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Friday, May 16, 2008

Loyalty Cards and Polymorphic Equilibria

Tyler Cowen:

Retail loyalty card programs, by Tyler Cowen: From some time ago, Kevin Drum reports:

I really loathe retail loyalty card programs.

These programs serve two functions. First, they are a form of price discrimination. Buyers who are willing to collect and show the cards pay lower prices while the "I can't be bothered with this ****" types pay higher prices.

Second, retail loyalty cards enforce partial collusion ex post in an oligopolistic setting. In other words, cards and frequent flyer programs "lock in" buyers to their favored firms. Once that lock-in is accomplished, all firms have weaker incentives to cut price to lure away buyers from their favorites. (The smarty-pants point is to note that firms have to give buyers a better deal upfront in anticipation of this lock-in but still if the company moves first with a non-negotiable offer it still can come out ahead and raise the P/MC ratio.)

The first function is usually welfare-improving, the second function usually is not. Overall you personally benefit from loyalty card programs if you don't mind holding the cards (you have a thick wallet) and you have a strongly favorite company/product anyway. In the latter case you are likely locked in anyway, so the strengthening of the lock-in effect doesn't so much restrict your freedom. This is tricky of course because you might miss out on preemptive price cuts from your favorite firm to keep you, since maybe they don't otherwise know how much you love their stuff. Still, I will stick with this mechanism as a plausible guess of the net effect.

You suffer from loyalty card programs if...you hate them. Not only do the programs and the smiling clerks bug you but you are the kind of person who ends up paying more. Which means you hate the programs even more. Which means...

But wait: the equilibrium seems to converge and so Kevin Drum's anger at retail loyalty card programs remains, in reality, quite low.

Grocery store cards don't lock you in as described above since you can get one for each store, and having one doesn't stop you from shopping for lower prices elsewhere (though occasionally they will give a discount or some other benefit for reaching an accumulated total which does have a lock-in effect). The lock-in is more like S&H or Blue Chip stamps in the old days if you remember those (you would get a certain number of stamps per dollar spent at, say, a grocery store, and the stamps would be collected in books, and the books could be redeemed for items in a catalogue, the more books, the better the item). At that time there were two competing strategies for retail stores, some stores offered stamps and others didn't, and both were successful side by side - one didn't seem to drive out the other - they seemed to coexist in equilibrium (they were polymorphic - the linked paper mentions the trading stamp example). But in the 1970s this changed and the stamps became less common, perhaps because inflation caused variation in the value of the stamps (?), and the programs fell out of favor. Since then, the trading stamp programs have been replaced by other gimmicks that lock customers into using a particular means of payment or shopping in a particular place.

But the two different types of strategies still appear to coexist, e.g some credit cards accumulate rewards and other don't, not all grocery stores require those stupid cards even if they aren't always easy to find, etc., and one reason for that could be strongly polarized customer preferences - Kevin Drum and anti Kevin Drum types - that support a partitioned market.

    Posted by on Friday, May 16, 2008 at 03:33 AM in Economics | Permalink  TrackBack (0)  Comments (27)



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