Appendix to Chapter 9 Bundling and Tying 395studio’s total profit is (18,000 10,000)(1,000) (15,000 5,000)(500)
$13,000,000. Relative to pure bundling, mixed bundling has increased the stu-
dio’s profit by $2.5 million.
What is the source of this $2.5 million advantage? First, the studio gains by
raising the bundled price paid by chains 1 and 2 from $17,000 (under pure
bundling) to $18,000, thereby increasing its profit by $1 million. Second, under
pure bundling, chain 3 was induced to buy film Y—a film that costs $5,000 per
print but only returns $2,000 to chain 3 in value. Mixed bundling precludes this
purchase and transfers the savings, (5,000 2,000)(500) $1,500,000, to the
studio in added profit. In short, these two gains, $1,000,000 $1,500,000,
account for the total $2,500,000 increase in profit.
In this example, mixed bundling is more profitable than pure bundling,
but this need not be the case in general. As the example shows, the potential
advantage of mixed bundling occurs when there are significant marginal costs
associated with separate goods and some consumers place very low values on
some goods. Under these circumstances, allowing separate purchases via mixed
bundling benefits both buyer and seller. Absent these conditions, pure
bundling or even separate sales may be more profitable.
Finally, the case of mixed bundling clearly underscores a basic point: At
bottom, bundling (of either sort) is a form of price discrimination.^3 In effect,
bundling represents a quantity discount; the price of the package is far less
than the sum of the separate goods’ prices. As this example showed, a partic-
ular customer may put a much lower value on one item in the bundle than
another. By offering the second item in the bundle at minimal extra cost, the
firm lures additional purchasers and increases its revenue in the process.TYING Closely related to bundling is tying, which occurs when a firm selling
one product requires (or attempts to require) the purchase of another of its
related products. For instance, 30 years ago, customers who leased Xerox
copiers were required to buy Xerox paper. Although strict requirements are
rare today, companies continue to try to induce customers to purchase related
items. Kodak promotes its quality film and developing paper as ideal for its
cameras. Microsoft Corporation claims that its applications programs work best
with its Windows operating systems. General Motors insists that genuine GM
replacement parts are essential for its cars and trucks.
A firm has several reasons for tying. First, it is one way to ensure peak per-
formance for the good or service. By ensuring quality, the firm protects its
brand name and reputation. For instance, McDonald’s insists that all its fran-
chise restaurants buy materials and food from itself. Second, the firm can use
tie-in sales as a subtle form of price discrimination. By charging a price above
marginal cost for the complementary product (copier paper for instance), the
firm can effectively require intensive users of its main product (the copier) to(^3) Price discrimination and related practices are discussed in the latter half of Chapter 3.
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