Loyalty programs enable firms to offer significantly lower prices to some of their customers. You’d think this would encourage strong competition. But that isn’t always what actually happens. New research shows that paradoxically, by changing the way companies target customers, loyalty programs can sometimes reduce price competition. The research also points to solutions.
A win-win proposition?
- You – the customer – get to enjoy perks and discounts, while the company gains useful commercial insights and builds brand allegiance.
- The hotel chain, in turn, records and analyses how you spend money and encourages you to stay with them again.
- Loyalty schemes can have pro-competitive effects and intensify competition between rivals leading to competing loyalty discounts and lower prices for consumers.
- But on the other hand:
Loyalty schemes can also reduce the flexibility of consumers’ buying patterns and responsiveness to competing offers, which may reduce competition.
- Loyalty schemes can also reduce the flexibility of consumers’ buying patterns and responsiveness to competing offers, which may reduce competition.
How a two-speed price system can hurt everyone
A new economic theory research working paper, coauthored by one of us (Kominers), suggests that on competitive grounds alone, loyalty programs can sometimes harm all consumers – both ordinary shoppers and the program’s own members.
- Since a firm’s loyalty program enables it to offer discounted prices to its members, the firm can raise the base prices it offers to everyone else.
- Those not participating in the program pay more than they otherwise would have, and the firm can respond by saying “join our program!” instead of having to lower its price.
- This, in turn, reduces overall price competition for loyal customers, so firms can raise prices for them, too.
What’s the solution?
- So, how do we preserve these benefits while enabling price competition?
- The research suggests an answer: making a customer’s loyalty status verifiable, transparent and portable across firms.
- To address this, in 2015, the Victorian government launched a program encouraging households to compare energy offers.
- These allow direct transfer of loyalty status, but currently rely on a lengthy, individual-level verification process.
- Both startups and established firms have experimented with building such systems.
What next?
New academic research helps us model and better understand when loyalty programs could be weakening supply side competition and undermining consumer welfare. A neat universal solution may prove elusive. But targeted government or industry interventions – centred on increasing the transparency of a customer’s loyalty status and letting them move it between firms – could help level the playing field between firms and consumers.
- Part of this work was conducted during the Simons Laufer Mathematical Sciences Institute Fall 2023 program on the Mathematics and Computer Science of Market and Mechanism Design, which was supported by the National Science Foundation under Grant No.
- DMS-1928930 and by the Alfred P. Sloan Foundation under grant G-2021-16778.
- He also holds digital assets, including both fungible and non-fungible tokens, and serves as an expert on marketplace design and Web3-related matters.
- DMS-1928930 and by the Alfred P. Sloan Foundation under grant G-2021-16778.
