Tug-of-War Economics of Product Bundling

From computer software to fast food meals to vacation packages, the practice of bundling—offering two or more products or services together as a combined product—has worked very well for companies to give customers a simple, discounted option.

In researching the practice, Professor Hemant Bhargava distinguishes between bundles of goods made by the same firm and bundles created by retailers that combine products from multiple companies. While the single-firm bundling strategy is highly profitable, retailers face severe challenges when bundling, which can lead to lower profits for both the retailer and manufacturers.

“The culprit is a combination of horizontal channel conflict (each manufacturer wants a higher share of profits from bundle sales) and vertical conflict (incentive misalignment with respect to bundle versus component sales),” Bhargava said. These weaken the case for bundling.

Bhargava highlights carriage fees in the television industry, where a distributor such as Dish Network or Comcast bundles channels from multiple producers such as Disney, ESPN or Food Network. Clashes over these fees have led in recent years to blackouts of favorite shows and millions of disgruntled customers. “The dispute gets so intense that the content producer ultimately holds the retailer hostage,” Bhargava said.

Bhargava’s research, “Retailer-Driven Product Bundling in a Distribution Channel,” was published in Marketing Science (November/December 2012). Bhargava suggests that these conflicts will motivate companies to integrate vertically by moving up or down the value chain. He suggests that firms need to become their own producers—for example, Comcast acquired NBC, and Amazon now offers movies through Amazon Studios.

In further research on product bundling, Bhargava tackles the previously intractable mixed bundle pricing problem—how to optimally price a product line with two goods and a bundle of the two goods. The result is a mathematical equation outlined in, “Mixed Bundling of Two Independently-Valued Goods.” His paper has been accepted for publication in Management Science.