Bundling, Tying, and Portfolio Effects: Part 1 Conceptual Issues

4.4 Strategic Reasons
4.4.1 BUNDLING COMPLEMENTS TO UNDERCUT RIVALS
The use of bundling to gain an advantage over rivals was at the heart of the European
Commission’s case against the GE-Honeywell merger. We examine some of the general
issues in this section and then apply this analysis to the GE-Honeywell merger in Section
IV of Part II.
When there is competition in the complementary products markets, there are two
reasons to cut price: market expansion and competition with rivals.
The previous section set out the Cournot monopoly model. The original Cournot model
looked only at market expansion, as there were no rivals from whom market share could
be taken. In some cases, the market expansion effect will be small when compared to
the potential gain from an increase in market share. For example, in the jet engine
industry, a price reduction may increase the total demand for airplane engines. But, such
a price reduction is likely to have a small effect on demand for airplanes, as the engine
represents only a minority of the total airplane cost. The greater incentive for a price cut
is the potential to gain market share from rivals.
Because there are rival firms, there will also be a response to a price cut. This response
may offset the potential gain to the merging firms. Thus, we need to consider the impact
on the non-merging firms and on consumers to determine the overall social welfare
implications of the expanded Cournot effect.
The predictions of such a model are ambiguous as to whether bundling leads to higher
profits. The answer will depend upon the parameter values and modelling assumptions.
The reason why the results have changed is that there are now two countervailing
effects. Bundled pricing will almost always lead to a reduction in prices due to
elimination of the double marginalisation effect. However, because single-product rivals
also lower their price, the net gain in market share will be smaller and, thus, the result
on profits is ambiguous.
We are also most interested in the case where a firm with products A and B sells them
both as a package and individually. This is the mixed-bundling case. Recall here the
example of Microsoft Word and Excel, which can be purchased individually or together
as part of the Office bundle.
A series of simulations suggests bundling will help a firm expand its share of the market.
Whether or not the bundling also leads to a short-run increase in profits is less clear.
We provide one example of a simulation below. 44 It is discussed in greater detail in the
GE-Honeywell case study. Here, there are two sellers of a differentiated A good and
two sellers of a differentiated B good. One of the A sellers gets together with a B seller
to offer a bundle. We find that bundling leads to a 3% decline in profits for the firm that
bundles and a 20% decline in profits for the firms that sell products individually.
44 This approach is based on Nalebuff (2000b) “Competing Against Bundles” in Incentives, Organization, and Public Economics, (P.
Hammond and G. D. Myles, eds.) Oxford University Press: London.
39