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The Economic Viability of Frequency Reward Programs in a Strategic Competitive Environment

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  • Kopalle Praveen K

    ()
    (Tuck School of Business, Dartmouth College)

  • Neslin Scott A

    ()
    (Tuck School of Business, Dartmouth College)

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    Abstract

    We examine the conditions that enhance the economic viability of frequency reward programs in a strategic competitive environment. We focus particularly on conditions related to consumer behavior, namely the extent to which consumers value the future benefits offered by the reward, the expandability of the category, and consumers’ preferences for competing brands. Consumers maximize utility over a long-term time horizon, taking into account the value of the reward. Two firms maximize profits over a long-term time horizon. They first decide between implementing a frequency reward program or a traditional pricing policy (a constant price), and then decide on the specific prices. We numerically solve for the sub-game perfect equilibrium for this two-stage game. We find that a brand is more likely to find reward programs to be viable strategies if consumers value future benefits, if reward programs can expand the market, and if the brand has a higher preference. The market expandability finding is particularly interesting. If the sales increases generated by reward programs represent category growth, the power of frequency reward programs makes them an effective vehicle for generating profits. However, if gains come mainly from competitors, the power of frequency reward programs precipitates a strong competitive response that erodes profits in a classic prisoner’s dilemma. We use the airline industry to explore our market expandability finding. We find evidence that the “major” airlines introduced reward programs to counter-act a stronger outside category (new entrants), and in doing so, they expanded their market.

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    Bibliographic Info

    Article provided by De Gruyter in its journal Review of Marketing Science.

    Volume (Year): 1 (2003)
    Issue (Month): 1 (August)
    Pages: 1-41

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    Handle: RePEc:bpj:revmkt:v:1:y:2003:i:1:p:1-41:n:3

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    Web page: http://www.degruyter.com

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    Web: http://www.degruyter.com/view/j/roms

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    Cited by:
    1. Dorotic, Matilda, 2009. "Do vendors benefit from marketing actions in a multi-vendor loyalty program?," Research Report 09001, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
    2. Julian Villanueva & Pradeep Bhardwaj & Sridhar Balasubramanian & Yuxin Chen, 2007. "Customer relationship management in competitive environments: The positive implications of a short-term focus," Quantitative Marketing and Economics, Springer, vol. 5(2), pages 99-129, June.
    3. Matilda Dorotic & Dennis Fok & Peter Verhoef & Tammo Bijmolt, 2011. "Do vendors benefit from promotions in a multi-vendor loyalty program?," Marketing Letters, Springer, vol. 22(4), pages 341-356, November.
    4. Ramon Caminal, 2009. "The design and efficiency of loyalty rewards," Working Papers 408, Barcelona Graduate School of Economics.
    5. Wagner Kamakura & Carl Mela & Asim Ansari & Anand Bodapati & Pete Fader & Raghuram Iyengar & Prasad Naik & Scott Neslin & Baohong Sun & Peter Verhoef & Michel Wedel & Ron Wilcox, 2005. "Choice Models and Customer Relationship Management," Marketing Letters, Springer, vol. 16(3), pages 279-291, December.

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