The Design and Efficiency of Loyalty Rewards

Authors


  • I thank Roberto Burguet, Adina Claici, Mara Lederman, coeditor, two anonymous referees, and participants in 2009 annual meetings of the EEA (Barcelona) and EARIE (Ljubljana) for their useful comments and suggestions. I also thank the Spanish Ministry of Science and Innovation (ECO2008-08150 and ECO2011-25293), Barcelona GSE Research Network and Generalitat de Catalunya (2009 SGR 1420) for their support.

Abstract

The goal of this paper is to reexamine the optimal design and efficiency of loyalty rewards (LRs) in markets for final consumption goods. Although the literature to date has emphasized the role of LRs as endogenous switching costs (which distort the efficient allocation of consumers), l analyze instead the ability of alternative designs to foster consumer participation and increase total surplus. First, the efficiency of LRs depends 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 regular prices and are likely to reduce total surplus. Second, firms may prefer to set up inefficient rewards (discounts), especially in circumstances where a commitment to the price of repeat purchases triggers Coasian dynamics.

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