Interfirm Bundling and Vertical Product Differentiation

In this paper, we study the competitive effects of bundled discounts offered by pairs of independent firms. In a setting with vertically differentiated goods, where firms decide whether to participate in a discounting scheme before prices are set, it is shown that, in equilibrium, all pairs of firms producing goods of the same quality level offer bundled discounts. Relative to the no-bundling benchmark, we find that (i) all headline prices rise, (ii) all bundle prices, net of the respective discount, decrease, and (iii) only high-quality sellers will obtain higher profits. Furthermore, this equilibrium corresponds to the worst scenario in terms of consumer welfare, and it and decreases social welfare.