Bundling decisions in a two-product duopoly – Lead or follow?

Abstract

We evaluate the impact of bundling on firms’ product and pricing strategies by developing and solving a multi-stage game theoretic model to represent strategic interactions between two competing firms. Each firm is able to produce two homogeneous products and can opt to bundle them together, which may have the dual benefits of providing added value to consumers and reducing marginal cost for firms. One firm (the leader) determines its product offering before the other (the follower), and both then simultaneously set prices. We demonstrate the existence and uniqueness of a Nash equilibrium and show that the option to bundle can benefit all competitors simultaneously. When mixed bundling is not an option, we characterize and quantify the leader’s advantage in terms of profitability. However, when mixed bundling is an option, the follower may reverse its profit disadvantage by using it as a potential threat. Furthermore, our numerical results show that (i) bundling enhances the balance between firms’ total profit and consumer surplus; (ii) for the firm that bundles, value addition and cost saving brought by bundling act as strategic complements in that their combined benefit is larger than the sum of individual benefits; and (iii) value addition and cost saving improve the market demand, firms’ total profit as well as consumer surplus.