6. Bundling

1
6. Bundling

• Eugenio J. Miravete

2
Outline

• Definition.
• Pure vs. Mixed Bundling.
• Analysis with independent products.
• Bundling with positive marginal costs.
• Bundling and competition.
• Tie-ins.
• Antitrust considerations. Foreclosure.
• Example.

3
Definitions

• Bundling is a common practice by multiproduct
  firms. Essentially this is another form of price
  discrimination where the seller takes advantage
  of consumers differences in willingness to pay
  for different types of products.
• Bundling may take several different forms. If the
  monopolist sells products X and Y, he/she can do
  the following
• Pure Bundling. Ask consumers to buy both
  products. It is not possible to buy one product
  in isolation.
• Mixed Bundling. Sell both products in isolation
  as well as the bundle, normally at a discount.
• Multiproduct Nonlinear Tariff. Offer discounts
  depending on the consumption of each product in
  the bundle. Complex problem.

4
Example (1/3)

• Suppose that a movie distributor sells two
  movies together to movie theaters. Together with
  Gladiator, (A) the distributor insists in
  selling Babettes Feast, (B) a slow spirited,
  sociological analysis of religion and
  closed-mindedness in a small fishing village in
  early 19th century Denmark, and obviously spoken
  in Danish.
• There are two potential movie theaters. Movie
  theater M1 is located close to a popular shopping
  mall. Movie theater M2 is in the surroundings of
  an Ivy-League university where culture-addicts
  students insist in broadening their horizons even
  during weekends.
• Assume that the willingness to pay for each movie
  by the owner of each movie theater is as follows
• M1 A 2,500 B 1,800.
• M2 A 2,000 B 3,000.

5
Example (2/3)

• Suppose also that cost of movies for the
  distributor are either negligible or sunk.
• First Degree Price Discrimination The
  distributor sells each movie to each movie
  theater by the maximum amount that they are
  willing to pay
• M1 pays 4,300.
• M2 pays 5,000.
• Distributors profits 9,300.
• Third Degree Price Discrimination The
  distributor may charge different prices for
  different products but they should be the same
  for all customers. No customer can be excluded.
• The price of A is 2,000 while the price of B is
  1,800.
• Distributors profits 7,600.

6
Example (3/3)

• Bundling The distributor charges a single price
  for the bundle (observe that this is similar to
  the first strategy of the pub owner example
  studied in previous lectures).
• M1 is willing to pay 4,300 for the bundle of
  movies AB.
• M2 is willing to pay 5,000 for the bundle of
  movies AB.
• The distributor charges 4,300 for the bundle and
  makes profits 8,600.

7
Independent Pricing (1/2)

• Independent goods There are two goods, X and Y
  (for instance basic cable service and fast
  internet access). These goods are independent in
  the sense that the valuation of the bundle is
  just the sum of valuations of each component
• V(XY) V(X) V(Y)
• Assume individual unit demands.
• Marginal cost of production is assumed to be
  zero.
• Assume that PX 30 and PY 45.
• Under independent pricing
• Subscribers to cable are such that V(X) ? 30.
• Subscribers to fast access to internet are such
  that V(Y) ? 45.

8
Independent Pricing (2/2)
V(Y)

B
A
45
C
D
V(X)
30
9
Pure Bundling (1/2)

• Under pure bundling consumers have to buy both
  products together. It is not possible to buy only
  one of the products of the bundle.
• This policy raises serious antitrust concerns.
• Suppose that the seller find optimal to offer
  both cable service and internet access for PXY
  55.
• Under pure bundling
• Subscribers that buy the bundle are such that
  their joint valuation of components exceeds the
  price V(XY) ? 55.
• Is this policy efficient? Is it fair? Is the
  seller forcing consumers to buy both products? Do
  consumers buy something that they do not want? Is
  there any discount involved?

10
Pure Bundling (2/2)
V(Y)

C
D
A
45
E
F
G
25
I
V(X)
30
10
11
Mixed Bundling (1/2)

• Under mixed bundling consumers have more
  alternatives. They can buy the bundle (normally
  at a discount) or they can buy its component
  separately
• This policy should not raise any antitrust
  concerns.
• Under mixed bundling
• Subscribers that buy the bundle are such that
  their joint valuation of components exceeds the
  price V(XY) ? 55.
• Subscribers of the cable service are such that
  V(X) ? 30 and V(Y)
• Subscribers of the internet service are such that
  V(Y) ? 45 and V(X) ? 10.
• What is the real cost of forbidding bundling? Who
  gets really hurt by not allowing bundling?
• Role of the distribution of valuations.

12
Mixed Bundling (2/2)
V(Y)

B
C
D
A
45
E
F
G
25
H
I
V(X)
30
10
13
Bundling with Positive Marginal Costs

• Cross-subsidization is possible. Some customers
  may get a product in the bundle when their
  valuation is actually below the marginal cost of
  producing it.

V(Y)
1
MCX
V(X) MCX MCY V(Y)
2
45
MCY
3
V(X)
30
14
Bundling and Competition (1/2)

• Bundling threats the effectiveness of competition
  when multiproduct firms can use it to
  cross-subsidize across markets.
• Assume that production of X (local calls) is
  monopolized. Production of Y (long distance) is
  competitive and PY MCY.
• Depending on the valuation of each service, there
  are several possibilities
• D1 and D2
• A1 Only buy Y (from competitor if the monopolist
  uses pure bundling).
• A2 They could buy the bundle but buying Y only
  leaves then more CS.
• B Buy the bundle.
• C Buy the bundle although the valuation for Y is
  below MCY.
• Unbundling. Introducing competition in the market
  of X will increase welfare because D2 will now
  buy X.

15
Bundling and Competition (2/2)
V(Y)

PXY
A2
B
A1
PY MCY
C
D1
D2
V(X)
PXY -PY
PXY
16
Problem (1/4)

• A cable company has two services. One is the
  Basic Service channel. The other is the Walt
  Disney Movie channel. The potential subscribers
  for the services regard them as separate
  alternatives. Their demands for the two services
  are completely unrelated for each and every
  consumer.
• Each consumer type is characterized by a pair of
  reservation prices
• Students 5 (BS) 15 (WD).
• Families 11 (BS) 9 (WD).
• Hotels 14 (BS) 6 (WD).
• Schools 4 (BS) 16 (WD).
• Young Adults 0 (BS) 17 (WD).
• Pensioners 17 (BS) 0 (WD).
• Marginal cost of each service is 3.
• There are equal numbers of consumers in each
  category.

17
Problem (2/4)

• If services are sold separately and not offered
  as a bundle what price should the cable operator
  set for each service? (Just a single price per
  service. Third degree price discrimination is not
  allowed). What profits will she earn? Which
  consumers will subscribe to which services?
• Basic Service
• Price 11.
• Profits 24 (from families, hotels, and
  pensioners).
• Disney Channel
• Price 15.
• Profits 36 (from students, schools, and young
  adults).
• Total profits 60.

18
Problem (3/4)

• Suppose that the operator decides to pursue a
  pure bundling strategy. What price should be set
  for the bundled service? Which consumers buy
  which options, and what are the cable operators
  profits?
• Bundle
• Price 17.
• Profits 66 (from all customer groups).

19
Problem (4/4)

• Suppose that the operator decides to pursue a
  mixed bundling strategy. What price should be set
  for the bundled service? What price should she
  set for each service if purchased individually?
  Which consumers buy which options, and what are
  the cable operators profits?
• Bundle
• Price 20.
• Profits 66 (from students, families, hotels, and
  schools).
• Basic Service
• Price 17.
• Profits 14 (from pensioners).
• Disney Channel
• Price 17.
• Profits 14 (from young adults).
• Total profits 94.

20
Tie-ins

• Features
• Purchase of two (or more) related goods in
  variable proportions.
• Examples Xerox, Polaroid, Kodak.
• Complementarity either economic or due to
  technological standards.
• It is a way to implement price discrimination
• It avoids arbitrage
• Effectively charges different prices to
  consumers.
• Applied to goods easily produced in competitive
  environments.
• Antitrust
• As price discrimination it should avoid
  anticompetitive effects.
• Quality control should be specified in contracts
  giving options to customers.
• Change in the 60s to emphasize the reduction of
  transaction costs and efficiency gains.
• Since 1984, there are concerns about market power
  and foreclosure.