ENTRY DETERRENCE , AND SPECIALIST INNOVATORS By Jay

We examine a mechanism by which bundling may inefficiently deter entry into the market. The model considers an incumbent monopolist in two complementary components that faces a series of entry attempts by rivals. It is shown that the incumbent can practice bundling to buttress its monopoly position by keeping specialist innovators out of the market. Bundling prevents specialist rivals from coordinating in the dynamic entry process, reducing the probability of an eventual displacement of the incumbent. Bundling may thus lead to lower customer and total economic welfare. * Department of Economics, Michigan State University, East Lansing, MI 48824, tel. (517) 353 7281, e-mail: [email protected]. ** Jones School of Management, Rice University – MS 531, 6100 Main Street, Houston, TX 77005, tel. (713) 348 6342, e-mail: [email protected]. We thank Kyle Bagwell, Devashish Mitra, Patrick Rey, Santanu Roy, Valter Sorana, and Mike Waldman for helpful suggestions. We are also grateful to conference participants in the IDEI Conference on the Economics of the Software and Internet Industries, the 4th Kiel Workshop in Economics on the Microeconomics of the New Economy and the 2002 North American Winter Meeting of the Econometric Society.