Research has found that downstream bundling aggravates the problem of double marginalizationin a decentralized channel, but reduces the intensity of downstream price competitionwhen trading homogeneous goods. We study the validity of those results in a set-upwhere the traded goods have heterogeneous product qualities. We find that the quality relationbetween the goods determines whether the competition reduction effect of bundlingoutweighs the aggravation of double marginalization in a decentralized channel. Thus, thequality relation between the goods determines the profitability of downstream bundling.The underlying market consists of a distribution channel with two downstream firms andtwo price-setting monopolistic upstream producers. One upstream firm sells good 1 exclusivelyto one downstream firm and the other upstream firm sells good 2 to both downstreamfirms. The downstream firms compete in prices and the two-product downstream firm hasthe option to bundle both goods. In particular, we find bundling to be profitable for the twoproductdownstream firm only when the quality of good 2 exceeds the quality of good 1.However, we find bundling always to be profitable when the production process is controlledby the downstream industry. The impact on total welfare is ambiguous and dependson the distribution of market power in the channel and the quality levels of the goods.