The loyalty penalty – when a company offers steep discounts and other benefits to sign up new customers while leaving existing ones on standard rates – is increasingly attracting the attention of regulators. However, new research shows attempts to ban these unfair practices without the proper competition settings can ultimately make things worse for consumers.
Loyalty penalties have become notorious in important sectors like finance and communications, and these practices reportedly cost Australian home loan customers as much as $4.5 billion a year. They allow companies to exploit existing customers’ loyalty – in the form of their disinclination to search for and switch to new providers – while attracting new customers with lower introductory rates, effectively creating two markets subject to different terms.
“Usually, we would imagine firms offer value to their loyal customers by, say, providing coupons or exclusive access to some premier services or products,” says Dr Xingyu Fu, a lecturer in the School of Marketing at UNSW Business School who has recently researched these tactics. “But nowadays, penalties on loyal customers, such as secret price increases for existing consumers in the telecommunications industry, challenge this conventional wisdom.”
In 2019, the Australian Competition & Consumer Commission (ACCC) issued a report recommending improvements and broader legislative reforms, calling out frequent-flyer, supermarket and hotel loyalty schemes. Earlier this year, ACCC chair Gina Cass-Gottlieb said the agency was investigating banks’ deposit rates as a potential “loyalty tax”. Other countries have attempted to tackle the loyalty penalty through legislation and regulation, including the UK, which has officially banned the practice in certain markets.
But as well-intentioned as these efforts can be, they also have unintended consequences that can potentially do more damage than good, says a new research paper, Fairness regulation of prices in competitive markets, co-written by Dr Fu, Zongsen Yang and Pin Gao of the School of Data Science at Chinese University of Hong Kong, Shenzen, and Ying-Ju Chen of the School of Business and Management, Hong Kong University of Science & Technology.
These regulations are a “win-win outcome” when competition is intense, Dr Fu says. But in a weak competitive landscape, they can have the opposite effect, instead contributing to a firm’s existing monopoly power.
“This potentially leads to collusive high prices that are detrimental to consumers and society,” he says.
A look at regulatory changes
While loyalty is generally considered a positive consumer characteristic, it’s also something companies can exploit to engage in discriminatory pricing practices. And these tactics, prevalent in essential services, disproportionately hurt more vulnerable consumers.
“For instance, in the United Kingdom’s insurance market, 32% of those penalised for loyalty are above the age of 65, compared with 23% in the general population,” Dr Fu says. “Similar statistical patterns are observed among individuals with low incomes and those with mental/physical health issues.”
Public engagement around these concerns has led to attempts to ban loyalty penalties as an unethical business practice and prompted some regulators to take action. The researchers highlight the example of the UK’s response to the loyalty penalty, or ‘price walking’.
In response to a 2018 ‘super-complaint’ from a consumer rights group, the UK’s Competition and Markets Authority committed to ‘direct pricing intervention’ measures in five essential markets. The government subsequently banned the loyalty penalty in the country’s home and motor insurance markets, mandating that insurers provide fair value to their customers.
In Australia, many companies claim to price fairly, Dr Fu says. For example, the online mortgage platform Athena has implemented an ‘automatic rate match’ mechanism to ensure loyal customers don’t receive worse rates than new customers on similar loans. These regulatory changes and business trends drove the team’s research, he says.
How policies backfire
Dr Fu says the findings “surprisingly” suggest fears that price fairness regulation hurts businesses are likely exaggerated.
“In fact, when competition between firms is intense, fairness regulation on prices (e.g. limiting penalties on loyal customers) can alleviate cutthroat competition between firms, possibly resulting in higher profits for firms,” he says.
“This is counterintuitive because conventional wisdom suggests that regulation usually results in lower industry profits,” he says. “In addition, price fairness regulation on prices can save consumers from constant switching between brands/firms, resulting in higher consumer surplus.”
However, there is a flip side to this positive finding when competition in the market is subdued.
“When competition between firms is weak, fairness regulation on prices can further enhance firms’ existing monopoly power” by laying the groundwork for collusive high prices, Dr Fu says.
“This unexpected finding raises concerns that policies aimed at protecting consumers, such as the banning of loyalty penalties as implemented by the FCA in the UK’s home and motor insurance industry, may actually backfire and harm consumers and society.”
Getting the settings right
To counter high-price collusion, the researchers concluded that additional policies are needed to complement fairness regulation. They propose a two-pronged regulatory approach combining price fairness regulation with price cap regulation.
According to Dr Fu, the study shows policymakers must conduct comprehensive market investigations to assess the competitive landscape in a given market before implementing fairness-related policies.
“Firms can benefit financially by following these fairness regulations and pricing fairly, but well-intentioned fairness regulations may have adverse effects on consumers.”
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