Essays on Bundling, Compatibility and Competition

Abstract

The bundling literature has devoted much attention to the use of this pricing strategy as a deterrent to entry of a rival or the foreclosing of one. However, there are numerous industries where a two-product seller is a monopolist in one market and competes in the second, where neither entry was deterred, nor the rival was foreclosed. The first chapter makes progress in developing a framework that analyzes the profitability of bundling for such a two-product firm. Consumers are assumed to have negatively correlated valuations for the two types of products. We show that in equilibrium, the two-product seller will offer the products only in a bundle, thus preventing any consumer from forming his own bundle using the rival's product. Furthermore, he ensures himself highest profits by having all consumers interested in only the monopoly product purchase the bundle. The welfare results under this strategy show the consumers being harmed the most, as they would prefer variety in the bundle formation and/or being able to purchase only the monopoly product, should they choose to.

Compatibility of products has been addressed mostly in a mix and match scenario, where a consumer must purchase two different components to form the final system. The components themselves have no individual use. In the second chapter, we further extend this type of framework, by assuming that one of the two components (the platform) does have a stand alone use. The other type of product is offered by only one of the firms in the market, has no individual use, but could enhance the utility of one's platform. Therefore, the firm offering the complement must first decide whether to make it compatible with the rival platform and, furthermore, what pricing strategy is best. There are two types of consumers in the market: new and legacies. The new consumers are interested in platforms and, depending on compatibility, the complement. Legacy consumers are those who have already purchased a platform in a previous period and, currently, are only interested, if at all, in the complement.

We find that compatibility is optimal, as it reduces competition and maximizes profits. In such an outcome, the two-product seller offers the goods a la carte. If compatibility is not feasible due to exogenous factors, the legacy consumers in the market are of great importance. Our results indicate that the profit maximizing strategy depends on the mass of the two-product seller's legacy consumers in the market relative to the rival's.