Abstract
We show that loyalty discounts create an externality among buyers even without economies of scale or downstream competition, and whether or not buyers make any commitment. Each buyer who signs a loyalty discount contract softens competition and raises prices for all buyers. We prove that, provided the entrant's cost advantage is not too large, with enough buyers, this externality implies that in any equilibrium some buyers sign loyalty discount contracts, reducing total welfare. Moreover, if loyalty discounts require buyers to commit to buy only from the incumbent, there exists an equilibrium in which all buyers sign, foreclosing the rival entirely. As a result, the incumbent can use loyalty discounts to increase its profit and decrease both buyer and total welfare.
Highlights
The proper antitrust treatment of loyalty discounts has been a contentious issue
We focus on a unique feature of loyalty discounts that is not present with either ordinary exclusive dealing or ordinary predatory pricing: the fact that loyalty discounts involve a seller commitment to charge loyal buyers less than disloyal buyers
We show that the incumbent can profitably guarantee that there does not exist an equilibrium in which all buyers reject the loyalty discount contract
Summary
This paper can be downloaded without charge from: The Harvard John M. Olin Discussion Paper Series: http://www.law.harvard.edu/programs/olin_center/ The Social Science Research Network Electronic Paper Collection: http://ssrn.com/. Wickelgren[1] Harvard University and University of Texas at Austin
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