Loyalty Rewards, Litigation under Court Error, and Pharmaceutical Price Regulation

Beschreibung

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.

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Philipp Ackermann

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