From airline miles to tech gadgets, loyalty programs reward consumers for sticking to a brand. In programs that have fixed starting and ending dates, consumers earn rewards by making a certain number of purchases before time runs out.

But these types of loyalty programs can drive up consumer costs, according to Purdue’s Federico Rossi and Chicago Booth’s Pradeep K. Chintagunta. In a study of two Italian gas station chains, they find that the companies sponsoring the programs hiked prices as the expiration date approached—and so did competitors.

While past research has demonstrated that consumers in loyalty programs become less likely to switch to competing brands, little attention has been paid to the programs’ implications for price competition, Rossi and Chintagunta write. Their finding that service-station chains tend to raise prices as more consumers get hooked suggests that businesses in other industries such as airlines could do the same thing.

In addition, the researchers write, “since only a fraction of customers in the market is usually enrolled in the program, price increases might unfairly punish certain groups of individuals, such as infrequent customers who typically do not reach redemption, raising potential issues of fairness.”

Rossi and Chintagunta examined two gas-station loyalty programs in Italy from January 2015 to December 2018. Drivers could earn points toward rewards when they bought fuel at stations affiliated with gasoline brands Eni and Q8. Enrollment was free for both the Eni and Q8 programs. Consumers got 1 point for each liter of fuel purchased and could trade in their points for rewards such as electronics or travel vouchers.

The research data included daily prices for self-serve unleaded gasoline set by 22,434 gas stations collected by the Italian Ministry of Economic Development. Studying programs with beginning and ending dates enabled the researchers to establish a cause-and-effect relationship between consumers’ progress and the pricing behavior of stations. They explored and ruled out alternative explanations for the price changes, such as advertising and brand-level cost shocks.

Locked in

The difference in gasoline price between Eni and other stations widened after Eni’s loyalty program ended. This suggests that Eni may have kept prices high late in the program, knowing that customers would face switching costs if they changed brands.

The data provide evidence of an invest-and-harvest—or a “bargain-and-rip-off”—strategy by companies. The gasoline chains would lower prices at the beginning of the programs to attract participants and then crank up prices once consumers were invested.

In the later stages of the Eni program, affiliated stations increased prices by 1.4 euro cents per liter. In the Q8 program, stations raised prices by 0.8 euro cents, the study demonstrates. The researchers then looked for pricing patterns of rival brands and independent competitors around the start and end dates of the Eni and Q8 loyalty programs. Using geographic coordinates and Microsoft Bing Maps API, they computed the driving time from each loyalty program¬–affiliated station to the 20 closest gas stations.

Pairing up gas prices with map coordinates, they find that when Eni and Q8 raised prices in the later stages of the loyalty programs, competitors followed suit. Stations within a five-minute drive of an Eni or Q8 station, for example, jacked up prices by 0.3 to 0.5 euro cents per liter during the same period.

The study has implications for other markets, the researchers write. As demand for loyalty programs increases, so too will the market power of companies that offer them, allowing them to potentially increase prices and lessen competition.

“Our results show that the switching costs generated by these programs are significant enough to increase firms’ market power and allow higher prices,” they write.

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