bunding & tying

8/13/2019 Bunding & Tying

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ECON 121A: Industrial Organization

Week 9: Bundling & Tying


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Bundling

Firms sell goods as bundles selling two or more goods in a single package

complete stereo systems

Other examples?

Something that is close in nature, but slightly different: tie the sale of one good to the purchase of another

Computer printers and printer cartridges

Cell phones and minutes

Constraining the use of spare parts

Why? Because it is profitable to do so!


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Bundling: an example

Two movies are available from the same producer Star WarsandBubble Boy

No price discrimination is possible

Willingness to pay is:

Theater A

Theater B

Wil l ingness to

pay for

Star Was

Wil l ingness to

pay for

Bubble Boy

$8,000

$7,000

$2,500

$3,000

$7,000

How much canbe charged for

Bubble Boy?

$2,500

I f the f i lms are sold

separately total

revenue is $19,000

How much can

be charged for

Star Wars?


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Bundling: an example

Theater A

Theater B

Wil l ingness to

pay for

Star Wars

Wil l ingness to

pay for

Bubble Boy

$8,000

$7,000

$2,500

$3,000

Total

Willingness

to pay

$10,500

$10,000

Now suppose

that the two fi lms are

bundled and soldas a package

How much can

be charged for

the package?

$10,000

I f the f i lms are soldas a package total

revenue is $20,000

Bundling is prof i table

because it exploitsaggregate wi l l ingness

pay


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All consumers in

region A buy

both goods

No Bundling: More detail

R2

R1

Consumer x has

reservation price px1

for good 1 and px2

for good 2

xpx2

px1

ypy2

py1

Suppose that the f irm

sets price p1for

good 1 and pr ice p2

for good 2

p1

p2

AB

DC

Consumers

split into

four groups

All consumers in

region B buy

only good 2

All consumers in

region C buy

neither good

All consumers in

region D buy

only good 1


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Pure Bundling: the example

R2

R1

Now consider pure

bundling at some

price pB

pB

pB

Consumers

now split into

two groups

E

All consumers in

region E buy

the bundle

F

All consumers in

region F do not

buy the bundle


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Good decision for the firm? Sometimes

R2

R1pB

pB

p1

p2

Bundling benefitssome consumers

But, others lose

Partial gain

Partialgain

lose

lose

Higher price

(why do I know that?)


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Issues with bundling

Can it lead to an inefficiency?

Can we do even better than pure bundling?


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Is itsociallyefficient? Not always

R2

R1c1

c2

pB

pB

E

F

Consumers in these two regions

buy each good even thoughtheir reservation price for one of

the goods is less than its

marginal cost

Can you think of a reason why bundling would not be efficient?


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Inefficiencies

A new type of inefficiency is created

We have consumers with a WTP for a product that is

below the price buying the product!


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Mixed Bundling

Mixed bundling is when you offer both the bundle

and the two products separately

Examples?

In this case, what must be true of the bundled

price?

The bundled price must be below the sum of the two

stand-alone prices

Can mixed bundling ever do worse than bundling?


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Mixed bundling

R2

R1pB

pB

p1

p2


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The end results

We will figure out where all of these come from

R2

R1pB

pB

p1

p2


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Consumers choices

Consumers have four choices

Buy nothing (type 1)

Buy only good 1 (type 2) Buy only good 2 (type 3)

Buy the bundle (type 4)


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There are a four types of consumers

The easy one:

Type 1. Your WTP for both products is less than the

stand along prices and your WTP for the bundle is lessthan the bundle price

You dont buy anything


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Buy just good 1

When would you buy just good one?

Type 2. For this to happen, (a) your WTP for good 1

has to be above the stand-alone price and (b) you mustget more utility from just good 1 than from the bundle

Hmm, lets think about that:

(a) CS1>0

WTP1p1 > 0

WTP1 > 0

(b) CS1>CSb

WTP1 - p1 > WTP1 + WTP2pb

Algebra: WTP2 < pbp1

These types buy just one


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Buy both:

Type 4. For this to happen, (a) your WTP for good

bundle has to be above the bundle price, (b) you mustget more utility from the bundle than just good 1, and

(c) you must get more utility from the bundle than just

good 2

Where is this?


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Putting this on the graph

R2

R1pB

pB

p1

p2

Type 1Type 2

Type

3 Type 4


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Which is more profitable?

Mixed bundling must always be as profitable as pure

bundling, because the option always exists to set the a-la-

carte prices arbitrarily high.

This effectively returns you to the pure bundling outcome

However, it is not necessarily the case that bundling (pure

or mixed) must yield higher profits than a la carte. Bundling is only profitable when there is lots of customer variation in how

much they value the goods.


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Introducing Tying

Tying (tie-in) sales occurs when you requireconsumers to

buy two complementary products from you

Notice the similarity with bundling

Differences:

The two goods are complements (examples?)

Use of one of the goods often varies by consumers

(The Microsoft case is really about tying, not bundling)

In some ways the difference is semantics

Tying: To buy A, you must also buy B Pure Bundling: You can only buy A and B together


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Two Motives

One: the motive behind tying is to use your market power

in one product (the tying product) to gain market power in

the other (the tied product)

The usual idea is that you have a monopoly in one good (Lexmark

printers), but there are lots of firms that make, or could make, theother (cartridges)

By tying the products together, the firm drives the other cartridge

makers out of business

This is evil

Two: Price discrimination This is less evil and can be good for society


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Bundling, Tying and the Law

Legal treatment:

Bundling is rarely challenged as such

Tying is often challenged, strict legal standard Given economic similarities, strange differences in treatment

Classic treatment of tying is modified per se.

Tying is illegal if:

Firm has market power in the tying market Products are separate

Tying forces purchase of tied good


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Example of a Recent Case

US retailers sue Visaand MasterCard for reported $8.1bn 2/00

Led by Wal-Mart Stores Inc., the nation's biggest retailers will seek damagesof $8.1 billion from VisaUSA Inc. and MasterCard International for allegedantitrustviolations in the debit-card business.

It alleges that card issuers used a monopoly in one market to enter another bytyingtheir new debit cardsto credit cardsand forcing merchants to acceptthem -- and higher fees -- in order to continue accepting credit cards.

The Visaand MasterCard debit cardsare different from traditional bank debitcards, or "ATM" cards, which charge a fee averaging about eight cents atransaction and are processed online immediately. Visaand MasterCard-debitcardsare processed "off-line," which takes longer and is somewhat more

susceptible to fraud than ATM cards. They also add a fee of about 50 cents fora typical sale, or more than 1% per transaction, the retailers say.

Outcome: Visa paid $2billion and Mastercard paid $1billion.


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Price Discrimination Motives

Suppose there are two types of customers and you cannot distinguish

the different types

Similar to 2nddegree price discrimination

Also, in many cases you cant have packages

You know there are some people that print a lot of pages, and others

that dont

The idea is to offer the printer for cheaper than normal but charge a high

price for the cartridge

Why does this work? You are letting the customer tell you their type

You make more money on the high demand types and less on the low demand

types (like you should)


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An example

High demand for printed pages is: P = 16 Q

Low demand for printed pages is: P = 12 Q

How should it price the printer and toner?

suppose that marginal costs of the toner and of making

the printer are zero (to keep things simple)


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Tie-In Sales: an Example

High-DemandConsumers Low-DemandConsumers

Demand: P = 16 - Q Demand: P = 12 - Q

$

Quantity Quantity

$16

16

$12

$

12

Low-demand

consumers are

willing to buy 12

units

$72

High-demand

consumers buy 16

units$128

I f we charge a two-part tar i ff :

Profi t is $72 from each type of consumer

So this gives prof it of $144 per pair of high-and

low-demand consumers


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Tie-in sales

Now, instead of making all of our money on printers, we

lower price of printers, but increase the price of toner

The idea is: by increasing the price of toner cartridges we end up

making more money on the high demand types

For example, charging $2 for toner and $50 for the printer

is more profitable


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Tie-In Sales: an ExampleHigh-DemandConsumers Low-DemandConsumers

Demand: P = 16 - Q Demand: P = 12 - Q

$

Quantity Quantity

$16

16

$12

$

12

$2 $2

14

Low-demand

consumers buy 10

units

10

Consumer surplus

for low-demand

consumers is $50

$50

Triangle for high-demand consumers

is $98

$98

High-demand

consumers buy 14

units

Profi t is $70 from low-demand consumer: $50 + $20

and $78 from high-demand consumer: $50 + $28

giving $148 per pair of high-demand and low-demand


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Figuring out the best tie-in price

NOTE:This is extra,

and wont be on the exam But, if you like this sort of stuff, cool!

First, lets call the price of toner,pT

The thing to think about is that the price of toner will dictate how

much we can charge for the printer

And, this will be determined by the low demand type

In particular, the most we can charge for the printer is:

.5(12-pT)(12-pT) (This is the area of the triangle)

What will profits be:

= 2*.5(12-pT)(12-p

T) + p

T(16-p

T) + p

T(12-p

T)

We want to maximize this, so we take the derivative and set it

equal to zero:

d/dpT= -2(12-pT) + (16-2pT) + (12-2pT)=0

d/dpT= 4 - 2pT=0, Or pT=2

bunding & tying

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