State Dependence in Frequency Reward Programs: A Dynamic Structural Examination

• Main Author: Karaca, Huseyin Sami
• Format: Dissertation
• Language: English
• Published: ProQuest Dissertations & Theses 01.01.2012
• Subjects: Brand loyalty; Consumer behavior; Consumers; Loyalty programs; Marketing; Product choice; Profitability; Purchasing; Studies
• ISBN: 1267339934; 9781267339935

In this dissertation, I study consumer choice behavior in a frequency reward program. The presence of a reward program and habit persistence in consumer choices create certain forms of state dependence that stimulate consumers to purchase repeatedly. I disentangle two specific forms of state dependence that affect consumer choices, a firm "induced" state dependence and consumers' "intrinsic" state dependence. Induced state dependence is specific to reward program settings and is induced on consumers by the reward program. This type of state dependence creates an incentive for repeat-purchase which is based on the economic benefits associated with rewards. Intrinsic state dependence, on the other hand, is common in most choice settings and occurs due to habit-forming effects of past consumption on current choices. This type of state dependence represents a psychological form of persistence in consumer choices. I develop a comprehensive dynamic structural model of purchase behavior that incorporates response to reward, state dependence, heterogeneity and forward-looking behavior. I apply the model to a unique panel data set that includes consumer purchases in a buy-ten-get-one type of reward program administered by a chain of tea cafes. I find that customers are sensitive to intrinsic state dependence with a great deal of heterogeneity in the response levels, whereas only the moderately frequent customers are sensitive to induced state dependence. Furthermore, even though on a periodical basis, i.e., after the cash-in of rewards, customers are released from the induced state dependence associated with the reward program, and hence are more likely to choose alternative options, the intrinsic state dependence mitigates such behavior. The results also reveal a dynamic interaction effect between the induced and intrinsic state dependence, which points to a multi-fold effect of the reward program. I conduct several counterfactual studies to analyze the potential value of the reward program as well as the profit implications of changes in the structure of the program.