The hidden costs of consumers’ loyalty
Yes, United Continental Holdings has gone ahead with those dreaded changes to its MileagePlus frequent-flier program. Starting March 1, 2015, the company confirmed this month, travelers will earn rewards based on dollars spent rather than miles flown. Delta Air Lines already made the switch earlier this year, and American Airlines is expected to switch to a dollar-based reward system after its merger with US Airways.
You would think these changes are bad for leisure travelers. While business travelers may get more rewards, consumers flying on discount fares will get less. A coast-to-coast round trip will no longer earn you 6,000 miles. At the high end, no-restriction fares may accrue more award miles; the miles earned for sale-price fares will be significantly fewer.
United has thrown a “curveball at customers,” Brian Kelly, of mileage blog ThePointsGuy.com, said. “For the general traveler, this is a reduction in value earned from the program.”
But the view that stingier loyalty programs hurt consumers is wrong. Here’s why.
Businesses love to lock in their clients. Mobile-phone companies and satellite television providers require extended commitment from customers. Fitness clubs offer long-term subscriptions. They lure people into these contracts with upfront discounts, free phones, membership privileges and other perquisites. Then, patiently, over time, they recoup the costs of these enticements.
In an article forthcoming in the Journal of Legal Analysis, we show the effect of this lock-in. The consumer, who was originally happy to enter into these agreements and enjoy the discounts, becomes loyal against her will. She can’t switch to lower-cost alternatives and can’t quit when she no longer needs the service. If she tries to leave, a hefty early termination penalty awaits her.
That is why many people have grown to hate lock-in contracts, abhorring the exit penalties, inflexibility and extra cost they impose. Consumers are rightly seeking commitment-free options. And in many markets they are now offered such options — no-contract phone plans, for example, and pay-as-you-go gym memberships.
What consumers rarely notice, however, is that loyalty reward programs, such as airlines’ frequent-flier plans, are a lock-in in disguise. True, you don’t pay an early termination fee when you abandon your longtime airline to take a more convenient and cheaper flight with Spirit Airlines. But there is an implicit penalty — what economists call an alternative cost — in the form of reduced rewards.
You were so close to the elite-level milestone of your loyalty airline, or you were so accustomed to the priority boarding or the free checked bag. Flying Spirit instead of United would set you back on these reward goals, so you decide to pay a higher ticket price, or fly at a less convenient time, just to remain in United’s network.
Loyalty rewards lock consumers in just as effectively as termination penalties. A $250 penalty creates the same loyalty incentive as a forgone $250 reward. A rational consumer would recognize that both programs penalize her for being unfaithful. The wireless company will charge a $250 fee; the airline will deny a $250 reward. Either way, the consumer sacrifices the flexibility to choose new, low-price or high-convenience options.
Loyalty deals are a honey trap. Take the loyalty cards offered by supermarkets and pharmacies. With consumers more eager to shop in their stores because of discounts and coupons, these chains can in turn charge higher prices. Is it surprising that dollar stores and discount chains have no loyalty plans?
Loyalty programs, such as lock-in plans, also stifle competition. If many customers are loyal to existing stores and services, new entrants will have less business. This deters others from even trying to break in, and with fewer competitors, everyone pays more.
In fact, loyalty rewards are more harmful than exit penalties for two reasons. First, consumer protection laws have long targeted termination penalties and limited their dollar amount. But the law does nothing to protect consumers against the lock-in effect of loyalty plans. Why should it? There is no political pressure to regulate these beloved plans. Second, the psychology of “rewards” — as distinguished from “penalties” — explains why the same consumers who revolted against early termination fees and who sought market alternatives continue to chase loyalty programs.
By trimming down the miles, United and Delta have done their leisure travelers a service, making these plans less attractive and freeing their customers from the hidden cost of the programs. With less honey, the trap will be less effective.
Oren Bar-Gill is a professor at New York University School of Law. Omri Ben-Shahar is the Kearny Director of the Coase-Sandor Institute for Law and Economics, and the editor of the Journal of Legal Studies.