An analytical investigation of the effectiveness of customer loyalty programs

This dissertation investigates the effectiveness of customer loyalty programs. Loyalty programs, as a prevalent marketing strategy, aim to enhance customers’ loyalty and thereby increase a firm’s long-term profitability. Despite the ubiquity of loyalty programs, the empirical research shows contradictory findings on their effectiveness. Analytical studies, on the other hand, leave notable gaps in the research on different aspects of loyalty programs. In this study, taking an analytical approach, some of the research gaps in the adoption as well as the design of loyalty programs are addressed. Specifically, in evaluating the profitability of loyalty programs, this study incorporates customers’ valuation for the product and their post-purchase satisfaction level, two factors that are not considered in previous studies. The formulations result in stochastic models that are analyzed to gain insights into the profitability of loyalty programs. Based on the model assumptions, it is observed that if a firm maintains satisfaction among customers, not adopting a loyalty program yields optimal profits. It is also shown that this result holds even when the uncertainty in customers’ satisfaction levels is incorporated in the model.

From the design perspective, the reward structure is discussed as one of the main drivers of loyalty programs’ effectiveness. Particularly, the multitier reward scheme, a commonly-used yet underexplored reward structure, is studied. A model is developed to compare the effectiveness of multitier reward schemes with that of single-tier rewards. In the framework of the model assumptions, it is shown that the multitier scheme is more effective than the single-tier scheme in increasing a firm’s profitability and driving repeat purchase behavior. Also, a model is developed to characterize the conditions under which a multitier reward scheme is the preferred choice. The conditions are formulated based on the sensitivity of customers’ demand to the offered price, rewards and the distance from the next tier, and also based on the price offered by the competitor. It is shown that low levels of sensitivity to rewards and distance in customers can result in suboptimal revenue from a multitier reward scheme. Also, it is observed that if the competitor offers deeper discounts, the multitier reward structure becomes optimal in more cases.