Retailer-Driven Product Bundling in a Distribution Channel

This paper studies product bundling in a distribution channel where a downstream retailer combines component goods produced by separate manufacturers acting independently. Past literature offers deep insights about bundling by a single firm whose unit costs are not impacted by choice of selling strategy. But when the retailer bundles goods from separate manufacturers, unit costs for the bundler (retailer) are, being the prices set by the manufacturers, no longer exogenous. This alters the economic balance with respect to bundling. I show that channel conflicts weaken the case for bundling. Although bundling is better than component selling for the integrated firm, it is no longer so in the decentralized channel. The culprit is a combination of vertical channel conflict (incentive misalignment with respect to bundle versus component sales) and horizontal conflict (each manufacturer wants a higher share of profits from bundle sales), with the latter playing a dominant role. They cause manufacturers to overprice component goods, weakening the retailer's incentives to bundle. The competitive interplay between firms when one (retailer) merges the prices of several (manufacturers) leads to lower profits for all. Price coordination between the firms could partially restore the role of bundling and improve the firms' profits as well as consumer surplus.