Robust Exclusion through Loyalty Discounts with Buyer Commitment
Harvard Discussion Paper No. 722
36 Pages Posted: 7 Aug 2012
Date Written: August 1, 2012
We show that loyalty discounts with buyer commitments create anticompetitive effects beyond those possible with pure exclusive dealing. The loyalty discount adds a seller commitment to maintain a distinction between the loyal and disloyal price. This seller commitment reduces the seller's incentives to compete for free buyers because the loyalty discount means that lowering prices to free buyers requires lowering prices to committed buyers. This softened seller competition reduces the rival's incentive to lower its own prices to free buyers. The result is inflated prices to free buyers, which in turn inflates prices to committed buyers because they are priced at a loyalty discount from those free buyer prices. Because each buyer who signs a loyalty discount contract thus softens competition and raises prices for all buyers, the result is to create an externality among buyers even without economies of scale or downstream competition. If enough buyers exist and the entrant's cost advantage is not too large, we prove that this externality means that: (1) in any equilibrium, enough buyers sign loyalty discount contracts to anticompetitively increase prices; and (2) there always exists a possible equilibrium in which all buyers sign, completely foreclosing a more efficient rival. As a result, the incumbent can use loyalty discounts to increase its profit and decrease both buyer and total welfare.
JEL Classification: C72, K0, K21, L12, L40, L41, L42
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