Stockpiling in Linear Loyalty Programs

Abstract:     
Customers often stockpile reward points in linear loyalty programs (i.e., programs that do not reward stockpiling) despite several economic incentives against doing so (e.g., the time value of money). We develop a mathematical model of redemption choice in which customers are assumed to evaluate the gains and losses of points separately from those of cash (i.e., transactions in each currency are booked in separate mental accounts). If a loss of cash has greater disutility than an equivalent loss of points, the model predicts that customers will be motivated to stockpile on their own, even though the retailer does not reward them whatsoever for doing so. Specifically, customers’ separate mental accounts create latent “stockpiling thresholds” above which redemptions are more likely to occur than not.

The model is estimated on data from an international retailer using Markov Chain Monte Carlo methods, and is shown to accurately forecast redemptions during an 11-month out-of-sample period. As an example application, the model is used to assess how changes to the structure of the linear program would likely impact customer behavior and consequently, the program’s revenues and point liabilities.

Number of Pages in PDF File: 40

Keywords: loyalty programs, mental accounting

working papers series