Tying and Bundling: A critical analysis8 min read

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Tying: Economics

Meaning

Tying is a form of price discrimination in which is one good, called the base good, is tied to a second good called the variable good or more disposable goods[1]. The most relevant example in tying is the printer and the ink cartage, where the printer is the base good, and the ink cartage is the variable good. The other examples are Cellphone (base good) and the Service Plans (variable goods), amazon kindle fire (base good) and the accompanying books (variable goods), Gillette Mach 3 Razor (base good) and the Gillette Mach 3 Blade (variable good), and the like.

In each of the above cases, the base good is typically cheaper (price closer to marginal cost) while the tied good or the variable good is priced at above marginal cost. The printers are very cheap in comparison to the ink cartages. Moreover, the printer (suppose Canon LBP 2900) will work with only the ink cartages built to fit with Canon LBP 2900 printer.

Tying is a flexible way to charge different prices to different customers. The producer charges a higher price to customers with high willingness to pay and vice-versa. Therefore, the producer intends to charge the high users higher price and the low users lower price. The high users and low users signify the high use and low use of the Canon LBP 2900 Printer.

Typing, through the variable good, acts as the meter. The more meter reads, the higher the prices relative to marginal cost. Firms price discriminate by pricing the base good below the marginal cost and the variable good above the marginal cost. Consumers reveal their willingness to pay through the variable good. Hence, the variable good acts as the meter.

Typing tends to increase social welfare because it will typically increase output. In our earlier example of Canon LBP 2900 Printer, if the printer were not tied to ink cartages, the printer would have been more expensive, and ink cartages much cheaper. Under these circumstances, the business houses or the people who want to print a lot of documents or photos would continue to buy and are probably in better-off condition. But, the ordinary customers will not buy the printer because the entry fee or the initial cost is too high for general customers to afford the printer. Consequently, the total output is lower.

Benefits of Tying

  • The tie-in is a substitute for a lump sum payment well-designed to extract the consumer’s surplus in the tying good market.
  • The tie-in ensures the quality of the tied-good when the tied good is used in conjunction with the tying good.
  • The tie-in monitors cheating in a cartel producing the tied good.
  • The tie-in permits evasion of price controls.
  • The tie-in serves to price discriminate among types of consumers having different demand elasticity.
  • Tie-In reduces the risk to consumers.

Tying and Price discrimination

Both second degree and third-degree price discrimination are applicable in typing. The producer can implement both second and third-degree price discrimination depending upon the market. The producer can either reduce the price of tied good to bulk buyers or can segregate the market on the basis of elasticity and set the price of the tied good in the respective market. For example, Canon LBP 2900 printer uses only the cartage designed for it. The cost of a printer is same all over the market (and is relatively cheap that is price close to marginal cost). But, the producer does price discrimination in the ink cartages, which is technologically designed to tie to the printer.

Hence, the bulk buyer of the cartages will be charged less (second-degree price discrimination). On the other hand, the relatively elastic market will be charged less in comparison to a relatively inelastic market because inelastic market buyer exerts more power than the producer (third-degree price discrimination).

Welfare aspect of Tying

Tying increases social welfare. Tying is beneficial for both consumer and producer. A producer is benefited in a sense that the output or sales increases as the cost of a printer, the entry cost for the consumer, decreases with tying. Thus, the total sales of the tying good increases; consequently, the sales of tied good, which is priced above marginal cost, also increases. Hence, the profit of the producer increases. Tying also prevents other competitors from entering into the market, and may also be used with or in place of patents or copyrights, discouraging innovation.

On the other hand, the customer is also in better off. The low-end consumer can easily afford the printer as the printer is cheaper. Tying also reduces risk to customers as the customers do not need to worry to choose tied good such as If a consumer purchases Canon LPB 2900 Printer, then he or she must not worry regarding which ink cartage to use because the printer is technologically designed to fit with Canon LBP 2900 ink cartage. Hence, the customer is in safety.

Bundling

Bundling is a marketing strategy that joins two or more products or services together in order to sell them as a single combined unit[2]. Bundling is the practice of joining the related products for the purpose of selling them as a single unit. Bundling is the act of selling two or more goods or services together as a package. The best example of bundling is Microsoft Office that comes with the bundle of 4 to 7 different programs such as Microsoft Word, Excel, PowerPoint, Publisher, and a few others. A consumer can buy these products individually, but the total cost significantly exceeds the total cost of a bundle.

Suppose there are two products word and excel. First imagining to sell the products individually to John and Tyler.

tying and bundling

The table clearly presents that the word can have two sensible prices $120 and $50 as John and Tyler have the willingness to pay $120 and $50 respectively. Hence, the company must charge either $120 or $50. Similarly, for Excel, the company shall charge either $30 or $115.Source: A hypothetical data

The available options for the Microsoft for word are:

  • To set the price of Word at $120 and sell one unit or
  • To set the price of Word at $50 and sell two units

The available options for the Microsoft for excel are:

  • To set the price of Word at $115 and sell one unit or
  • To set the price of Word at $30 and sell two units

If Microsoft uses high price strategy,

Total Revenue = 1×120+1×115=$235

If Microsoft uses a low price strategy

Total Revenue = 2×30+2×50=$160

If the Microsoft sells the product in the bundle,

Total Revenue = 2×150=$300

Therefore, the maximum revenue from the individual sale is $235 but the maximum revenue from the sale of the bundle is $300. Hence, the bundling significantly increases the revenue. Here, the bundling increased revenue by $65 or 27.66 percentage.

Reasons for bundling

  • The demand for individual products is variable. The individual has a vast variation in willingness to pay for the same product. For example, John wills to pay $120 and Tyler wills to pay $50 for Microsoft Word. In such cases, the firm is forced to choose either high price or low price.
  • Demand for bundled good has less variability than the demand for individual good. The willingness to pay for a bundle stands at $150 and $165 for John and Tyler respectively. So, there is less variability of price in a bundle.
  • Bundling of products rises the market power of the company. Microsoft offers Office Package which consists of a bundle of products such as Word, Excel, PowerPoint, Publisher, and the like. Since office package comes with a bundle of handy products, people usually prefer Microsoft Office to other Office Products. The bundled product encompasses large market scope. The single Office Package fulfills the demand for Word Processing, Spreadsheet, Presentation software, and many more.
  • Negative correlation, not often, helps in the bundling of products. Customers have heterogeneous demand. In our example of Word and Excel, John has a high willingness to pay for Word, while Tyler has a high willingness to pay for Excel. In such negatively correlated situation, revenue cannot be maximized without bundling because if the price of Word exceeds $50, Tyler will not purchase the Word, and if the price of Excel exceeds $30, John will not buy the Excel.
  • Companies bundle goods and/or services to save marginal cost, improve quality, and enhance customer convenience.
  • Bundling allows producers to offer bundle more cheaply or to provide more value to consumers who want two or more products.
  • Bundling increases profit. Some of the increase in profits come from reductions in consumer surplus and some from reductions in deadweight loss (increased sales)

When should Bundling be used?

Bundling is most often used when:

  • Economics of scale exists in production.
  • Economics of scope exists in distribution.
  • The marginal cost of bundling is low.
  • Initial cost or Production set up cost is high.
  • Consumer acquisition costs are high.
  • Negative correlation among the products

Welfare aspect of Bundling

Bundling increases total welfare. The bundling reduces deadweight loss through increased sales. Though there might be some reduction in consumer surplus, total welfare that is producer surplus plus consumer surplus increases. In other words, the reduction in deadweight loss is greater than the reduction in consumer surplus. From the view of the customer, some of the customer surpluses get eroded, but the customer is in the better off situation as (i) the bundled product is offered relatively cheaper, (ii) the transaction and agency cost is reduced, and (iii) availability of the quality product in the same bundle.

Argument against Bundling

With reference to our previous example of Microsoft, consumers who need the only word, excel, and PowerPoint might not be in better of position because he or she does not use other products available in the bundle, which is definitely a loss for him or her. So, he may go for la carte pricing. Similarly, the Naïve Theory states that if Microsoft offers Office package with 7 products bundled for $560, then Microsoft must offer an individual product at $80. But, Microsoft charges more than $80 for an individual product.

References

[1] Marginal Revolution University. (2018). Tying. Retrieved from https://www.mruniversity.com/courses/principles-economics-microeconomics/tying-economics-example

[2] Investopedia. (2018). Bundling. Retrieved from https://www.investopedia.com/terms/b/bundling.asp

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