Transcript Chapter 8 - Web.UVic.ca

Chapter 8
• Commodity Bundling and Tie-in Sales
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Introduction
• Firms often bundle the goods that they offer
– Microsoft bundles Windows and Explorer
– Office bundles Word, Excel, PowerPoint, Access
• Bundled package is usually offered at a discount
• Bundling may increase market power
– GE merger with Honeywell
• Tie-in sales ties the sale of one product to the purchase of
another
• Tying may be contractual or technological
– IBM computer card machines and computer cards
– Kodak tie service to sales of large-scale photocopiers
– Tie computer printers and printer cartridges
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• Why? To make money!
Bundling: an example
• Two television stations offered two old
Hollywood films
– Casablanca and Son of Godzilla
• Arbitrage is possible between the
stations
• Willingness to pay is:
Willingness to
pay for
Casablanca
Willingness
to pay for
Godzilla
Station A
$8,000
$2,500
Station
B
$7,000
$3,000
1, How much can
be charged for
Casablanca &
Godzilla? $7000 &
$2500 respectively
2, If the
films are
sold
separately
total
revenue is
$19,000
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Example on next page
Now suppose that the two films are bundled and sold as a
package
How much can be charged for the package?
If the films are sold as a package total revenue is $20,000
Bundling is profitable because it exploits aggregate willingness pay
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Bundling: an example
Willingness to Willingness to
pay for
pay for
Casablanca
Godzilla
Total
Willingness
to pay
Station A
$8,000
$2,500
$10,500
Station B
$7,000
$3,000
$10,000
$10,000
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Now Extend this example to allow for
(1) costs ,
(2) mixed bundling :offering products in a bundle and separately
Suppose that there are two goods and that consumers differ in
their reservation prices for these goods
Each consumer buys exactly one unit of a good provided that price
is less than her reservation price
Consumer x has reservation price px1 for good 1 and px2 for good 2
Consumer y has reservation price py1 for good 1 and py2 for good 2
Suppose that the firm sets price p1 for good 1 and price p2 for good 2
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Bundling: another example
3, All consumers in
region B buy
only good 2
R2
B
A
y
py2
p2
px2
4, All consumers in
region D buy
only good 1
x
D
C
px1
5, All
consumers in
region C buy
neither good
2, All consumers in
region A buy
both goods
p1 py1
R1
1, Consumers
split into
four groups
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Now consider pure bundling at some price pB
Consumers now split into two groups
R2
pB
E
c2
F
c1
2, All consumers in
region F(left of PB
line) do not
buy the bundle
pB
1, All consumers in
region E (right of PB
line) buy
the bundle 3, Consumers
in these two
black regions
can buy each
good even
though
their
reservation
price for one
of
R1
the goods is
less than its
marginal cost
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Now consider mixed bundling ( see next page)
Good 1 is sold at price p1
Good 2 is sold at price p2
The bundle is sold at price PB < P1 + P2
Consumers split into four groups: buy the bundle, buy only good
1, buy only good 2 , and buy nothing
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Mixed Bundling
5,
Consume
rs in this
region
buy only
good 2
3,
Consu
mers in
this
region
buy
nothing
R2
pB
8, In this region
consumers buy
either the bundle
or product 2
1, Consumers in this
region are willing to
buy both goods. They
buy the bundle
6, This leaves
two regions, 7&8
p2
7, In this region
consumers buy
either the bundle
or product 1
pB - p1
2, Consumers in
this
region also
buy the bundle
pB - p2
p1
pB
R1
4, Consumers in this
region buy only
good 1
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See next page
Consider consumer x with reservation prices p1x for product 1 and
p2x for product 2
Her aggregate willingness to pay for the bundle is p1x + p2x
Consumer surplus from buying the bundle is p1x + p2x - pB
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Mixed Bundling (cont.)
5, Similarly, all
consumers in
this region buy
only product 2
R2
pB
3, The
consumer x
will buy only
product 1
p2
4, All consumers in
this region buy
only product 1
pB - p1
p2x
x
pB - p2
p1
pB
p1x
R1
p1x+p2x
1, Which is this
measure
2, Consumer
surplus from
buying product
1 is
p1x - p1
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Mixed Bundling (cont.)
• What should a firm actually do?
• There is no simple answer
– mixed bundling is generally better than pure
bundling
– but bundling is not always the best strategy
• Each case needs to be worked out on its
merits
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An Example
Four consumers; two products; MC1 = $100, MC2 = $150
Consumer
Reservation
Price for
Good 1
Reservation
Price for
Good 2
Sum of
Reservation
Prices
A
$50
$450
$500
B
$250
$275
$525
C
$300
$220
$520
D
$450
$50
$500
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Consider simply monopoly pricing
Good 1 should be sold at $250 and Good 2 at $450. Total
profit is $450 +$300 =$750.
Good 1: Marginal Cost $100
Price
Quantity
Total revenue
$450
1
$450
$300
2
$600
$250
3
$750
$50
4
$200
Price
$450
$450
$275
$220
$50
Good 2: Marginal Cost $150
Quantity
Total revenue
1
$450
2
$550
3
$660
4
$200
Profit
$350
$400
$450
-$200
Profit
$300
$200
$210
-$400
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1,The highest
bundle
price that can be
considered is $500
Now
consider
pure
bundling
2, All four consumers will buy
the bundle and profit is
4x$500 - 4x($150 + $100)
= $1,000
Consumer
Reservation
Price for
Good 1
Reservation
Price for
Good 2
Sum of
Reservation
Prices
A
$50
$450
$500
B
$250
$275
$525
C
$300
$220
$520
D
$450
$50
$500
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Now consider mixed bundling
Take the monopoly prices p1 = $250;
p2 = $450 and a bundle price pB = $500
1, All four consumers buy
something and profit is
$250x2 + $150x2
= $800
Reservation
Price for
Good 1
Reservation
Price for
Good 2
Sum of
Reservation
Prices
A
$50
$450
$500
B
$250
$275
$525
$500
C
$300
$250
$220
$520
D
$450
$250
Consumer
$50
2, Can the
seller
improve
$500
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1, Try instead the prices p1 = $450;
p2 = $450 and a bundle price pB = $520
3, This is actually
the best that the
firm can do
2, All four consumers buy and
profit is $300 + $270x2 + $350 =
$1,190
Consumer
Reservation
Price for
Good 1
Reservation
Price for
Good 2
Sum of
Reservation
Prices
A
$50
$450
$450
$500
B
$250
$275
$525
$520
C
$300
$220
$520
D
$450
$450
$50
$500
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Bundling (cont.)
• Bundling does not always work
• Requires that there are reasonably large differences in
consumer valuations of the goods
• What about tie-in sales?
– “like” bundling but proportions vary
– allows the monopolist to make supernormal profits on the
tied good
– different users charged different effective prices depending
upon usage
– facilitates price discrimination by making buyers reveal
their demands
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Tie-in Sales
• Suppose that a firm offers a specialized product – a
camera? – that uses highly specialized film cartridges
• Then it has effectively tied the sales of film cartridges
to the purchase of the camera
– this is actually what has happened with computer printers and
ink cartridges
• How should it price the camera and film?
– suppose that marginal costs of the film and of making the
camera are zero (to keep things simple)
– suppose also that there are two types of consumer: highdemand and low-demand
See example in next page
Suppose that the firm leases the product for $72 per period
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Tie-In Sales
3, Profit is $72 from
each type of consumer
So this gives profit of
$144 per pair of highand low-demand
consumers
High-Demand
Consumers
Demand: P = 16 - Q
4, Is this
the best
that
the firm
can do?
$
$16
$128
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Quantity
Low-Demand
Consumers
Demand: P = 12 - Q
$
$12
1,High- $72
demand
consumer
s buy 16
units
2, Low-demand
consumers are
willing to buy 12
units
12
Quantity
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1,Suppose
that the firm
sets a price of
$2 per unit
Demand: P = 16 - Q
$
$16
Tie-In Sales
7, Profit is $70 from
each low-demand
6, So the firm can set consumer: $50 + $20
and $78 from each
a lease charge of $50 Low-Demand
high-demand
Consumers
to each type of
consumer: $50 + $28
consumer: it cannot Demand:
P = 12 - Q
giving $148 per pair
discriminate
of high-demand and
$
low-demand
$12
$98
4, Consumer
surplus for highdemand consumers
is $98
$2
2, Highdemand
consumers
buy 14 units
$50
$2
14 16
Quantity
3, Lowdemand
consumers buy
10 units
Demand: P = 12 - Q
5, Consumer
surplus for lowdemand
consumers is $50
10 12
Quantity
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See example in next page
1, Suppose that the firm can bundle the two goods instead of tie
them
2, Produce a bundled product of camera plus 12-shot cartridge
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Tie-In
Sales
7, Profit is $72 from each
low-demand consumer and
$80 from each highdemand consumer giving
Low-Demand
$150 per pair of highConsumers
demand and low-demand
5, So produce a
second bundle of
camera plus 16shot cartridge
Demand: P = 16 - Q
$
$16
4, High-demand
consumers get $48
consumer surplus
from buying it
$
Demand: P = 12 - Q
$12
$48
$72
$72
$8
6, High-demand
consumers will pay
$80 for this bundled
camera ($128 - $48)
12 16
Quantity
12
Quantity
3, Lowdemand
consumers
can be sold
this bundled
product for
$72
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Complementary Goods
• Complementary goods are goods that are
consumed together
– nuts and bolts
– PC monitors and computer processors
• How should these goods be produced?
• How should they be priced?
• Take the example of nuts and bolts
– these are perfect complements: need one of each!
• Assume that demand for nut/bolt pairs is:
Q = A - (PB + PN)
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Complementary goods (cont.)
This demand curve can be written individually for nuts and bolts
For bolts: QB = A - (PB + PN)
For nuts: QN = A - (PB + PN)
These give the inverse demands: PB = (A - PN) - QB
PN = (A - PB) - QN
These allow us to calculate profit maximizing prices
Assume that nuts and bolts are produced by independent firms
Each sets MR = MC to maximize profits
MRB = (A - PN) - 2QB
MRN = (A - PB) - 2QN
Assume MCB = MCN = 0
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Complementary goods (cont.)
Therefore QB = (A - PN)/2
and PB = (A - PN) - QB = (A - PN)/2
by a symmetric argument PN = (A - PB)/2
The price set by each firm is affected by
the price set by the other firm
In equilibrium the price set by the two
firms must be consistent
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Complementary goods (cont.)
PB
2, Pricing rule for
the Nut Producer:
PN = (A - PB)/2
PB = (A - PN)/2
PN = (A - PB)/2
 PN = A/2 - (A - PN)/4
= A/4 + PN/4
 3PN/4 = A/4
 PN = A/3
A
A/2
1, Pricing rule
for the Bolt
Producer:
PB = (A - PN)/2
 PB = A/3
 PB + PN = 2A/3
 Q = A - (PB+PN) = A/3
A/3
3, Equilibrium
is
where these
two
pricing rules
intersect
A/3 A/2
A
PN
Profit of the Bolt Producer
= PBQB = A2/9
Profit of the Nut Producer
= PNQN = A2/9
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Complementary goods (cont.)
What happens if the two goods are produced by the same firm?
The firm will set a price PNB for a nut/bolt pair.
Demand is now QNB = A - PNB so that PNB = A - QNB
 MRNB = A - 2QNB
MR = MC = 0
 QNB = A /2
$
A
 PNB = A /2
Profit of the nut/bolt producer
is PNBQNB = A2/4
A/2
Demand
MR
A/2
A
Quantity
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Merger of the two firms results in consumers being charged
lower prices and the firm making greater profits.
Why? Because the merged firm is able to coordinate the
prices of the two goods
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Complementary goods
• Don’t necessarily need a merger to get these benefits
– product network
• ATM networks
• airline booking systems
– one of the markets is competitive
• price equals marginal cost in this market
• leads to the “merger” outcome
• There may also be a countervailing force
– network externalities
• value of a good to consumers increases when more
consumers use the good
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Network externalities
• Product complementarities can generate network effects
– Windows and software applications
• substantial economies of scale
• strong network effects
– leads to an applications barrier to entry
• new operating system will sell only if applications
are written for it
• but…
• So product complementarities can lead to monopoly
power being extended
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Anti-trust and bundling
• The Microsoft case is central
– accusation that used power in operating system (OS)
to gain control of browser market by bundling
browser into the OS
– need\ to show
• monopoly power in OS
• OS and browser are separate products that do not
need to be bundled
• abuse of power to maintain or extend monopoly
position
– Microsoft argued that technology required integration
– further argued that it was not “acting badly”
• consumers would benefit from lower price because
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of the complementarity between OS and browser
Microsoft and Netscape
• Complementarity products
– so merge?
– what if Netscape refuses?
– then Microsoft can develop its own browser
– MC ≈ 0 so competition in the browser market drives
price close to zero
– but then get the outcome of merger firm through
competition
• So Microsoft is not “acting badly”
• But
– JAVA allows applications to be run on Internet browsers
– Netscape then constitutes a threat
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– need to reduce their market share
Antitrust and tying arrangements
• Tying arrangements have been the subject of extensive
litigation
• Current policy
– tie-in violates antitrust laws if
• there exists distinct products: tying product and
tied one
• firm tying the products has sufficient monopoly
power in the tying market to force purchase of the
tied good
• tying arrangement forecloses or has the potential
to foreclose a substantial volume of trade
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