Interestingly enough, consumers often view loyalty programs very favourably – they love saving up their Optimum points for that big trip to Shoppers, or cashing in their Air Miles for a wonderful vacation. Yet, the concept of price discrimination frustrates many people - the thought of Coke being able to “take advantage of me” by charging more, just because it’s hot outside, is outrageous.
What may surprise many consumers is that these two strategies often work hand-in-hand and actually feed off of each other in order to maximize a company’s profits.
Price discrimination is based on the concept that consumers differ in their demands for a given good or service, and therefore can be charged different prices based on their willingness to pay. In order to segment consumer demand, companies often use characteristics such as geography, nationality, age, gender and purchasing history. Conveniently, loyalty programs are designed to capture this information exactly. Companies can analyze what products you buy, whether you pay full price or wait for them to come on sale, and how often you use discount cards or coupons to limit your spending. These criteria, as well as countless others, all add up to your willingness to pay, also know as your price elasticity. Once a retailer is able to track this metric, they can essentially use price discrimination tactics to capture every last dollar from each of their customers.
Imagine a grocery store in a higher-income area. Customers are monitored on their sensitivity to price increases as well as how well premium and luxury products sell. These customers can be charged significantly higher prices for the exact same products at the exact same grocery chain in another area of town, just because the company is able to exploit their price elasticity. Companies often send millions of different versions of a flyer in the mail, each offering different discounts based on the personal characteristics and buying history of the recipient customer. One tactic often used to get rid of “lead” customers is only offering special discounts to more profitable customers, while low-value customers are charged full price for the exact same item.
While it may not be a huge surprise that loyalty programs help in creating lucrative price discrimination strategies, an interesting insight is that the information available in the underlying distribution of customer demand elasticities is reciprocated in designing highly profitable loyalty programs. Meaning, once a loyalty program is able to produce sufficient information about consumer demand, this same information can be used to adjust the loyalty program to further maximize profitability. For example, the decision whether to have an expiring or renewable based program (duration), which rewards to offer and at what volume (number of reward-earning opportunities), etc. depends on the tradeoff between increased sales and redemption losses between higher and lower spending customers. These tradeoffs can be interpolated from demand data.
Therefore, if customers perceive loyalty programs as a way for a company to “reward” them for their repeat business, they should think again. Not only are loyalty programs designed to increase the company’s profitably, but they also aid in designing price discrimination strategies used to exploit your desire for certain products. This information can then be further used to adjust that beloved loyalty program into another tactic to increase their bottom line.
“Quantity-Based Price Discrimination Using Frequency Reward Programs” by Wesley R. Hartmann and V. Brian Viard, Stanford Graduate School of Business. January 23, 2006
“Price Discrimination”, by R. Preston McAfee, in Issues in Competition Law and Policy 465 (ABA Section of Antitrust Law 2008)
"Do Supermarkets Price Discriminate?" February 25, 2009