Pricing Strategies with Costly Customer Arbitrage

A monopolist's ability to conduct non-linear pricing is limited because customers can, at a cost, unbundle bundled output. Three pricing strategies are available to a firm: (1) a separating strategy; (2) a pooling strategy; and (3) an exclusion strategy. Each is optimal for some set of unbundling cost and distribution of customer types. The optimal pricing strategies are contrasted with the well-studied benchmark cases, in which unbundling costs are either zero or arbitrarily high. It is shown that it is not always possible to extrapolate the conclusions from the benchmark cases with respect to pricing, profitability, consumer surplus or efficiency.