Consumer Loyalty Programs and Retail Prices: Evidence from Gasoline Markets

Abstract

Past research shows that loyalty programs can generate switching costs for consumers and increase their purchase frequency. Theoretical work suggests that if switching costs are significant, firms should charge lower prices in the early periods of a program to boost market share, and increase prices in later periods, to take advantage of the ``lock-in'' effect. However, it is not clear whether these costs soften or exacerbate price competition. Using a large database of gas stations' prices in the Italian market, we study fuel prices in early and late periods of loyalty programs: the sharp price changes adopted by gas stations affiliated with the program during the introduction and termination dates of the program allow us to establish the causal relationship between the program and the pricing behavior of gas stations. We find evidence that gas stations affiliated with the program increase prices in later periods of the program, as predicted by theory. The higher prices of affiliated stations lead to an increase in prices, on average, across all other stations competing in the local market. We also find that affiliated stations reduce their prices in early periods of the program; however, this evidence is less conclusive, as our data cannot exclude other factors explaining the price reduction. We discuss implications for managers and policy makers.

Keywords: Loyalty Programs, Reward Programs, Pricing, Natural Experiment