Moral Hazard and Customer Loyalty Programs

38 Pages Posted: 29 Jun 2006 Last revised: 14 May 2008

See all articles by Leonardo J. Basso

Leonardo J. Basso

Universidad de Chile - Civil Engineering Department

Matthew T. Clements

St. Edward's University

Thomas W. Ross

University of British Columbia (UBC) - Sauder School of Business

Date Written: August 7, 2007

Abstract

Frequent flier plans (FFPs) may be the most famous of customer loyalty programs and plans created on the FFP model are now offered by sellers in a number of other industries. We present a theory of FFPs that models them as efforts to take advantage of the agency relationship between employers - who pay for airline tickets - and employees - who book those tickets. In this view, FFP benefits constitute bribes, inducing employees to book flights at higher prices. We show that a single airline offering an FFP has a large advantage over its rival. However, when competing airlines operate plans, benefit competition may be so intensified that the airlines' profits fall even while prices to employers rise. Thus, in contrast to switching cost treatments of FFPs, we may observe prices and profits moving in opposite directions.

Keywords: moral hazard, loyalty, airlines

JEL Classification: D43, L11, L13, L93

Suggested Citation

Basso, Leonardo J. and Clements, Matthew T. and Ross, Thomas, Moral Hazard and Customer Loyalty Programs (August 7, 2007). Available at SSRN: https://ssrn.com/abstract=911641 or http://dx.doi.org/10.2139/ssrn.911641

Leonardo J. Basso (Contact Author)

Universidad de Chile - Civil Engineering Department ( email )

Casilla 228-3
Santiago
Chile
56 2 978 4380 (Phone)
56 2 689 4206 (Fax)

HOME PAGE: http://tamarugo.cec.uchile.cl/~dicidet/leo.html

Matthew T. Clements

St. Edward's University ( email )

3001 South Congress Avenue
Austin, TX 78704
United States
(512) 428-1321 (Phone)

Thomas Ross

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
(604) 822-8500 (Phone)
(604) 822-8521 (Fax)

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