A Dynamic Structural Model of the Impact of Loyalty Programs on Customer Behavior

We develop and estimate a dynamic structural model to determine the impact of frequency reward and customer tier components of a loyalty program on customer behavior. The contribution of this paper is: (i) we provide an integrated analysis and measurement of the impact of two critical components of a loyalty program; (ii) we develop a comprehensive model that incorporates key phenomena such as customers’ purchase and cash-in decisions, rewarded behavior, state dependence, heterogeneity, and forward-looking behavior; and (iii) our substantive results enable us to answer questions such as the strength of response to frequency reward and customer tier programs, level of heterogeneity, and the corresponding policy implications. We estimate our model using data from an airline’s loyalty program. Our findings are that a two-segment solution fits the data best both in estimation and validation samples, revealing a “service-oriented” segment that attaches a net negative value to the frequency reward but highly values the customer tier component, and a “deal prone” segment that values both frequency reward and customer tier programs.. We illustrate the points pressure and rewarded behavior effects and find that while both program components increase the number of paid flights, the paid no cash-in flights decrease under the frequency reward program.