Landsburg's Internet-Popcorn Paradox

One of my life’s greatest joys is surfing over to Slate.com and finding a new piece by Steven Landsburg. Landsburg is the Armchair Economist. His regular contributions to Slate explore the hidden economics in day-to-day activities. His latest explains why some hotels charge extra for internet access and others don’t, then leaves the reader with an unsolved puzzle. (See the link to view the article: http://www.slate.com/id/2135226/ . I assume in what follows that the reader has read the article.)

The puzzle identified by Landsburg is as follows: Some hotels charge extra for internet access while others include internet access in the price of the room. This makes sense as hotels with different types of clientele will want to charge differently for internet access. But movie theatres differ in their clientele just as much as hotels do, but seemingly all movie theatres charge separately (and exorbitantly) for popcorn. The question is, what makes hotels and movie theatres so different?

The issue Landsburg analyzes belongs to the economic literature on product bundling, where bundling refers to the practice of pricing two goods as if they were one product. Like the literature, Landsburg shows that there exists conditions under which bundling is profitable and under which it is not. One condition he doesn’t address is that of cost. According to the literature, the strategy of bundling is less likely to be profitable when the bundled good is sold to buyers whose willingness to pay for the add-on is less than the marginal cost. To see why, let’s stay with the hotel example but say the add-on is towel service rather than internet access. Suppose the hotel is charging $120 per night for the bundled good, but many of its guests stay only one night and are not willing to pay anything for towel service though they will pay $120 for the room. By charging separately for towel service, the hotel can continue to charge these people $120 for the room alone, while saving money by not hiring as many chamber maids. This is not an issue as far as internet access is concerned as the marginal cost of internet access is zero—not so for movie theatre popcorn. The lesson for the movie theatre is, if the marginal cost of popcorn is substantial enough, selling the popcorn separately is more profitable than bundling it with the movie ticket regardless of demand conditions.

This explains why bundling may be profitable for a hotel but never for a movie theatre. But why then does my local pub offer popcorn for free, implicitly bundling the popcorn with the beer? For one thing, popcorn and beer are complementary goods so the money lost on popcorn is more than made up for on additional beer sales. But there is also a cost difference between offering free popcorn in a pub and doing so in a movie theatre. Can you guess what it is? I’ll give you a hint: it involves a teenage boy and a broom. That’s right, the difference is in the cleanup cost. Movie theatre popcorn must be swept up after each showing, while pub popcorn is swept up at most once a night. Plus, the popcorn at the pub is self-serve, so you don’t bother getting it unless you plan on eating it. At the theatre, the popcorn is served to you on the way in. And any popcorn served to someone who values it little is likely to end up on the floor. The upshot is, the cost of serving free popcorn in a movie theatre may be substantial enough to preclude bundling when you take into account the clean-up cost.

I have to say I’m not completely happy with this answer. I would have preferred an explanation relying more on game theory, but that’s what I came up with and it does seem to fit. Please post a comment if you think I’ve missed something.