bunding & tying
TRANSCRIPT
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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