Strategic Consumers, Revenue Management, and the Design of Loyalty Programs

Abstract

We study the interaction between the design of a premium-status loyalty program, revenue management, and strategic consumer behavior. Specifically, we consider a contemporaneous change where firms across several industries switch their loyalty programs from quantity-based toward spending-based designs. This change has been met with fierce opposition from the media and consumers. Building on the microfoundations of strategic, forward-looking, and status-seeking consumer behavior, we endogenize strategic consumer response to firms’ pricing and loyalty program design decisions, and we characterize conditions under which, by coordinating these decisions, firms can benefit from strategic consumer behavior. We further show that by switching to a spending-based design, firms can benefit from strategic behavior even more, under broader conditions, and in a Pareto-improving way. Finally, we also analyze combined designs, which utilize a combination of quantity and/or spending requirements, and show how they can be used to better manage the transition toward spending-based designs, possibly minimizing negative consumer reactions. This paper was accepted by Serguei Netessine, operations management.