Bundling of Vertically Differentiated Products in a Supply Chain*

We consider a supply chain consisting of a single manufacturer and a single retailer. The manufacturer produces a basic and a premium product. If desired, a bundle of the two products might also be produced at a unit bundling cost. We allow either the manufacturer or the retailer to produce the bundle from the component products. All products, however, must be sold exclusively through the retailer. Using game theoretic models, we compare and contrast the equilibrium outcomes under retailer bundling and manufacturer bundling scenarios. We show that under manufacturer bundling, the manufacturer never offers the full product line composed of the basic product, the premium product, and the bundle, at equilibrium; while the same does not hold under retailer bundling. We show that total supply chain profit under retailer bundling weakly dominates that under manufacturer bundling and characterize the region in the parameter space where this domination is strict. We explore an extension where there is a capacity constraint in producing one or both of the component products and characterize the equilibrium outcomes. We show that unlike the infinite capacity case, offering the full product line is an equilibrium outcome under manufacturer bundling when the capacity of the premium good is limited.