Reaching for Gold: Frequent-Flyer Status Incentives and Moral Hazard

Abstract

We study how frequent-flyer program members change their purchase behaviors as they progress towards achieving elite status. Using data from a leading U.S. airline, we empirically test the theoretical prediction that travelers' switching costs vary dynamically with their progress towards attaining status. We show evidence for increased switching costs as the consumer approaches the target pace of point accumulation required to attain status. These switching costs reflect changes in booking behavior with the airline: Travelers become more likely to choose the airline even when it is less appealing than its competitors, and to pay higher prices than they otherwise would. These responses are reduced when travelers accumulate points at a rate substantially ahead of the target pace. The increase in switching costs is more pronounced for consumers at a hub of the airline and for business travelers. Moreover, we document a stronger willingness-to-pay response when consumers are less likely to shoulder the ticket costs themselves because they are traveling for business. This response suggests that asymmetric incentives induced by business travel explains much of the heterogeneity between business and leisure travelers, and moral hazard may be responsible for a large part of the profitability of frequent-flyer status incentives.

Keywords: Loyalty Programs, Tiered Status Incentives, Moral Hazard