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Bundling and Competition on the Internet

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  • Yannis Bakos

    ()
    (Stern School of Business, New York University, New York, New York 10012-1126)

  • Erik Brynjolfsson

    ()
    (Massachusetts Institute of Technology, Cambridge, Massachusetts 02142-1347)

Abstract

The Internet has signi.cantly reduced the marginal cost of producing and distributing digital information goods. It also coincides with the emergence of new competitive strategies such as large-scale bundling. In this paper, we show that bundling can create “economies of aggregation” for information goods if their marginal costs are very low, even in the absence of network externalities or economies of scale or scope. We extend the Bakos-Brynjolfsson bundling model (1999) to settings with several different types of competition, including both upstream and downstream, as well as competition between a bundler and single good and competition between two bundlers. Our key results are based on the “predictive value of bundling,” the fact that it is easier for a seller to predict how a consumer will value a collection of goods than it is to value any good individually. Using a model with fully rational and informed consumers, we use the Law of Large Numbers to show that this will be true as long as the goods are not perfectly correlated and do not affect each other's valuations significantly. As a result, a seller typically can extract more value from each information good when it is part of a bundle than when it is sold separately. Moreover, at the optimal price, more consumers will find the bundle worth buying than would have bought the same goods sold separately. Because of the predictive value of bundling, large aggregators will often be more pro.table than small aggregators, including sellers of single goods. We find that these economies of aggregation have several important competitive implications: 1. When competing for upstream content, larger bundlers are able to outbid smaller ones, all else being equal. This is because the predictive value of bundling enables bundlers to extract more value from any given good. 2. When competing for downstream consumers, the act of bundling information goods makes an incumbent seem “tougher” to single-product competitors selling similar goods. The resulting equilibrium is less profitable for potential entrants and can discourage entry in the bundler's markets, even when the entrants have a superior cost structure or quality. 3. Conversely, by simply adding an information good to an existing bundle, a bundler may be able to profitably enter a new market and dislodge an incumbent who does not bundle, capturing most of the market share from the incumbent firm and even driving the incumbent out of business. 4. Because a bundler can potentially capture a large share of profits in new markets, single-product firms may have lower incentives to innovate and create such markets. At the same time, bundlers may have higher incentives to innovate. For most physical goods, which have nontrivial marginal costs, the potential impact of large-scale aggregation is limited. However, we find that these effects can be decisive for the success or failure of information goods. Our results have particular empirical relevance to the markets for software and Internet content and suggest that aggregation strategies may take on particular relevance in these markets.

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File URL: http://dx.doi.org/10.1287/mksc.19.1.63.15182
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Bibliographic Info

Article provided by INFORMS in its journal Marketing Science.

Volume (Year): 19 (2000)
Issue (Month): 1 (May)
Pages: 63-82

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Handle: RePEc:inm:ormksc:v:19:y:2000:i:1:p:63-82

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Keywords: Bundling; Internet; Pricing; Information Goods; Software; Competition; Digital Goods;

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Citations

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Cited by:
  1. Anja Lambrecht & Katja Seim & Naufel Vilcassim & Amar Cheema & Yuxin Chen & Gregory Crawford & Kartik Hosanagar & Raghuram Iyengar & Oded Koenigsberg & Robin Lee & Eugenio Miravete & Ozge Sahin, 2012. "Price discrimination in service industries," Marketing Letters, Springer, vol. 23(2), pages 423-438, June.
  2. Li, Minqiang & Feng, Haiyang & Chen, Fuzan & Kou, Jisong, 2013. "Numerical investigation on mixed bundling and pricing of information products," International Journal of Production Economics, Elsevier, vol. 144(2), pages 560-571.
  3. Akifumi Ishihara & Noriyuki Yanagawa, 2013. "Dark Sides of Patent Pools with Compulsory Independent Licensing," CARF F-Series CARF-F-318, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  4. Yao, Dong-Qing & Liu, John J., 2005. "Competitive pricing of mixed retail and e-tail distribution channels," Omega, Elsevier, vol. 33(3), pages 235-247, June.
  5. Slawomir Czetwertynski, 2012. "Peer production on the Internet as an example of global disintegration of production process," Ekonomia i Prawo, Uniwersytet Mikolaja Kopernika, vol. 11(4), pages 47-60, December.
  6. Chiarvesio, Maria & Di Maria, Eleonora & Micelli, Stefano, 2004. "From local networks of SMEs to virtual districts?: Evidence from recent trends in Italy," Research Policy, Elsevier, vol. 33(10), pages 1509-1528, December.
  7. repec:cpn:umkeip:2012:v4:p:47-60 is not listed on IDEAS
  8. Dixit, Ashutosh & Braunsberger, Karin & Zinkhan, George M. & Pan, Yue, 2005. "Information technology-enhanced pricing strategies: managerial and public policy implications," Journal of Business Research, Elsevier, vol. 58(9), pages 1169-1177, September.
  9. Cheng, Wenli & Yang, Xiaokai, 2004. "Inframarginal analysis of division of labor: A survey," Journal of Economic Behavior & Organization, Elsevier, vol. 55(2), pages 137-174, October.
  10. repec:tru:umkeip:2012:v4:p:47-60 is not listed on IDEAS
  11. McCardle, Kevin F. & Rajaram, Kumar & Tang, Christopher S., 2007. "Bundling retail products: Models and analysis," European Journal of Operational Research, Elsevier, vol. 177(2), pages 1197-1217, March.
  12. Agarwal, Manoj K. & Frambach, Ruud T., 2003. "Customized service bundles in a competitive context : integrating consumer's bundling, brand and quantity decisions," Serie Research Memoranda 0015, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.
  13. Altug, Mehmet Sekip & van Ryzin, Garrett, 2013. "Product quality selection: Contractual agreements and supplier competition in an assemble-to-order environment," International Journal of Production Economics, Elsevier, vol. 141(2), pages 626-638.
  14. Darren Filson, 2002. "The Impact of E-Commerce Strategies on Firm Value: Lessons from Amazon.com and its Early Competitors," Claremont Colleges Working Papers 2003-06, Claremont Colleges.
  15. Peitz, Martin, 2008. "Bundling may blockade entry," International Journal of Industrial Organization, Elsevier, vol. 26(1), pages 41-58, January.

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