Abstract
Tying, bundling, minimum purchase requirements, loyalty discounts, exclusive dealing, and other purchase restraints can create stronger incentives for firms to invest in product quality. In our first example, the firm sells a durable experience good and a complementary non-durable good to a representative consumer. Tying shifts profits from the durable to the non-durable good, making profits more sensitive to the consumer's experience. In our second example, the firm sells a single experience good to consumers with heterogeneous demands. Minimum purchase requirements screen out the low-volume consumers who would otherwise free ride on the superior monitoring of the high-volume consumers. The examples illustrate that purchase restraints can increase both firm profits and consumer surplus by making firm profits more sensitive to consumer experience, either directly by giving the consumer more control over the stream of profits or indirectly by constraining consumers to monitor more intensively.
Highlights
Why do firms constrain consumer choice by physically bundling their products together or by contractually mandating their products be jointly purchased? In the law and economics and industrial organization literatures, most research on product bundling and product tying focuses on price discrimination or market foreclosure.[1]
We describe the ways in which purchase restraints – including tying, bundling, quantity forcing, volume discounts, and loyalty programs – can create stronger incentives for firms to invest in product quality, and can increase both profit and consumer surplus
Quantity forcing, and other purchase restraints serve to exclude these low-volume consumers from the market, increasing the average speed of consumer learning and
Summary
Why do firms constrain consumer choice by physically bundling their products together or by contractually mandating their products be jointly purchased? In the law and economics and industrial organization literatures, most research on product bundling and product tying focuses on price discrimination or market foreclosure.[1]. If the firm ties the products, it charges a lower price for the durable good but a higher-than-market price for the complementary non-durable good Through this scheme, bundling or tying creates a stream of rents that will accrue to the firm if and only if the consumer remains satisfied with his or her purchases.[5]. We show that the presence of too many of these free-riding consumers erodes the firm’s incentives to invest in product quality and makes the provision of a high quality product unsustainable.[7] Minimum purchase requirements, quantity forcing, and other purchase restraints serve to exclude these low-volume consumers from the market, increasing the average speed of consumer learning and
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