Tying and Entry Deterrence in Vertically Differentiated Markets

Abstract

This paper analyzes tying and bundling as an entry deterrence tool. It shows that a multi-product firm can defend its monopoly position in one market via tying also when it does not have market power in another market. This is shown on a model with two complementary goods, each of which is vertically differentiated and consumers' preferences for the goods are positively correlated. Some implications for competition policy are discussed.

The leverage effect of bundling on monopoly power and product quality

“…All the papers mentioned above use a horizontal product‐differentiated model without taking quality into account, but more recent literature incorporates vertically‐differentiated products with different quality levels into the bundling model, such as Diallo (2006), Kovac (2007), Gilbert and Riordan (2007), Kramer (2009), Banciu et al. (2010), Avenali et al.…”

“…Diallo (2006) assumes an endogenous bundling discount and exogenous quality levels, noting that bundling is a dominant strategy Nash equilibrium that decreases consumer surplus while increasing social welfare. Kovac (2007) builds up a two‐product, three‐firm, and exogenous quality model and presents that a firm can defend its monopoly status via mixed bundling, which decreases social welfare. On the contrary, this paper presents a result that bundling may increase social welfare by sufficiently enhancing quality differentiation.…”

“…With respect to the types of bundling strategies, in addition to pure bundling, mixed bundling is another often seen strategy in practice. The existing literature on the choice of pure and mixed bundling strategies include Adams and Yellen (1976), Schmalensee (1982), Lewbel (1985), Economides (1993), Kovac (2007), and Chao and Derdenger (2013), etc. Adams and Yellen (1976) assume that the two products to bundle are independent and obtain the conclusion that bundling causes over or under supply.…”

“…Under price competition, the duopolists’ dominant strategies are mixed bundling, which will bring down the social welfare. Kovac (2007) sets up a model with three firms and two products. Under the exogenous quality, he concludes that when the bundling firm adopts the mixed bundling, it can defend its monopoly market status while it will bring down the social welfare.…”

“…All the papers mentioned above use a horizontal product-differentiated model without taking quality into account, but more recent literature incorporates vertically-differentiated products with different quality levels into the bundling model, such as Diallo (2006), Kovac (2007), Gilbert and Riordan (2007), Kramer (2009), Banciu et al (2010), Avenali et al (2013), Chung (2013), Chung et al (2014), and Brito and Vasconcelos (2014, 2015. Gilbert and Riordan (2007) establish a two-firm, two-system-product model and assume identical consumer preferences toward quality levels.…”