The Simple Economics of Optimal Bundling

TL;DR

This paper develops a theoretical framework for optimal bundling strategies in markets with consumers differing in one dimension, identifying conditions under which nested bundling is optimal and linking it to quality design and screening.

Contribution

It introduces a partial order on bundles and characterizes when nested bundling is optimal, connecting it to price elasticities, cost structures, and screening mechanisms.

Findings

Nested bundling is optimal when undominated bundles are nested.

Optimal nested menu depends on sales volumes of bundles.

Conditions established for when costly screening is optimal.

Abstract

We study optimal bundling when consumers differ in one dimension. We introduce a partial order on the set of bundles defined by (i) set inclusion and (ii) sales volumes (if sold alone and priced optimally). We show that if the undominated bundles with respect to this partial order are nested, then nested bundling (tiered pricing) is optimal. We characterize which nested menu is optimal: Selling a given menu of nested bundles is optimal if a smaller bundle in (out of) the menu sells more (less) than a bigger bundle in the menu. We present three applications of these insights: the first two connect optimal bundling and quality design to price elasticities and cost structures; the last one establishes a necessary and sufficient condition for costly screening to be optimal when a principal can use both price and nonprice screening instruments.