Abstract
We show that loyalty discounts without buyer commitment create an externality among buyers because each buyer who signs a loyalty discount contract softens competition and raises prices for all buyers. This externality can enable an incumbent to use loyalty discounts to effectively divide the market with its rival and raise prices. 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, segmenting the market and reducing consumer welfare and total welfare. These propositions are true even if the buyers coordinate, the entrant is more efficient, the loyalty discounts cover less than half the market, and all the loyalty discounts are above cost. We also prove that these propositions hold even if we assume no economies of scale, no downstream competition, no buyer switching costs, no financial constraints, no limits on rival expandability, and no intraproduct bundle of contestable and incontestable
Highlights
The issue of how to treat loyalty discounts has split both the courts and scholars
We show that loyalty discounts with buyer commitment have stronger anticompetitive e ects than simple exclusive dealing. (Elhauge and Wickelgren 2012)
We formally analyze the optimal fraction of buyers to whom the incumbent will o er these discounts, showing that with either simultaneous pricing or an incumbent who prices rst, the optimal fraction is always less than half. This distinction has important policy relevance because it means that loyalty discounts without buyer commitment can, without economies of scale, have anticompetitive e ects even when they cover a minority of the market. (C) Because he does not analyze the optimal fraction of buyers that will be covered, he does not correctly establish the prices that will be paid
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 & University of Texas at Austin/Yale
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