Bundling, discounts across product lines and volume discounts in competitive markets: a prisoners' dilemma?

This paper analyses how competition over rebates for customer loyalty across product lines affects firms' pricing and consumers generally. If buyers incur firm specific costs or have shop specific tastes then competitive loyalty discounts lower consumer surplus overall and raise profits - the same is true of competitive volume discounts. Competition without these discounts causes all prices to be kept low as larger customers are targetted; with discounts the prices for heavy users drop, but more is extracted from small users. The consumer surplus result is reversed if the differentiation between components as opposed to firms is key. Price discrimination is shown not to be the driving force behind the equilibrium prices - sellers price to steal customers from their rivals. The implications for diverse industries from professional services to cars and supermarkets are explored.