Robust Exclusion through Loyalty Discounts with Buyer Commitment

36 Pages Posted: 7 Aug 2012  

Einer Elhauge

Harvard Law School

Abraham L. Wickelgren

University of Texas at Austin - School of Law; University of Texas at Austin - Center for Law, Business, and Economics

Date Written: August 1, 2012

Abstract

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

Suggested Citation

Elhauge, Einer and Wickelgren, Abraham L., Robust Exclusion through Loyalty Discounts with Buyer Commitment (August 1, 2012). Harvard Discussion Paper No. 722; U of Texas Law, Law and Econ Research Paper No. 240. Available at SSRN: https://ssrn.com/abstract=2125398 or http://dx.doi.org/10.2139/ssrn.2125398

Einer R. Elhauge (Contact Author)

Harvard Law School ( email )

1575 Massachusetts
Hauser 406
Cambridge, MA 02138
United States

Abraham L. Wickelgren

University of Texas at Austin - School of Law ( email )

727 East Dean Keeton Street
Austin, TX 78705
United States

University of Texas at Austin - Center for Law, Business, and Economics

Austin, TX 78712
United States

Paper statistics

Downloads
211
Rank
118,548
Abstract Views
1,308