Lower Price or Higher Reward? Measuring The Effect of Consumers' Preferences on Reward Programs
Management Science, Forthcoming
Posted: 28 May 2017 Last revised: 9 Oct 2018
Date Written: April 3, 2017
Despite criticisms regarding their effectiveness, reward programs today represent a prevalent and apparently successful form of marketing investment for several industries such as airlines, hotels, gas stations, and credit cards. To understand what might contribute to their success, this paper investigates the purchase behavior of consumers who participate in a reward program from the travel industry. We estimate a dynamic demand model of gasoline purchase, and compare the value that consumers attach to rewards with the value they attach to the money spent for gasoline. We find that there exists a significant portion of frequent travelers who extract more value from one dollar's worth of rewards than from one dollar spent for gasoline. Most of the effectiveness of the reward program is due to the behavior of these consumers. Their insensitivity to price induces firms to increase fuel prices by 1 euro cent per liter, which corresponds to about 10% increase in their margins. The program also contributes to soften competition, increasing margins by 4%.
Keywords: reward programs, loyalty, pricing, dynamic programming, travel industries
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