Sorting out bundling and antitrust law from a seat at the Saturday double feature.
New York Times; New York, N.Y.; Jul 26, 2001; Hal R. Varian

REMEMBER double features? Back in the 1950's, movie theaters used to show two films for a single price. But there was a catch: often only one of the two films was worth seeing.

As we put it back then, ''Roses are red, violets are pink. If it's a double feature, one's gonna stink.'' This bit of doggerel is part of a particularly rare form of poetry: that with an economic theme.

Double features were a result of a practice known as block booking. If a theater wanted to buy a hit, it was forced by the studios to buy a dud as well. Theater owners didn't want to show the duds on their own, so they bundled them with another movie and showed them as part of a double feature.

In 1962 the Supreme Court declared that block booking was a form of ''tying'' and was illegal under Section 1 of the Sherman Antitrust Act.

But the court was clear that not every form of bundling was illegal. It is illegal only when a company with significant market power -- a monopolist -- packages its monopolized product with one of its other products. To buy the monopolized product, customers must also buy the other product. Under certain conditions this sort of tying can be used to extend a monopoly in one market to another market.

The most famous recent example of this reasoning is, of course, the Microsoft case, in which Judge Thomas Penfield Jackson held that the bundling of the Windows operating system with Internet Explorer constituted illegal tying. But last month the United States Court of Appeals for the District of Columbia Circuit asked a lower court to revisit that issue, so the legality of this particular bundling example is still unresolved.

Bundling is particularly attractive for computer software and other sorts of information goods since there is negligible incremental cost in packaging two software products. Furthermore, as Microsoft emphasized in the trial, there are advantages to software bundles in that individual programs can share components and an integrated package may be easier both to program and to operate.

Leaving aside these monopoly tying issues, bundling itself can significantly contribute to profit, in at least two different ways: by enabling price discrimination and by blocking entry.

In a comment on the 1962 decision on block booking, George Stigler, a Nobel winner in economics, described how bundling can facilitate price discrimination.

Suppose there are two films, ''Dinosaur Dystopia'' and ''Kung-Fu Katie,'' and 100 potential viewers. Fifty would be willing to pay $3 to see ''Dinosaur'' and $2 to see ''Katie,'' while the other 50 would be willing to pay $3 for ''Katie'' and $2 for ''Dinosaur.'' If the studio prices the movies separately, it would want to set a price of $2 for each movie, realizing a total revenue of $200 for each film, or $400 in total.

But look what happens if the studio uses block booking. Assuming that the willingness to pay for the double feature is the sum of the willingness to pay for the individual films, all members of the audience would be willing to pay $5 for the bundle. This yields a revenue of $500, significantly more than with unbundled pricing.

In this case, bundling makes customers' willingness to pay less spread out. This means that the seller does not have to make significant cuts in the price of the bundle to attract additional customers.

In theory, adding more goods to the bundle would concentrate that willingness even more. Saturday afternoon is only a few hours long, so this doesn't work very well for movies, but other examples are easy to find. In fact, you are holding one in your hands right now -- a newspaper.

Some people like the sports section, some people like the business section, some people like arts and living. Even Economic Scene has its fans. The willingness to pay for the bundle of articles tends to be less dispersed than the willingness to pay for each article on its own, so charging for the bundle is generally more profitable than selling the articles separately. Of course, there are also big cost savings to bundling articles together for newspapers, but even if the cost savings were not there, as with online publications, the revenue effect would still be present.

Two economists, Yannis Bakos of New York University and Erik Brynjolfsson of the Massachusetts Institute of Technology, have extended this analysis in a variety of ways in their joint work on bundling information goods.

The entry-blocking aspect of bundling has been investigated by several economists, including Mr. Bakos and Mr. Brynjolfsson, Barry Nalebuff of the School of Management at Yale University and Michael Whinston of Northwestern University. To use Mr. Nalebuff's example, consider a company that has substantial market power in both the word-processor and the spreadsheet markets and contemplates bundling them into an office suite.

By bundling these products and selling the bundle at an attractive price, the seller can assure that most potential customers for either product buy the bundle. This means that anyone who wants to enter the market for either word processors or spreadsheets won't have a significant market left. Here bundling has reduced the reward to potential competitors who want to enter either market.

The only way a potential entrant could effectively compete with the bundle is by entering both markets simultaneously. This, of course, makes the entry costs significantly higher and also ensures that the ensuing competition will be much more intense. In fact, when Sun Microsystems offered its StarOffice suite to compete with Microsoft Office, it set a particularly interesting price: zero. Presumably Sun recognized that aggressive pricing would be necessary to penetrate the office-suite market.

Bundling offers a way to extend monopoly, to increase revenue and to raise entry costs. But it may also offer enhanced functionality and lower production costs. Sorting out these benefits and costs of bundling will be particularly challenging for the courts, since the balance of benefits and costs will differ significantly case to case.