Bundling and horizontally differentiated innovation

Abstract This research builds a three‐stage (bundling, horizontally differentiated innovations [HDIs], and outputs) game in which only one multi‐product firm undertakes a bundling strategy in order to analyze the impacts of bundling on HDIs and competes with a single‐product firm. It is found that no matter what the degree of initial product substitution is, bundling will definitely amplify the degree of horizontal product differentiation. When the initial degree of product substitution is large, the bundling strategy subdues the firm's HDI while increasing the competitor's HDI. However, when the initial degree of product substitution is small, the bundling increases both firms' HDIs, resulting in higher competitor's profit, consumer surplus, and social welfare. An important policy implication of our results is that antitrust regulation that allows bundling may contribute to the multi‐product firm's HDI.