Loyalty Discounts

Posted by D. Daniel Sokol

Ugur Akgun (CRA) and Ioana Chioveanu (Brunel University) explore Loyalty Discounts

ABSTRACT: This paper considers the use of loyalty inducing discounts in vertical supply chains. An upstream manufacturer and a competitive fringe sell differentiated products to a retailer who has private information about the level of stochastic demand. We provide a comparison of market outcomes when the manufacturer uses two-part tariffs (2PT), all-unit quantity discounts (AU), and market share discounts (MS). We show that retailer ís risk attitude affects manufacturer’s preferences over these three pricing schemes. When the retailer is risk-neutral, it bears all the risk and all three schemes lead to the same outcome. When the retailer is risk- averse, 2PT performs the worst from manufacturer’s perspective but it leads to the highest total surplus. For a wide range of parameter values (but not for all) the manufacturer prefers MS to AU. By limiting the retailer’s product substitution possibilities MS makes the demand for manufacturer’s product more inelastic. This reduces the amount (share of total profits) the manufacturer needs to leave to the retailer for the latter to participate in the scheme.