Do Frequency Reward Programs Create Switching Costs? A Dynamic Structural Analysis of Demand in a Reward Program

Abstract

This paper examines a common assertion that customers in reward programs become "locked in" as they accumulate credits toward earning a reward. We define a measure of switching costs and use a dynamic structural model of demand in a reward program to illustrate that frequent customers' purchase incentives are practically invariant to the number of credits. In our empirical example, these customers comprise over eighty percent of all rewards and over two-thirds of all purchases. Less frequent customers may face substantial switching costs when close to a reward, but rarely reach this state.

Keywords: switching costs, reward programs, dynamic programming, discrete-choice

JEL Classification: L11, L13, M31, D43