The Paradox of Loyalty: How Programs May Raise Prices for All

Loyalty programs are designed to reward consumers for their repeat business while helping companies foster brand allegiance and gather valuable insights. However, in their article, “Loyalty programs may limit competition, and they could be pushing prices up for everyone,” Scott Duke Kominers, Professor at Harvard Business School and Principal Investigator of D^3’s Crypto, Fintech, & Web3 Lab, and Alexandru Nichifor, Professor at the University of Melbourne, suggest that these programs might inadvertently limit competition and drive up prices for both loyal customers and non-members alike. As business professionals, understanding these dynamics is crucial for strategic decision-making.

Key Insight: The Dual Pricing Dilemma

“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.” [1]

Loyalty programs can create a two-tier pricing system where companies benefit by enticing customers to join loyalty programs for discounts while increasing the prices of their base products. This practice can lead to inflated prices for those who choose not to participate, limiting consumer choice. According to Nichifor and Kominers, this dynamic not only impacts those outside the program but can also indirectly hurt loyal customers by making overall price competition less aggressive. For instance, a supermarket that offers discounts to loyalty members may charge higher prices for non-members, thus alienating a portion of its customer base.

Key Insight: Stifled Competition for Loyal Customers

“When a given customer’s loyalty status is not visible to a firm’s competitors…it’s hard for those competitors to identify them and entice them to switch.” [2]

Many loyalty programs do not disclose members’ statuses to competitors, creating a barrier to competitive pricing. Without knowing who the loyal customers are, competitors are limited in their ability to attract these consumers. As a result, firms tend to focus on maintaining higher base prices rather than engaging in price competition. A real-world example can be found in the airline industry, where frequent-flier status is often opaque to other carriers, allowing airlines to sustain elevated prices without fear of losing their best customers.

Key Insight: The Hidden Costs of Loyalty

“Hidden costs – such as having to pay a redemption fee on rewards or losing benefits when points expire – are another way these schemes can harm consumers.” [3]

While loyalty programs promise rewards, they often come with hidden costs that diminish their perceived value. Members may find themselves paying fees or losing accrued points if they do not redeem them in time. This situation creates a paradox where the initial allure of discounts and perks is overshadowed by the financial burden associated with maintaining loyalty. For example, many credit card rewards programs impose annual fees that can offset the benefits received, leaving consumers questioning the value of their loyalty.

Key Insight: The Case for Transparency

“Making a customer’s loyalty status verifiable, transparent and portable across firms would make it possible for firms to tailor offers for their competitors’ loyal customers.” [4]

Transparency is key to fostering healthy competition. By making loyalty statuses visible, firms can compete more effectively for each other’s customers, which can lead to better pricing and service offerings. Australia’s Victorian government initiative in the retail electricity sector exemplifies this approach by allowing consumers to compare energy offers based on their consumption profiles. This openness enabled competitors to tailor offers directly to the customers of their rivals, enhancing competition and potentially leading to lower prices.

Key Insight: Innovative Solutions Through Technology

“A design paradigm known as “Web3” – where customer transactions and loyalty statuses are recorded on public, shared blockchain ledgers – offers a way to make loyalty transparent across the market.” [5]

Emerging technologies like blockchain can revolutionize how loyalty programs operate. By recording loyalty statuses on decentralized ledgers, companies can easily identify competitors’ loyal customers and offer tailored incentives. This innovation increases competition and empowers consumers to switch brands with minimal friction. Startups and established firms alike are exploring blockchain applications to create a more competitive landscape, potentially reshaping customer engagement in the process.

Why This Matters

For C-suite executives and business professionals, understanding the dynamics of loyalty programs is crucial for strategic decision-making. While these programs can enhance customer retention and data collection, they can also inadvertently stifle competition and inflate prices. By advocating for transparency and exploring innovative solutions like blockchain, companies can create a more equitable marketplace. Embracing these insights will not only enhance customer satisfaction but also foster a competitive edge, ultimately leading to sustainable growth in an evolving business environment.

References

[1] Nichifor, Alexandru, and Scott Duke Kominers, “Loyalty programs may limit competition, and they could be pushing prices up for everyone” The Conversation (April 8, 2024).

[2] Nichifor and Kominers, “Loyalty programs may limit competition, and they could be pushing prices up for everyone”.

[3] Nichifor and Kominers, “Loyalty programs may limit competition, and they could be pushing prices up for everyone”.

[4] Nichifor and Kominers, “Loyalty programs may limit competition, and they could be pushing prices up for everyone”.

[5] Nichifor and Kominers, “Loyalty programs may limit competition, and they could be pushing prices up for everyone”.

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