Optimal bundling under imperfect competition

This paper examines the profitability of bundling for a two-product seller of differentiated products facing competition from a one-product rival. In the presence of imperfect competition, Pure Bundling emerges as the optimal pricing strategy. Other than ensuring the monopoly product can only be purchased in a bundle, Pure Bundling's additional advantages stand in its ability to (i) prevent consumers from forming their own bundle using the single-product seller's product, (ii) reduce aggressiveness in pricing and (iii) smooth over the variation in valuations consumers have for the two types of products. However, the profit maximizing strategy is not welfare maximizing: consumers are best off when all products are available a la carte only, the competitor maximizes profits under Mixed Bundling, and total welfare would be highest if the two-product supplier were to offer only the monopoly product a la carte.