Bundling and Firm Reputation

Abstract

By bundling experience goods, a manufacturer can more easily maintain a reputation for high quality over time. Formally, we extend Klein and Lefler's (1981) repeated moral hazard model of product quality to consider multi-product firms and imperfect private learning by consumers. When consumers are small, receive imperfect private signals of product quality, and have heterogeneous preferences over available products, then purchasing multiple products from the same firm makes consumers more effective monitors of the firm's behavior. These consumers observe more signals of firm behavior and detect shirking with a higher probability, which creates stronger incentives for the firm to produce high quality products. By constraining all of the firm's consumers to use more effective monitoring and punishment strategies, bundling creates an even stronger incentive for a multi-product firm to produce high quality products. The impact of bundling on incentives is even greater when consumers cannot identify which of the goods is responsible for poor overall product performance.