Bundling

To put Casablanca, Sergeant York and The Treasure of the Sierra Madre on its Washington, D.C. television station, WTOP had to license 99 films for $118,800. The films came in three tiers of 33, sorted by quality, and the price of the good ones included Gorilla Man, Kid Nightingale and Tear Gas Squad. The distributor, Associated Artists Productions, was one of six sued by the U.S. government for block booking. On November 5, 1962, the Supreme Court held the practice illegal. The Court’s reasoning left a puzzle that economists have argued over since: if the station wanted Casablanca, why did the distributor gain by attaching Gorilla Man?

George Stigler answered the puzzle the next year. The trial court had said that forcing a station that wants Gone with the Wind to take Getting Gertie’s Garter exploits the fact that there is only one Gone with the Wind. Stigler replied that if the station values Gone with the Wind at $10,000 and the other film at nothing, the distributor can charge $10,000 for the first film alone. A worthless film adds nothing. The bundle pays only when buyers disagree about which film is worth more. In his example, exhibitor A values film X at $8,000 and film Y at $2,500, and exhibitor B values X at $7,000 and Y at $3,000. Priced separately, the best the distributor can do is $7,000 for X and $2,500 for Y, which collects $9,500 from each exhibitor, $19,000 in all. Priced as a pair at $10,000, both exhibitors buy, and the total is $20,000.

Bundling means selling two or more products together at one price. In a pure bundle, the package is the only way to buy. In a mixed bundle, the parts are also sold separately, and the package competes with them. Cross-selling is different: it invites a buyer to add an item, while a bundle makes the items a single purchase. Stigler’s example shows the mechanism. Exhibitors A and B rank the films in opposite order, so their valuations of the pair sit close together, at $10,500 and $10,000. The seller cannot know each buyer’s taste for each part, but can predict the value of the whole far more reliably.

Yannis Bakos and Erik Brynjolfsson generalized that point in 1999. When a bundle contains many goods, the law of large numbers pulls buyers’ total valuations toward the average, so the seller can set one price that most of them accept. The result holds when the marginal cost of a good the buyer does not use is close to zero, which describes films already made, software and streaming catalogs. It does not extend to most physical goods, because the cost of producing unused parts cancels the benefit. That is why the bundle is common in media and software and rare in physical goods.

The bundle also changes what the customer compares. On August 6, 2019, Disney said it would sell Disney+, ESPN+ and Hulu with ads for $12.99 a month, against $17.97 if bought separately. The standard Netflix plan cost the same $12.99. A rival with one good product now has to beat a package, not a component.