Understanding Consumer Dynamic Decision Making Under Competing Loyalty Programs

Abstract

We develop an incentive-aligned experimental paradigm to study how consumer purchase dynamics are affected by the interplay between the loyalty programs and the pricing and promotional strategies of competing firms. In our experiment, subjects made sequential choices between two competing airlines in a stylized frequent traveler task for which an optimal dynamic decision policy can be numerically computed. We find that, on average, subjects are able to partially realize the long-term benefits from loyalty programs, though they are most sensitive to prices. We also find that the preferences and the levels of bounded rationality of our subjects depend on the nature of the competitive environment, the particular state of each decision scenario, and the type of optimal action. Accordingly, we use an approximate dynamic programming model to incorporate boundedly rational decision making. The model classifies subjects into five segments that exhibit variation in their performance and decision strategies. Importantly, we find that the overall market outcome and the performance of each firm are influenced by both the competitive environment and the assumption on the extent of consumer optimality.

Keywords: Loyalty Programs, Promotions, Competition, Bounded Rationality, Approximate Dynamic Programming, Experiments

JEL Classification: M31