Profitability of loyalty reward programs: An analytical investigation

Abstract

Loyalty programs, as a prevalent CRM strategy, aim to enhance customers’ loyalty and thereby increase a firm’s long-term profitability. Recent analytical and empirical studies demonstrate inconsistent findings on the efficacy of loyalty programs in fulfilling these goals. In this study, an analytical model is developed to analyze the effect of customers’ valuation and their post-purchase satisfaction level on a loyalty program’s profitability. The results reveal how customers’ satisfaction plays a significant role in profitability of loyalty programs. We consider a profit-maximizing firm selling a good or service through two periods. Valuation is modeled as a deterministic parameter, as well as a stochastic variable with two arbitrary distributions. Depending on the customers’ valuation distribution, the model results in either a linear or a nonlinear optimization problem. Optimization problems are solved analytically, in terms of the model parameters. The obtained solutions provide some useful insights into the effects of customers’ satisfaction on the profitability of loyalty programs. Specifically, it is shown that depending on the customers’ satisfaction level, it may be optimal not to offer a loyalty reward.