Bundling and joint marketing by rival firms

• Published date: 01 September 2017
• Date: 01 September 2017
• Author: Thomas D. Jeitschko,Jaesoo Kim,Yeonjei Jung
• DOI: http://doi.org/10.1111/jems.12199

Received: 20 April 2015 Revised: 1 December 2016 Accepted: 3 December 2016

DOI: 10.1111/jems.12199

ORIGINAL ARTICLE

Bundling and joint marketing by rival firms

Thomas D. Jeitschko1Yeonjei Jung2Jaesoo Kim3

1Department of Economics, Michigan

State University,East Lansing, MI, USA

(Email: jeitschk@msu.edu)

2Electricity Policy Research Group, Korea

Energy Economics Institute, Ulsan, Republic

of Korea (Email: yeonjei@keei.re.kr)

3Department of Economics,

IUPUI, Indianapolis, IN, USA

(Email: jaeskim@iupui.edu)

Abstract

We study joint marketing by firms who price discriminate between consumers who

patronize only one firm (single purchasers) and those who purchase from both (bun-

dle purchasers). Firms either set the price of the bundle and then compete along side

the bundle; or they determine a rebate that is applied to joint purchasers and then set

prices. Even though the pricing structure in the joint marketing scheme is determined

noncooperatively, the commitment to the joint marketing agreement allows firms to

leverage their stand-alone prices—leading to higher profits and lower consumer sur-

plus in either case, compared to both uniform pricing and independent price discrim-

ination without a joint marketing agreement. Nevertheless the two schemes differ

dramatically, in that rebates increase joint purchasing, whereas bundle pricing dimin-

ishes bundle purchases.

1INTRODUCTION

Joint marketing arrangements involving separate firms in which customers are charged differentially when they patronize multi-

ple firms are not new. Thus, the unilateral cancellation of a joint marketing agreement that involved discounted pricing to skiers

who bought passes to ski resorts run by separate operators gave rise to claims of illegal refusal to deal in the Aspen Skiing

antitrust suit.1In recent years, similar joint marketing arrangements involving separate firms have been on the rise. CityPASS,

for example, is a package that bundles multiple tourist attractions in nine popular destinations in North America. The package

for Chicago allows admission to five attractions: the Shedd Aquarium, the Field Museum, Skydeck Chicago, either of the Adler

Planetarium or the Art Institute of Chicago, and either of the John Hancock Observatory or the Museum of Science and Industry.

The attractions compete against each other for time-constrained travelers who cannot visit more than a few places. At the same

time, the participating venues offer discounted pricing by selling the CityPASS.2A related practice is for firms to enter into

shared rewards programs, such as Hotels.com or OpenTable, where customers collect loyalty points across different members

of the program that can be redeemed at the participating vendors. What differentiates these joint marketing agreements from

rewards programs of retailers who also cater to joint purchasers is that the pricing decisions in the joint marketing agreement

are retained by the firms.3

In this paper, we investigate the pricing incentives when companies choose pricing strategies that target consumers

who make purchase decisions across firms. Consumers have unit demands for any given firm’s product. However, each

firm’s product has unique features and attributes that give a consumer who has already purchased a unit an added utility

from buying the other product as well. The products can be either substitutes or complements, but each product also has

We thank Mark Armstrong, Se Hoon Bang, Roger Calantone, Sung Ick Cho, JayPil Choi, Carl Davidson, Ayça Kaya, Sang-Hyun Kim, Dan McCole, Yossi

Spiegel, Greg Werden, Zhiyun Xu, Aleks Yankelevich, the three reviewers and associate editor, and participants at the Spring 2013 Midwest Economic The-

ory Meetings, the 12th International Industrial Organization Conference, 2014 Western Economic Association International Annual Conference, 2015 Korea

Academic Society of Industrial Organization Winter Meetings, as well as seminar participants at IUPUI, MichiganState University, Ulsan National Institute of

Science and Technology,the U.S. Department of Justice, and the Federal Trade Commission for their helpful comments and suggestions. All remaining errors

are our responsibility.

J Econ Manage Strat. 2017;26:571–589. © 2017 WileyPeriodicals, Inc. 571wileyonlinelibrary.com/journal/jems

572 JOURNAL OF ECONOMICS & MANAGEMENTSTRATEGY

idiosyncratic features, which differentiate it from other products in the consumers’ eyes. And so, consumers are endoge-

nously divided into two groups: Whereas some consumers purchase a single product from either firm, others purchase both

products.

We consider two kinds of joint marketing schemes: firms set a price for their contribution to the bundle (bundle pricing) or

firms set a rebate offer that is applied to the stand-alone price when a consumer makes a joint purchase (rebate). In both cases,

joint marketing necessitates the communication and agreement across parties, which is not needed for the stand-alone pricing

decisions that are made, and so firms are able to leverage their commitment to a joint marketing agreement into higher prices

and higher profits compared to both uniform pricing and independent price discrimination.

The mechanism through which prices and profits are raised depend on the nature of the joint marketing scheme used. With

bundle pricing, an increase in one firm’s price for its contribution to the bundle increases the stand-alone demand for the rival’s

product. Consumers are drawn to single purchasing, and thus the rival firm is able to raise its stand-alone price. This enables

the firms to capture more surplus from single-purchasing customers. In contrast, an increase in the rebate leads to fewer single-

purchasing consumers of one’s own good. This draws consumers into joint purchasing. The increased demand for the bundle is

reinforced by charging high stand-alone prices, which yields higher profits because the fixed rebate then applies to a high price.

An implication of the latter is that when firms commit to their prices in the bundle, competition plays out only in the setting of

the stand-alone prices; whereas, when the firms implement a rebate scheme, the stand-alone prices also determine the price of

the bundle simultaneously.4

There is an extensive literature on bundling for the purpose of price discrimination.5Early papers in this literature, how-

ever, restrict attention to the case where bundle discounts are offered by a multiproduct monopolist (e.g., Adams & Yellen,

1976; Armstrong, 1996; McAfee, McMillan, & Whinston, 1989; Rochet & Choné, 1998), rather than independent firms. There

is a literature considering multiple firms (e.g., Thanassoulis, 2007, 2011; Armstrong & Vickers, 2010) in which Gans and

King (2006) are the first to study the situation where bundle discounts are offered by different firms through joint market-

ing. In contrast to our setting, the two products sold are independent, yet all consumers must purchase both goods so that

there are no single purchasers. They show that the unilateral bundling by the pair of firms against other firms is profitable,

whereas bundle rebates by both pairs of firms do not increase their profits. At the same time, mutual joint marketing diminishes

social welfare substantially. In our setting, price discrimination through joint marketing is always profitable and always hurts

consumers.6

The most closely related paper to ours is Armstrong (2013), who studies incentives to offer bundled discounts by sep-

arate sellers in a very general setup. He shows that when product valuations are negatively correlated and/or subadditive

(so that products are partial substitutes), firms benefit by offering independent discounts to consumers—a result that also

applies in our setting. He extends the analysis to show that coordinated discounts implemented by firms reduce competi-

tion by mitigating the substitutability of products and reduce total welfare, which is what also happens in our setting. Our

main distinction is that where Armstrong (2013) considers a rebate scheme only for symmetrical firms, our model accom-

modates asymmetric firms and goods can be partial complements as well as substitutes. In addition, we also consider the

important case where the bundle is marketed at a price, rather than with a discount; and we compare these two cases to each

other.

There is also a nascent literature on the impact of joint purchases to which our paper contributes. Gabszewicz and Wauthy

(2003) analyze how joint purchasesaffect pr ice competitionand show that various types of equilibria ar ise depending on the value

of incremental utilities from joint purchasing. Kim and Serfes (2006) and Anderson, Foros, and Kind (2012) extend Gabszewicz

and Wauthy (2003) by investigating joint purchasing in a horizontally differentiated market. Kim and Serfes (2006) ask under

what conditions the “Principle of Minimum Differentiation” is restored when firms choose their location on the Hotelling line;

and Anderson et al. (2012) find a nonmonotonic relationship between equilibrium prices and qualities under joint purchasing.

There, the additional gain by joint purchasing is valued more by closer consumers so firms have an incentive to sacrifice some

sales and set high prices to prevent joint purchases. In contrast to our work, these papers abstract from price discrimination as a

motivation for joint marketing.7

Somewhat related to joint marketing arrangements are several other recent papers on joint pricing in the context

of patents and patent pooling (e.g., Lerner & Tirole, 2004; Cheng & Nahm, 2007; Choi, 2010; Rey & Tirole, 2013;

Jeitschko & Zhang, 2014). Although this work generally does not consider price discrimination, Lerner and Tirole (2004)

and Rey and Tirole (2013) examine how individually set royalty rates interact with pricing in patent pools. Rey and

Tirole (2013) in particular, consider a two-stage approach in which patent-holders first form a pool and then sepa-

rately still determine stand-alone license fees. Similar to our setting, they also consider patents (goods) that can be com-

plements or substitutes, however, the two patents (goods) are homogenous and so there is no differentiation between

them.8