Competitive Bundling in a Bertrand Duopoly

Abstract

In competitive industries, some firms bundle their products whereas others unbundle them; still other firms occupy a niche position and offer only a subset of products. No general theory has been advanced to explain this variety of bundling strategies. We characterize the strategies of two symmetric firms competing (in a Bertrand fashion) with regard to two homogeneous components, where the firms bundling and pricing decisions are modeled as a two-stage non-cooperative game. Firms in the first stage select their product offerings, which may include any single-component product and/or the bundle; in the second stage, firms simultaneously set their products prices. We show that, under pure bundling, there is always an equilibrium in which one firm bundles while the other offers only a single-component product. Under mixed bundling, three types of equilibria emerge when customer valuations are highly heterogeneous: asymmetric bundling strategies, a monopoly, and head-to-head competition. Yet when those valuations are more homogeneous, almost any combination of offerings can be sustained in equilibrium. Our analysis indicates that in a competitive setting, bundling is essentially used to soften price competition or to defend a monopolistic position rather than to price discriminate, and that customer valuations need to be highly heterogeneous for the benefits of bundling to materialize.