The Role of Cost in Determining When Firms Offer Bundles

We incorporate marginal cost savings from bundling, fixed costs of product offerings, and variation in customer preferences into a model of bundling and tying. To focus on cost effects, we assume perfectly contestable markets and analyze sustainable product offerings. Pure bundling can arise either because few people demand only one component or because, with high fixed costs, a single product is the efficient way to satisfy customers with diverse tastes. We conclude with an empirical analysis of the bundling of pain relievers with decongestants. We document a sizeable discount for the bundled product and argue that our model provides a more compelling explanation for it than the demand-centered approach that has dominated the bundling literature.