Competitive Bundling in a Bertrand Duopoly

In competitive industries, some firms bundle their products, whereas others unbundle them; still other firms occupy a niche position and offer only a subset of products. No general theory has been advanced to explain this variety of bundling strategies. We characterize the strategies of two symmetric firms competing (in a Bertrand fashion) with regard to two homogeneous components. We model their decisions as a two-stage non-cooperative game. Firms in the first stage select their product offerings, which may include any single-component product and/or the bundle; in the second stage, firms simultaneously set their products' prices. We show that three types of equilibria always emerge in equilibrium: (i) Differentiated duopoly, in which one firm offers the bundle and the other firm offers only a single-component product; (ii) Monopoly, in which one firm offers the full set of products and the other firm stays out of the business; (iii) Perfect competition, in which both firms offer both single-component products (possibly along with the bundle) and compete on price, driving their profits down to zero. Hence, bundling can be anti-competitive (if it is used to defend a monopolistic position) or hyper-competitive (if it leads to head-to-head competition). In case of a differentiated duopoly, the bundler has a profit advantage|which remains moderate when customer valuations are negatively correlated and highly heterogeneous|but might grow out of bound otherwise. Therefore, bundling does not necessarily hurt customer welfare or competition, but under the wrong set of circumstances, it could be a terrible competitive weapon