The leverage effect of bundling on monopoly power and product quality

This paper re‐examines the leverage effect of bundling under vertical quality differentiation. That is, it studies whether or not the firm can still extend its monopoly power from the monopolist product market to the competing product market by bundling under vertical product quality differentiation. There is an intangible product (such as cloud storage, after sale service, etc.) in a bundled package with vertical quality differentiation. The model herein enables us to further analyze the effects of bundling on a competitor's profit, consumer surplus, and social welfare when the bundler is a high‐ or low‐quality firm and is facing a single‐product competitor. When the bundling product is a high quality product, bundling reinforces the monopolist's market power toward the monopoly good, which runs opposite from the traditional leverage effect. If bundling enhances (shortens) the quality difference in competing goods, then bundling increases (reduces) both the competitor's profit and social welfare, whereas it decreases (increases) consumer surplus. Contrary to traditional literature, we find that mixed bundling may not be superior to pure bundling and the price discrimination via mixed bundling by the multi‐product firm may enhance the consumer surplus.