Loyalty Rewards, Litigation under Court Error, and Pharmaceutical Price Regulation
1st Edition
Published on 5. July 2010
Book
106 pages
978-3-86624-494-8 (ISBN)
Description
This thesis consists of three chapters, each of which corresponds to
a separate paper. The chapters are not related to each other except
in the sense that they all deal with microeconomic problems.
Chapter 1 considers the increasing popularity of
customer reward programs, also known as loyalty programs. The
best-known reward programs are the frequent-flyer programs of the
major airlines. Similar programs are run by supermarket chains,
credit card companies, hotel groups, and car rental agencies.
However, loyalty-rewarding pricing schemes are not only used by big
companies. For instance, coffee shops and pizza deliveries use
simple, but effective punch cards to offer a free purchase to
customers who have made a certain number of purchases. Other firms
rely on repeat purchase coupons: they distribute a coupon along with
their product which customers can use to get a discount for their
next purchase of the same product.
One of the reasons why firms launch reward programs is to create
switching costs for consumers. Switching costs are defined as costs
incurred when a customer switches between suppliers, but not
incurred when remaining with the current supplier. Loyalty rewards
perfectly fit this definition because customers who participate in a
loyalty program forfeit their rewards if they change the supplier.
We are interested in the impact of customer loyalty programs on
price competition. We argue that loyalty discounts constitute a
commitment device beneficial to suppliers rather than customers. Our
analysis demonstrates that firms achieve otherwise unattainable
cooperative outcomes in finite period games by creating switching
costs through loyalty programs. The focus of the chapter lies on
programs offering lump sum loyalty discounts. Analyzing a two-period
Bertrand model we find that the use of such discounts makes it
possible for duopolists to collude on the monopoly price. Hence, the
offer of a generous loyalty discount is a credible self-commitment
to refrain from second-period poaching, provided that the competitor
is willing to share the market in the first period.
Chapter 2 contributes to the broad literature on
the economics of litigation and settlement. This literature
generally considers out-of-court settlements to be welfare-enhancing
because they save time and litigation costs. This conclusion is
entirely true if liability and damages are not in doubt; in the
context of court error, however, it might be wrong.
Even though court error may never be eliminated completely, there is
good evidence to suppose that judges get better in observing and
interpreting the legally relevant facts when they have dealt with a
similar issue before. This means that court decisions create a
positive externality for future litigants: the outcome of a trial is
easier to predict if one can draw on a precedent decision. However,
such an externality will not occur if a dispute is settled out of
court. The parties involved in a settlement usually agree not to
disclose any details of their agreement, which deprives the
public---and especially the courts---of useful information for
similar disputes in the future.
Focusing on private litigation, we examine the impact of court error
on the deterrent effect of the strict liability rule. We analyze a
model with asymmetric information where both underdeterrence and
overdeterrence are possible to occur under court error. We find that
court error increases the likelihood of out-of-court settlements,
which possibly offsets the positive externality of litigation.
Chapter 3 studies pharmaceutical price
regulation. There is a widespread agreement that an unregulated
pharmaceutical market would not lead to a socially desirable
outcome: neither in terms of safety nor in the access to life-saving
drugs. Most governments, therefore, regulate the price for
pharmaceutical products. In spite of the wide variety of existing
regulatory regimes, we can broadly distinguish two types of drug
price regulation: external price benchmarking and direct price
negotiations. External price benchmarking is the most widely used
technique to regulate pharmaceutical prices in European countries.
In essence, this technique imposes a price cap for pharmaceuticals
based on prices of identical products in other countries.
We analyze the incentives for a country to engage in external price
benchmarking as opposed to directly negotiating drug prices with
pharmaceutical manufacturers. Using a model where two countries
differ only in their market size, we show that a country prefers
benchmarking if its regulatory agency has considerably less
bargaining power compared to the regulatory agency in the other
country. This allows to free ride on superior negotiation skills of
the other country. Assuming that bargaining power is positively
correlated to country size, we find that only small countries might
have an incentive to engage in external price benchmarking. This
incentive shrinks if population size grows.
a separate paper. The chapters are not related to each other except
in the sense that they all deal with microeconomic problems.
Chapter 1 considers the increasing popularity of
customer reward programs, also known as loyalty programs. The
best-known reward programs are the frequent-flyer programs of the
major airlines. Similar programs are run by supermarket chains,
credit card companies, hotel groups, and car rental agencies.
However, loyalty-rewarding pricing schemes are not only used by big
companies. For instance, coffee shops and pizza deliveries use
simple, but effective punch cards to offer a free purchase to
customers who have made a certain number of purchases. Other firms
rely on repeat purchase coupons: they distribute a coupon along with
their product which customers can use to get a discount for their
next purchase of the same product.
One of the reasons why firms launch reward programs is to create
switching costs for consumers. Switching costs are defined as costs
incurred when a customer switches between suppliers, but not
incurred when remaining with the current supplier. Loyalty rewards
perfectly fit this definition because customers who participate in a
loyalty program forfeit their rewards if they change the supplier.
We are interested in the impact of customer loyalty programs on
price competition. We argue that loyalty discounts constitute a
commitment device beneficial to suppliers rather than customers. Our
analysis demonstrates that firms achieve otherwise unattainable
cooperative outcomes in finite period games by creating switching
costs through loyalty programs. The focus of the chapter lies on
programs offering lump sum loyalty discounts. Analyzing a two-period
Bertrand model we find that the use of such discounts makes it
possible for duopolists to collude on the monopoly price. Hence, the
offer of a generous loyalty discount is a credible self-commitment
to refrain from second-period poaching, provided that the competitor
is willing to share the market in the first period.
Chapter 2 contributes to the broad literature on
the economics of litigation and settlement. This literature
generally considers out-of-court settlements to be welfare-enhancing
because they save time and litigation costs. This conclusion is
entirely true if liability and damages are not in doubt; in the
context of court error, however, it might be wrong.
Even though court error may never be eliminated completely, there is
good evidence to suppose that judges get better in observing and
interpreting the legally relevant facts when they have dealt with a
similar issue before. This means that court decisions create a
positive externality for future litigants: the outcome of a trial is
easier to predict if one can draw on a precedent decision. However,
such an externality will not occur if a dispute is settled out of
court. The parties involved in a settlement usually agree not to
disclose any details of their agreement, which deprives the
public---and especially the courts---of useful information for
similar disputes in the future.
Focusing on private litigation, we examine the impact of court error
on the deterrent effect of the strict liability rule. We analyze a
model with asymmetric information where both underdeterrence and
overdeterrence are possible to occur under court error. We find that
court error increases the likelihood of out-of-court settlements,
which possibly offsets the positive externality of litigation.
Chapter 3 studies pharmaceutical price
regulation. There is a widespread agreement that an unregulated
pharmaceutical market would not lead to a socially desirable
outcome: neither in terms of safety nor in the access to life-saving
drugs. Most governments, therefore, regulate the price for
pharmaceutical products. In spite of the wide variety of existing
regulatory regimes, we can broadly distinguish two types of drug
price regulation: external price benchmarking and direct price
negotiations. External price benchmarking is the most widely used
technique to regulate pharmaceutical prices in European countries.
In essence, this technique imposes a price cap for pharmaceuticals
based on prices of identical products in other countries.
We analyze the incentives for a country to engage in external price
benchmarking as opposed to directly negotiating drug prices with
pharmaceutical manufacturers. Using a model where two countries
differ only in their market size, we show that a country prefers
benchmarking if its regulatory agency has considerably less
bargaining power compared to the regulatory agency in the other
country. This allows to free ride on superior negotiation skills of
the other country. Assuming that bargaining power is positively
correlated to country size, we find that only small countries might
have an incentive to engage in external price benchmarking. This
incentive shrinks if population size grows.