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Bundling under Competition: Duopoly and Oligopoly

  • Author(s): Khodabakhshian, Araz
  • Advisor(s): Karmarkar, Uday S
  • et al.
Abstract

In many markets, bundling, or the offering of two or more products in a package for a single price is a common practice. While most markets are competitive, the majority of research work around bundling has focused on monopolistic markets, which are more tractable for analysis. From a monopolist’s perspective, bundling has many benefits such as economies of scope, price discrimination, and expansion of demand. However, competition adds an important dimension to bundling decisions and their results. In this dissertation, the aim is to study the implications of competition for firms’ product offering, pricing, and bundle design decisions.

In the first chapter, we study bundling in a duopoly under price competition and show that bundling can serve as a product differentiation tool and moderate competition even when firms are perfectly identical and offer undifferentiated products. In equilibrium, firms have an asymmetric bundling strategy, i.e., if one firm bundles the other does not. The bundling decision depends on the valuations of customer groups for the two products in the market. However, the firm offering the bundle earns a higher profit. This suggests an inherent first-mover advantage to bundling. There are two factors predicting the success of bundling in a price-competition setting. One is being ahead of the competitor in offering the bundle, and the other is the degree of correlation or its lack in customer valuations of bundle components.

In the next chapter, we utilize a quantity competition (Cournot) framework to study the implications of bundling with entry. This model enables the analysis to go beyond duopoly to an oligopolistic market with fixed costs of entry, where firms enter as long as they can recover the fixed cost. We investigate firms' production quantity decisions and profits in equilibrium to determine the number of firms that enter each market. In a two-component setting, we consider examples with two types of offers: a single product, and the product bundled with the other. Then we consider the case of three markets consisting respectively of the first product, the second product, and a matched-quantity bundle of both products. We find that there may not be a unique equilibrium for the number of firms in each market. Moreover, we show that it is possible to construct settings where the number of equilibria can be arbitrarily large. We identify two factors for the success of bundles: one on the demand side and one on the supply side. On the demand side, customers buy bundles as long as both components within the bundle add relatively comparable values to them. On the supply side, firms enter the bundle market if the fixed-cost of entry for the bundle market is lower than the sum of fixed-costs of entry for all components within the bundle by at least a certain amount. We show that these results hold for a single customer group, as well as multiple customer groups.

In the last chapter, we study bundle design, which does not seem to be addressed in the literature. We relax the quantity matching assumption common to most bundling research, and allow the firm to choose the ratio of component quantities within the bundle, i.e. \textit{bundle proportion}, so as to maximize profits. We study four market settings: a monopolist with one type of bundle and one customer group, a monopolist with one type of bundle and two customer groups, two bundling firms with the same bundle design and with multiple customer groups, and two bundling firms in competition with potentially different bundling proportions. We conclude that for a monopolist bundler the optimal bundle proportion depends on the satiation consumption levels of the customer. When there is just one customer group in the market, the bundle proportion has a unique global maximum. However, with two customer groups the profit function can have two local maxima and it is possible, though unlikely, to have two optimal bundle proportions. When two bundlers offer potentially independent bundles, in equilibrium, the bundle proportion choices converge. The bundling proportions ratio is a function of the aggregate satiation consumption levels of all customers and is the same for simultaneous as well as sequential entry.

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