Bundling, Vertical Differentiation, and Platform Competition

Abstract This paper studies the bundling strategies of two firms that each sell a horizontally differentiated platform and a complementary good. When the complementary goods are vertically differentiated, the firm that sells the superior one can commit to a more aggressive pricing strategy through bundling. In the presence of asymmetry in externalities between the two sides in the platform market, bundling may be profitable without foreclosing the rival when platforms implement cross subsidies from the high-externality side (developers) to the low-externality side (consumers). Bundling has a positive effect on welfare because it allows for better internalization of the indirect network effects and reduces the developer cost of multi-homing, but it also has a negative effect because some consumers consume less-preferred components. Consequently, bundling is socially desirable when platforms are not too differentiated and the vertical differentiation between the complementary goods is high.