The Economic Viability of Frequency Reward Programs in a Strategic Competitive Environment

54 Pages Posted: 11 Apr 2001

See all articles by Praveen K. Kopalle

Praveen K. Kopalle

Dartmouth College - Tuck School of Business

Scott Neslin

Dartmouth College - Tuck School of Business

Date Written: January 2001

Abstract

We examine the conditions that enhance the economic viability of frequency reward programs in a strategic competitive environment. We focus particularly on conditions related to consumer behavior namely the extent to which consumers value the future benefits offered by the reward, the expandability of the category, and Consumers' preferences for competing brands. Consumers maximize utility over a long-term time horizon, taking into account the value of the reward. Two firms maximize profits over a long-term time horizon. They first decide between implementing a frequency reward program or a traditional pricing policy (a constant price), and then decide on the specific prices. We numerically solve for the sub-game perfect equilibrium for this two-stage game.

We find that a brand is more likely to find reward programs to be viable strategies if consumers value future benefits, if reward programs can expand the market, and if the brand has a higher preference. The market expandability finding is particularly interesting. If the sales increases generated by reward programs represent category growth, the power of frequency reward programs makes them an effective vehicle for generating profits. However, if gains come mainly from competitors, the power of frequency reward programs precipitates a strong competitive response that erodes profits in a classic prisoner's dilemma. We use the airline industry to explore our market expandability finding. We find evidence that the "major" airlines introduced reward programs to counter-act a stronger outside category (new entrants), and in doing so, they expanded their market.

JEL Classification: C0, D1, D4, M3

Suggested Citation

Kopalle, Praveen K. and Neslin, Scott, The Economic Viability of Frequency Reward Programs in a Strategic Competitive Environment (January 2001). Available at SSRN: https://ssrn.com/abstract=265431 or http://dx.doi.org/10.2139/ssrn.265431

Praveen K. Kopalle (Contact Author)

Dartmouth College - Tuck School of Business ( email )

100 Tuck Hall
Hanover, NH 03755
United States
603-646-3612 (Phone)
603-646-1308 (Fax)

Scott Neslin

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States

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