The Dynamic Effects of Bundling as a Product Strategy

Several key questions in bundling have not been empirically examined: Is mixed bundling more effective than pure bundling or pure components? Does correlation in consumer valuations make bundling more or less effective? Does bundling serve as a complement or substitute to network effects? To address these questions, we develop a consumer-choice model from micro-foundations to capture the essentials of our setting, the handheld video game market. We provide a framework to understand the dynamic, long-term impacts of bundling on demand. The primary well known explanation for the profitability of bundling relies on homogenization of consumer valuations. However, we find bundling can be effective through a previously unexamined mechanism of dynamic consumer segmentation that can operate even when homogenization might not be effective. In the absence of bundling, we find that sales of both hardware and software components decrease, and consumers who had previously purchased bundles might delay purchases, resulting in lower revenues. We also find that mixed bundling dominates pure bundling and pure components in terms of both hardware and software revenues. Investigating the link between bundling and indirect network effects, we find that they act as substitute strategies, with a lower relative effectiveness for bundling when network effects are stronger. ∗Both authors contributed equally to this paper, and are listed in alphabetical order. Tim Derdenger is Assistant Professor in Marketing & Strategy, Tepper School of Business, Carnegie Mellon University. e-mail:[email protected]. Vineet Kumar is Assistant Professor of Business Administration, Marketing Unit, Harvard Business School, Harvard University. e-mail:[email protected]. The authors would like to thank Sunil Gupta, Brett Gordon and Minjung Park and for comments on an earlier draft of the paper. They gratefully acknowledge feedback from seminar participants at Yale University, Catholic University of Leuven, and the University of Zurich as well as conference participants at Marketing Science, Northeastern Marketing Conference and the UT Dallas FORMS conference. All errors remain their own.