DP7588 The design and efficiency of loyalty rewards

Author(s): Ramon Caminal
Publication Date: December 2009
Keyword(s): Coasian dynamics, coupons, loyalty rewards, price commitment
JEL(s): D42, D43, L12, L13
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=7588

The goal of this paper is to reexamine the optimal design and efficiency of loyalty rewards in markets for final consumption goods. While the literature has emphasized the role of loyalty rewards as endogenous switching costs (which distort the efficient allocation of consumers), in this paper I analyze the ability of alternative designs to foster consumer participation and increase total surplus. First, the efficiency of loyalty rewards depend on their specific design. A commitment to the price of repeat purchases can involve substantial efficiency gains by reducing price-cost margins. However, discount policies imply higher future prices and are likely to reduce total surplus. Second, firms may prefer to set up inefficient rewards (discounts), especially in those circumstances where a commitment to the price of repeat purchases triggers Coasian dynamics.