Bundling Strategies When Products Are Vertically Differentiated and Capacities Are Limited

We consider a seller who owns two capacity constrained resources and markets two products (components) corresponding to these resources as well as a bundle comprising the two components. In an environment where all customers agree that one of the two components is of higher quality than the other and that the bundle is of the highest quality, we derive the seller’s optimal bundling strategy. We demonstrate that the optimal solution depends on the absolute and relative availabilities of the two resources as well as upon the extent of subadditivity of the quality of the products. The possible strategies that can arise as equilibrium behavior include a pure components strategy, a partial or a full spectrum mixed bundling strategy, and a pure bundling strategy, where the latter strategy is optimal when capacities are unconstrained. These conclusions are contrary to findings in the prior literature on bundling which demonstrated the unambiguous dominance of the full spectrum mixed bundling strategy. Our work expands the frontier of bundling to an environment with vertically differentiated components and limited resources. We also explore how the bundling strategies change as we introduce an element of horizontal differentiation wherein different types of customers value the available components differently.