Bundling

Bundling^[4]

Can a firm use bundling to increase profits? Bundling means selling many products in one package. Bundling can’t be used to get a single customer to pay more. If different customers place separate values on your products, however, bundling might enable you to increase profits.

Extending Monopolies Through Bundling (Slightly Technical)

Microsoft has a near monopoly on operating systems for PCs and bundles lots of software into its operating system. Microsoft doesn’t have a monopoly on all of this other software, because much of it has close alternatives produced by other companies. Does bundling permit Microsoft to extend its monopoly?

Consider the issue abstractly. Imagine that a firm has a monopoly on good M. This monopoly allows it to charge extremely high prices for M. The firm does not have a monopoly on good X. Could the firm enhance its monopoly profits by forcing consumers to buy X whenever they purchase M?

No, bundling cannot help a firm extend its monopoly. To understand this, assume that good M is worth $100 to you and good X is worth $20 to you.

Table 4: Value of Goods to One Customer

Product	Value To You
M	$100
X	$20

Sold separately, the most you would ever pay for M would be $100. Just because a firm has a monopoly doesn’t mean that it can charge whatever price it wants. (If a monopoly could sell M at any price it would set the price of M at infinity!) Obviously, the most you would pay for X is $20. Consequently, if the firm sells the goods separately the most it will ever be able to get from you is $120. If the firm bundles the two products, it doesn’t increase their value to you. Therefore, if the firm bundles, the most they could ever get you to pay would be $120. Hence, if you would have bought both goods anyway, bundling wouldn’t help the firm increase its profits.

Assume now, however, that you would only have bought M but not X if the two goods were sold separately. Can the monopolist now use bundling to increase its profits? No! The only way the monopolist could ever get you to buy the bundle is if the bundle’s price is $120 or less. By selling the goods separately at $100 for M and $20 for X, however, the monopolist could also have gotten you to buy both products. Thus, bundling doesn’t allow the monopolist to do anything it couldn’t do by selling the products separately.

While bundling can’t get a single customer to pay more, it can be used to get more money from a group of customers who place different valuations on your products.

When Bundling Can Be Profitable

Imagine that two customers place different values on products X and Y.

Table 5: Value of Goods to Two Customers

Product	Value to Abe	Value To Bill
X	$100	$40
Y	$40	$100

Assume that the firm can’t price discriminate. If the firm sold only product X, it could sell either to just Abe for $100 or to both Abe and Bill for $40 each.

Consequently, by selling both products separately the most revenue the firm could get would be $200, which would be achieved by selling both goods for $100 to one customer each. Now imagine that the seller bundles the two products and charges $140 each. Both consumers would be willing to pay $140 for this package, so bundling could gross this firm $280.

If some customers greatly value X and others place a high value on Y, then bundling can help a firm extract more total profits from its customers. The bundling doesn’t increase the value of the product to one particular customer but rather evens out how much customers are willing to pay.

This type of bundling is most profitable when a company sells an easy-to-replicate good. Imagine that a company sells many different types of software packages. Each package has a small value to many and a large value to a few. Without bundling, this company faces a difficult choice. It can either set a high price and attract a few customers or a low price and attract many. Its best option would be to bundle all the software into a single package. True, many customers would get software they don’t place a high value on, but since it’s so cheap to give customers copies of software, software bundling doesn’t significantly increase a company’s cost.

Microsoft’s bundling of so much software into its operating system can be explained not as an attempt to expand a monopoly, but rather as an attempt to put in something everybody likes.

^[4]Based on CNBC.com (February 15, 2000).