Bundling, Tying, Metering. Economics & Antitrust

1. Lecture 1 Bundling, Tying, Metering.Economics & Antitrust Antonio Nicita Siena Doctorate in L&E

2. Bundling: what and why? • A bundle of two products is effectively a way of offering discount to customers who buy one of your product, since customers can buy the other product at a lower price than the stand-alone price. • Do you want to offer a discount on the other product to customers who buy one product? • Why? • Price discrimination/efficiency

3. Tie-in • Tied Sales: Tying is the practice of requiring the purchaser of one product to also purchase a second product. • In the static tied-sale, the customer who wants to buy A must also buy B. It is possible to buy B without A which explains why this is a tie and not a bundle. Thus, the items for sale are B alone or an A-B package. • There are many legitimate reasons why firms resort to tied sales. One motivation that leads to an antitrust concern is when the tied sale is used as a metering device to facilitate price discrimination. • what is the appropriateness of direct price discrimination done through metering, without the use of a tied sale?

4. Metering • Metering is a form of pricing where the customer pays a per-use fee. • Examples include paying a per-page fee for photocopying, a per-nail fee for a nail gun, a per-hour-of-use fee for an aircraft engine (often called “power-by-the-hour”), or even a per-mile fee for auto insurance. • a distinction between (i) metering and (ii) tying that is used as a metering device. To illustrate this distinction, a photocopy machine seller could achieve a metered price result in two ways: It could require that the customer purchase its paper at an inflated price (tying). It could charge a price per copy and allow the customer to purchase any paper on the market (pure metering). • Although the two approaches have the same impact on the customer, they may have a different impact on the market and, thus, we may want to treat them differently.

5. Bundling with Negative Correlated Preferences • Selling separately: • Px=$10, Rev=$20 • Py=$3 , Rev=$6 • TR=$26 • Sell as bundle: • Pb=$14, TR=$14*2=$28 • Bundling is profitable in this case

6. Bundling with Positive Correlated Preferences • Selling separately: • Px=$10, Rev=$20 • Py=$3 , Rev=$6 • TR=$26 • Sell as bundle:Pb=$13, TR=$13*2=$26 • No difference!

7. The willingness to pay for the bundle is less dispersed than the willingness to pay for the components. This will happen when the consumers with a high value for one component tend to have low value for another component Consumption decisions when products are sold separately

8. Consumption decisions when products are sold as a bundle

9. Satisfaction Good X Good Y A 10 90 B 50 50 C 60 40 D 90 10 Mixed bundling Cost of X=$20 Cost of Y=$30 • Selling as mixed bundling • Px=Py=$89.99Pb=$100 • In this case: • A will buy Y only • B & C will buy bundle • D will buy X only • TR=$(89-30)+$(100-50)*2+$(89-20)=$228 • Selling separately: • Px=$50, Rev=$(50-20)*3=$90 • Py=$90, Rev=$(90-30)*1=$60 • TR=$90+$60=$150 • Selling as pure bundle: • Pb=$100, TR=$(100-50)*4=$200

10. Asymmetric Mixed Bundling (with Tying)

11. Tying+ Bundling

12. Bundling and Antitrust/1 • Chicago Critique: bundling as leveraging? Leveraging Market Power. Firms may use their market power in one market to leverage it towards another. • Bork (1978):you cannot raise more than one monopoly profit each time • Assumptions: perfect competitive market for bundled product; static environment • Double marginalization in monopolistic and oligopolistic environment: efficiency reasons

13. Bundling & Antitrust/2 (Nalebuff) • The creation of artificial scale economies. Absent bundling, a firm with larger scale or scope would not have an advantage over smaller rivals or entrants. However, the firm employs bundling to artificially create such scale and scope economies. A firm with power in several markets can use various bundling strategies to preserve and protect that market power. We illustrate this using examples from mobile phone pricing and airline pricing of roundtrip discounts. • Raising Rival’s Costs. Bundling and/or tying can be used to deny a rival or potential entrant access to a complementary market. For example, if bundling leads to the disappearance of an independent service market, then a potential entrant will have to enter with both a product and a service network. Cases in this report that illustrate this issue include Kodak, Guinness/Grand Met and SMG radio.

14. Bundling & Antitrust/3 • Lowering Rival’s Benefits. Parallel to the effect of raising rivals’ costs is a move that lowers the benefits that consumers anticipate from rivals’ products. • Efficiency Offence. In this case, bundling is used to mitigate what would otherwise be inefficiencies in pricing (such as double marginalisation). As a result, the bundling firm can gain a competitive advantage over rivals. • Anti-competitive leveraging. While the Chicago School has discredited the static theory of market leverage, there are reasons to believe that a firm can use leverage to gain a dynamic advantage.

15. Bundling & Antitrust/4 • Bundling to Protect Market Power. When an incumbent has market power in several goods, it can use bundling as a way to reduce the likelihood and/or mitigate the potential cost of entry to the incumbent. Bundling may also be effective in deterring entry. It reduces the expected profits to an entrant against an incumbent that might be slow to respond (or that might be thought to be slow to respond). The intuition for this effect is that bundling restricts the entrant to go after the more limited market of customers that like its one product and do not care for the other products in the bundle.

16. Bundling & Antitrust/5 • Bundling as a Commitment Device to Deter Entry. The first strategic theory of bundling explained how this strategy can be used to help a multi-product firm commit to taking a more aggressive stance towards rivals. In this context, bundling can also lead to advantageous R&D incentives. However, the conclusion is premised on a firm’s ability to commit to a bundling strategy. Commitment is required as a firm would seek to abandon bundling in response to entry. This theory has not been connected to specific firm practices and, thus, remains more speculative, for now. • Hidden Pricing. Bundling can also be used to obscure pricing. We believe these types of problems can be solved through remedies such as those provided in the travel agent insurance case.These issues are more in the realm of consumer protection than in antitrust. In some cases, however, the form of the bundled pricing contract distorts the nature of price competition to the point where there are large cross-subsidies and even potential entry barriers.

17. Discrimination & Antitrust • Is discrimination pro either anti-competitive? • PRO= efficiency increase (static environment) • ANTI = when efficient entry is inhibited (dynamic environment, network effects, one stop shop, standard) • Who’s welfare?

18. US vs Microsoft/1 (D. Diermeier) • In 1997 the U.S. Department of Justice (DOJ) files a civil antitrust case against Microsoft • Initially the case was limited to a violation of the 1994 Consent Agreement between DOJ and Microsoft , but later broadened • DOJs case was based on section 1 and 2 of the Sherman Act. • Section 1 prohibits “tying” (usually a per se violation) provided that tying (i.e. Windows) and tied (i.e. browser) products are separate products • The party imposing the tie has enough market power in the tying product market to force the purchase of the tied product. • A “not insubstantial “ amount of commerce in the tied product is affected. • Section 2 prohibits unlawful monopoly. The DOJ must show that: Microsoft has monopoly power, and that • Microsoft willfully acquired or maintained power through anticompetitive acts. • A complicating issue is the aspect of “leveraging” (just getting a better competitive position is not sufficient for a violation)

19. US vs Microsoft/2 • In the Fall of 1999, Judge Jackson issued his Rulings of Fact • damaging findings and harsh condemnation of Microsoft • among other things Microsoft is found a monopoly - may lead to private anti-trust suits • Rulings of Fact are hard to overturn on appeal • Microsoft’s stock-price hardly moved • In June 2000, Judge Jackson approves the submitted remedies by DOJ and state attorney generals • Main proposal is to break up Microsoft into two companies (operating system and everything else) plus temporary conduct remedies • Microsoft vows to fight on without any admission of guilt. • Files appeal

20. US vs Microsoft/3 • In 2001, U.S. Court of Appeals issued the following findings: • Monopoly finding in operating system market upheld • No monopoly finding in the browser market • Returned the issue of “tying” to the District Court changing the legal standard to be applied (no discussion of the merits) • From per se to rule of reason • Disqualified trial judge for interviews with media and offensive comments about MS; • the Court of Appeal held that these comments did not affect the judge’s finding of fact or conclusions of law.

21. US vs Microsoft/4 • On September 6, 2001, the DOJ announced: • The DOJ was no longer seeking a breakup of Microsoft; and • The DOJ was no longer pursuing its ‘tying’ claim against Microsoft (the strongest claim and most concerning to competitors) • On November 1, 2001, the DOJ announced that it had reached a settlement with Microsoft. • On November 6, 2001, nine states (including Connecticut, California, and Utah) reject the DOJ-MS agreement • On November 1, 2002 the new district court judge Colleen Kollar-Kotelly upholds the settlement (except for minor changes) • Microsoft has already complied with the 2001 settlement • Microsoft immediately implements minor changes required by judge

22. EU vs Microsoft/1 • In December 1998, Sun Microsystems, another US company, complained that Microsoft had refused to provide interface information necessary for Sun to be able to develop products that would "talk" properly with the ubiquitous Windows PCs, and hence be able to compete on an equal footing in the market for work group server operating systems. • The Commission's investigation revealed that Sun was not the only company that had been refused this information, and that these non-disclosures by Microsoft were part of a broader strategy designed to shut competitors out of the market. • As a result, an overwhelming majority of customers informed the Commission that Microsoft's non-disclosure of interface information artificially altered their choice in favour of Microsoft's server products. Survey responses submitted by Microsoft itself confirmed the link between the interoperability advantage that Microsoft reserved for itself and its growing market shares.

23. EU vs Microsoft/2 • In 2000, the Commission enlarged its investigation, on its own initiative, to study the effects of the tying of Microsoft's Windows Media Player with the company's Windows 2000 PC operating system. • This part of the investigation concluded that the ubiquity which was immediately afforded to WMP as a result of it being tied with the Windows PC OS artificially reduces the incentives of music, film and other media companies, as well software developers and content providers to develop their offerings to competing media players. • As a result, Microsoft's tying of its media player product has the effect of foreclosing the market to competitors, and hence ultimately reducing consumer choice, since competing products are set at a disadvantage which is not related to their price or quality.

24. EU vs Microsoft/3 • Available data already show a clear trend in favour of WMP and Windows Media technology. Absent intervention from the Commission, the tying of WMP with Windows is likely to make the market "tip" definitively in Microsoft's favour. This would allow Microsoft to control related markets in the digital media sector, such as encoding technology, software for broadcasting of music over the Internet and digital rights management etc. • More generally, the Commission is concerned that Microsoft's tying of WMP is an example of a more general business model which, given Microsoft's virtual monopoly in PC operating systems, deters innovation and reduces consumer choice in any technologies which Microsoft could conceivably take interest in and tie with Windows in the future.

25. EU vs Microsoft/4 • In March 2004, The European Commission has concluded, after a five-year investigation, that Microsoft Corporation broke European Union competition law by leveraging its near monopoly in the market for PC operating systems (OS) onto the markets for work group server operating systems and for media players • Because the illegal behaviour is still ongoing, the Commission has ordered Microsoft to disclose to competitors, within 120 days, the interfaces required for their products to be able to 'talk' with the ubiquitous Windows OS. • Microsoft is also required, within 90 days, to offer a version of its Windows OS without Windows Media Player to PC manufacturers (or when selling directly to end users). In addition, Microsoft is fined € 497 million for abusing its market power in the EU.

26. EU vs Microsoft/5 • Microsoft abused its market power by deliberately restricting interoperability between Windows PCs and non-Microsoft work group servers, and by tying its Windows Media Player (WMP), a product where it faced competition, with its ubiquitous Windows operating system. • This illegal conduct has enabled Microsoft to acquire a dominant position in the market for work group server operating systems, which are at the heart of corporate IT networks, and risks eliminating competition altogether in that market. In addition, Microsoft's conduct has significantly weakened competition on the media player market. • The ongoing abuses act as a brake on innovation and harm the competitive process and consumers, who ultimately end up with less choice and facing higher prices. • For these very serious abuses, which have been ongoing for five and a half years, the Commission has imposed a fine of € 497.2 million.

27. EU vs Microsoft - Remedies/1 • As regards interoperability, Microsoft is required, within 120 days, to disclose complete and accurate interface documentation which would allow non-Microsoft work group servers to achieve full interoperability with Windows PCs and servers. • This will enable rival vendors to develop products that can compete on a level playing field in the work group server operating system market. The disclosed information will have to be updated each time Microsoft brings to the market new versions of its relevant products. • To the extent that any of this interface information might be protected by intellectual property in the European Economic Area, Microsoft would be entitled to reasonable remuneration. The disclosure order concerns the interface documentation only, and not the Windows source code, as this is not necessary to achieve the development of interoperable products.

28. EU vs Microsoft - Remedies/2 • As regards tying, Microsoft is required, within 90 days, to offer to PC manufacturers a version of its Windows client PC operating system without WMP. • The un-tying remedy does not mean that consumers will obtain PCs and operating systems without media players. Most consumers purchase a PC from a PC manufacturer which has already put together on their behalf a bundle of an operating system and a media player. As a result of the Commission's remedy, the configuration of such bundles will reflect what consumers want, and not what Microsoft imposes. • Microsoft retains the right to offer a version of its Windows client PC operating system product with WMP. However, Microsoft must refrain from using any commercial, technological or contractual terms that would have the effect of rendering the unbundled version of Windows less attractive or performing. In particular, it must not give PC manufacturers a discount conditional on their buying Windows together with WMP.

29. Conclusions:Antitrust assessment of bundling See Nalebuff 2003