Moral Hazard and Customer Loyalty Programs

Frequent flier plans (FFPs) may be the most famous of customer loyalty programs and plans created on the FFP model are now offered by sellers in a number of other industries. We present a theory of FFPs that models them as efforts to take advantage of the agency relationship between employers - who pay for airline tickets - and employees - who book those tickets. In this view, FFP benefits constitute bribes, inducing employees to book flights at higher prices. We show that a single airline offering an FFP has a large advantage over its rival. However, when competing airlines operate plans, benefit competition may be so intensified that the airlines' profits fall even while prices to employers rise. Thus, in contrast to switching cost treatments of FFPs, we may observe prices and profits moving in opposite directions