Customer Reward Programs for Two-Sided Markets

Abstract

Some two-sided markets have been spending billions of dollars on customer reward programs every year. Yet, there is little research on the rationale and impacts of such programs, despite the large literature on customer reward programs in traditional markets. This paper examines the rationale and impacts of customer reward programs in two-sided markets, investigating the efficacy of such programs and highlighting their interplay with matching schemes. We adopt an analytical model for a platform that interacts with customers and service providers over an infinite time horizon. Under a customer reward program, a customer earns a cash reward for every purchase with a finite expiration term, which can be used to offset the selling price in a subsequent purchase within the expiration window. Customers are heterogeneous in their request probabilities and valuations, while providers differ in their service costs. The platform maximizes its profit by setting the service compensation for providers, and the price and reward program parameters for customers. We show that adopting a customer reward program can often dramatically improve the platform's profit. Importantly, matching schemes play an important role -- customer reward programs are much more lucrative under priority matching schemes than a random matching scheme. Our results rationalize the heavy investments made by many two-sided markets in customer incentives and demand/supply matching. Overall, we conclude that customer reward programs can be an even more important profit-boosting tool for two-sided markets than for traditional one-sided markets. We also discuss the welfare implications of our findings.

Keywords: Two-sided markets, customer reward programs, matching, revenue management, dynamic programming