Bundling and Line Extensions in Distribution Channels

We show how manufacturers can benefit from contracts that incentivize retailers to purchase multiple products from the same manufacturer. We isolate two effects: first, under standard contractual inefficiencies, which give rise to double marginalization, such contracts can increase channel profits (the “improved contractual efficiency” effect); second, when a weaker product is tied to a particularly strong “must-stock” product, such contracts can also reduce a retailer’s position and shift rent to the manufacturer (the “increased rent extraction” effect). To harness these effects, we show that it can even be profitable for the manufacturer to introduce a weak product that ultimately has the effect of foreclosing a rival’s more efficient substitute. Nevertheless, unless the tying product is sufficiently strong, the overall effect on welfare can still be positive, providing manufacturers with an efficiency rationale to use against common concerns held by antitrust agencies about such practices. This paper was accepted by Dmitri Kuksov, marketing.