Bundling, Competition and Quality Investment: A Welfare Analysis

We investigate how bundling affects investment in product quality, and derive welfare implications. A monopolist in a primary market competes with a rival in a complementary market. Bundling is the monopolist's preferred strategy, since it either extracts surplus from the rival's investment, or forces the rival to provide low quality. Bundling may reduce welfare without foreclosing the rival, but improves welfare when preventing undesirable investment. Since prohibiting bundling is not appropriate, we introduce a price test for bundled offers that preserves efficiencies from both bundling and quality investment, thereby improving welfare relative to the 'do-nothing' scenario. We consequently argue that this test should be applied whenever possible.