1 Bundling in Vertically Differentiated Communication Markets

We look at the competition and the welfare effects of bundling in the context of vertically differentiated communication services (Television, Telephone and Internet). We consider a two-stage game with two asymmetric firms. In the first stage firms simultaneously commit to adopt bundling or component pricing. These decisions give four possible configurations: (i) a configuration where both firms use component pricing; (ii) a configuration where both firms use bundling; and finally (iii) the two configurations where one firm use bundling and the other firm does not. In the second stage firms set simultaneously prices. We show that bundling is a dominant strategy equilibrium for both firms. The reason is that bundling increases the differentiation of services and reduces the intensity of price competition. We also find that although the bundling-bundling equilibrium reduces consumers ’ surplus, total economic welfare is higher than when both firms use component pricing