Loyalty Program Liabilities and Point Values

Abstract

A loyalty program introduces a new currency --- the points --- through which customers transact with a firm. Such points, whose value is controlled by the firm, constitute a promise for future service and therefore count as liabilities on the issuing firm's balance sheet. These liabilities introduce subtle channels through which the firm's decisions and the loyalty points' value affect profitability. These effects are exacerbated under certain managerial considerations such as taxation or earnings smoothing incentives.We study the problem of optimally setting the monetary value of points in view of the inherent liabilities they create, in a multi-period setting. We show that the value of loyalty points can be thought of as inventory, and the optimal policies set this value --- and the associated liability --- so as to reach particular base-stock'' targets. We find that loyalty programs can act as buffers against uncertainty, with the value of points increasing (decreasing) under strong (weak) operating performance, and increasing with uncertainty. This result shows that loyalty programs can act as a hedging tool against uncertainty in future operating performance, providing a new rationale for their existence, even in the absence of competition.