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 costs for manufacturers. One firm (the leader) determines the products offered to sell before the other (the follower), and both then simultaneously set the prices for their products. We demonstrate the existence and uniqueness of the Nash equilibrium for this game, 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 his or her disadvantage in profit by using it as a potential threat. Furthermore, we perform an extensive numerical study to examine the impact of value addition and cost reduction brought by bundling on firms' equilibrium product and pricing strategies and the resulting profits.

Keywords: pricing, bundling, game theory, duopoly competition