Price bundling

This article describes a pricing strategy used by sellers, typically in markets that suffer from imperfect competition, significant transaction costs or imperfect information.
View other pricing strategies

Definition

Price bundling is a strategy whereby a seller bundles together many different goods/items being sold and offers the entire bundle at a single price.

There are two forms of price bundling -- pure bundling, where the seller does not offer buyers the option of buying the items separately, and mixed bundling, where the seller offers the items separately at higher individual prices. Mixed bundling is usually preferable to pure bundling, both because there are fewer legal regulations forbidding it, and because the reference price effect makes it appear even more attractive to buyers.

Motivation behind price bundling

Exploit different valuations by different buyers

Suppose there are two buyers, $A$ and $B$, and two products, $X$ and $Y$. Suppose buyer $A$ values product $X$ at $20$ units above the cost of production, and values $Y$ at $15$ units above the cost of production. Suppose buyer $B$ values $Y$ at $20$ units above the cost of production, and $X$ at $15$ units above the cost of production.

The ideal thing for the seller would be to practice price discrimination: charge each buyer the maximum that buyer is willing to pay. However, this may be forbidden by law or otherwise difficult to implement.

Instead, the seller can pursue the following bundling strategy: charge slightly under $35$ units above production cost for the combination of $X$ and $Y$. Since both buyers value the combination at $35$ units above the cost of production, this deal appeals to both buyers. This allows the seller the obtain the entire social surplus as producer surplus. (It isn't true in general that bundling allows the seller to capture the entire social surplus -- however, bundling does allow the seller to capture more of the social surplus in many situations).

The seller can even make this a mixed bundling strategy: offer both $X$ and $Y$ individually for $20$ units above the cost of production, and offer the combination for slightly less than $35$ units above the cost of production.

External links

Weblog entries/articles

• Search for bundling on the Marginal Revolution weblog
• Search for bundling on the Library of Economics

Particular weblog entries/articles of interest:

• Why can't you choose your cable channels? -- Alex Tabarrok, Marginal Revolution, April 2004
• Sorting out bundling and antitrust law from a seat at the Saturday double feature -- Hal Varian, New York Times, July 26, 2001
• Bundling -- Arnold Kling, Econlog, 26 Match 2004
• Bundling ii -- Arnold Kling, Econlog, April 5, 2004