraint is significant

∗ , , , ∗ ,
because it defines the heterogeneity value. Heterogeneity
highlights the effects of customer preferences [12].
EQUATION6
, ∗ ,

, , 2 ∗ ,
∗ , ∀ ,
, , 2 , ,

, , ∗ , ,
Heterogeneity Qualifying Constraint - This constraint is
essential to the model as it pursues the effects of the
heterogeneity equation into selecting the best bundling
, ∗ ,
strategy.
EQUATION7
, ∗ ,
, 1 , ∀ ,

, , ∗ , , EQUATION8
, 0.0000001 1 , ∀ ,

Dead Stock Quality Constraint – This constraint identifies

Subject to the following Constraints
whether a component is a dead stock or not according to the
total sales it made in the previous periods.
Mixed Component Translation Constraint – This EQUATION9
constraint is essential to the model as it dictates the number of
mix component allocated from the total inventory. This is
, , ,, ∗ 2 ,
important because the number of components to be used for
bundles and mixed products is derived from the total number
.
of mixed components. AVESALES ∗ 1 ∀,,
,

EQUATION2
EQUATION10
, , ∗ 1 , ∀, ,

, , ,, ∗ 2 ,
Mixed Products Quantities Constraint - Dictates the total
number of bundles that can be made based on the available .
number of mixed components. As inventory is allocated, this AVESALES 0.000001
∗ 1 ∀, ,
constraint limits the number of products that will be used for ,

bundling. Dead Stock Translation Constraint – This constraint is

important because it identifies the number of dead stock
EQUATION3
inventory.
∑ EQUATION 11
, , ,, ∗2 .
1, ∗ 1 , ∀, , , , ∗ , ∀,

Bundles Quantity Constraint - This constraint ideally
dictates the number of bundles that can be sold from the total
number of mixed components. This limits the model to only
select products that were sold and were manufactured in the
profit optimization process.
EQUATION4
∑ , ,
, ∗ 1
Capacity Constraint –The capacity constraint puts importance
to the allocated inventory and holding cost because it limits the
availability of the product, the model must select the optimal
combination of products that maximizes the warehouse space
as well.
Dead Stock Ratio Equation - This constraint identifies the
component with the largest amount of dead stock in the
pursuance of selecting the dead stock component in the pairing
process. The
EQUATION12
∑ , ∗ ,
, , ∀, ,
∑ ,
,, ∗ 2 . Dead Stock Priority Bundle Equation - This is essential to
, ∀, , the model as it puts a relationship between the degree of
contingency and dead stock ratio. A high dead stock priority
bundle value signifies that the components are highly
considered in the bundling process because the two products
are contingent with one another and are possibly dead stocks.
Moreover, the incorporation of the variable FIT allows the

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model to prioritize the degree of contingency over the dead
stock ratio and vice versa. This helps in the analysis for firms
that prioritize one factor over the other.
EQUATION 13
, , ∗ , ,
1 ∗ , ,
Bundling qualifying Constraint – This constraint is
essential to the model because it allows the model to review
the importance of dead stocks in bundling decisions.
EQUATION14
, , , ∗ , ,
III. RESULTS AND DISCUSSION
The model formulated was validated by using the
software General Algebraic Modeling Software (GAMS), and
was coded using hypothetical data that were based on data
from fast moving consumer goods. GAM has a built-in
MINLP solver which evaluates nonlinear equations. Design
Expert was used to conduct design of experiments which
evaluates the effects of two factors on the decision variables.
A. Pure Component Characterization Analysis
An increasing degree of contingency is able to affect the
pure component variable. As the complementarity between
two products increase, the less desirable it becomes as a pure
component. Thus, judging from the graph produced as seen in
Fig 2, a pure component strategy is recommended for products
that are not considered as a perfect complement with another
product. Products that are able to stand alone and are able to
attract customers through its individuality should be kept and
sold as a pure component. Products with high inventory and
high degree of contingency with other products would not
result to a pure component strategy.
Fig 2. Pure Component Analysis
B. Interaction Between Individual Reservation Price and
Degree of Contingency
The interaction of degree of contingency and the
reservation price of a mixed individual appears to have a
significant effect on the number of pure bundles. From the 3-D
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Proceedings of the 2017 IEEE IEEM
Graph shown in Fig 3, while the degree of contingency
increases, the chances of adapting to a pure bundling strategy
increases. On the other hand, decreasing the reservation price
of the mixed individual would also lean to a pure bundling
strategy. Thus, the pure bundling strategy is recommended for
∀, , products that are perfect complements and would have
difficulty being sold as a stand-alone product. For products
with high complementarity however but displays a high
valuation as an individual, the less the product is leaning to a
pure bundling strategy and more as a mixed bundling strategy.
∀, ,
Fig 3. Individual Res Price Vs. Degree of Contingency
C. The Effects of Dead Stock and Degree of Contingency
Deadstock and valuation have adverse effects to bundling
optimization. As seen in the model, components that are
qualified as dead stock displayed low sales in the previous
period. These dead stock products were prioritized in the
bundling decision process. The degree of contingency was also
considered because it entails the degree at which products
complement each other more, which increases the chance of
selling the bundle. Through sensitivity analysis, the effects of
these two factors on bundling decisions are identified.
Fig 4. Deadstock vs. Degree of Contingency
In this analysis, the parameters were varied two at a
time. Fig 4 demonstrates the 3-D plot between the dead stock
inventory, degree of contingency and the response or the
number of bundles formed. The curve’s highest point can be
seen in the area where the dead stock inventory and the degree
of contingency is highest; therefore, such setting is able to
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produce the highest lot of bundles. Moreover, the region with
low degree of contingency - low dead stock inventory and
high degree of contingency - low dead stock inventory appear
to produce the least number of bundles. The region with high
dead stock inventory and low degree of contingency appear to
produce a mid-level number of bundles. It can be deduced that
the dead stock inventory affects the bundling decisions slightly
more than the degree of contingency. This is explained by the
fact that bundling is also heavily reliant on the number of
inventory to be able to produce more of such.
IV. CONCLUSION AND RECOMMENDATIONS
The addition of dead stock inventory into the model has
shown significant effects on the bundling policies and
decisions of the model. When dead stock products are not
pushed out of inventory, holding cost accumulates thus the
profit of the firm suffers. However, through enabling the
system to bundle and pair this product another product,
inventory could be cleared and avoid the accumulation of
holding costs.
Integrating both degree of contingency and dead stock
components was able to consider both the valuation and the
holding costs in measuring profitability. Thus, the possibility
that bundling could occur at low degree of contingency and
low dead stock component was shown and could exist. The
trade-off between bundling products with high dead stock
inventory and bundling products with high degree of
complementarity was able to be incorporated in the model.
There are certain instances and scenarios that bundling
products with low complementarity could be more profitable
for the company if it means pushing out dead stock with
accumulating holding costs. This proves the importance and
significance of considering both of these factors in deciding
which products should be bundled.
Fig 5. Summary of Findings
Integrating different bundling strategies (Pure
Component, Pure Bundling, Mixed Bundling) has shown that
a flexible bundling strategy depending on the different
parameters would enable the firm to optimize their
profitability. The results also show that products with high
individual reservation price and low degree of contingency
would be most likely sold as a Pure Component. For products
that have a high dead stock component and high degree of
contingency with other products is recommended to be sold as
a Pure Bundle as well while products, with high degree of
contingency and a high individual reservation price, which
indicates that it has a high value as both a bundle and as an
individual, is recommended to be sold as a Mixed Bundle as
summarized by Fig 5.
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Several recommendations can be made for future studies
such as the incorporation of the inventory management system
into a supply chain perspective. In product bundling, there are
various decisions to be made in many levels of the supply
chain which are affected by these decisions. Including the
decision variable of where to do the product bundling can also
be a valuable addition to the study for this is one of the crucial
decisions that managers would have to make in relation to
product bundling.
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