FADER
Customers often stockpile reward points in linear loyalty programs
(i.e., programs that do not explicitly reward stockpiling) despite several
economic incentives against it (e.g., the time value of money). The
authors develop a mathematical model of redemption choice that unites
three explanations for why customers seem to be motivated to stockpile
on their own, even though the retailer does not reward them for doing so.
These motivations are economic (the value of forgone points), cognitive
(nonmonetary transaction costs), and psychological (customers value
points differently than cash). The authors capture the psychological
motivation by allowing customers to book cash and point transactions in
separate mental accounts. They estimate the model on data from an
international retailer using Markov chain Monte Carlo methods and
accurately forecast redemptions during an 11-month out-of-sample
period. The results indicate substantial heterogeneity in how customers
are motivated to redeem and suggest that the behavior in the data is
driven mostly by cognitive and psychological incentives.
Keywords: prospect theory, mental accounting, loyalty programs, Bayesian
estimation
Online Supplement: http://dx.doi.org/10.1509/jmr.12.0354
253
254
0)
-Q
CO
0-
----------------------i
100
i---------------1-------------- 1---------------r
200
300
400
500
Stockpiled Points
B: Linear
4
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tr
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i
100
i
200
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300
i
400
n
500
Stockpiled Points
M ultiple Accounts
Single Account
MA
MLA
SA
SLA
255
in which we are interested; it assumes that redemption
occurs when customers have stockpiled enough points to do
so.
In summary, we use a model of mental accounting to
empirically examine the potential motivations to persist
ently stockpile in linear programs and how they vary across
customers. Our findings and documentation of stockpiling
behavior in a linear program respond directly to a call in a
recent article for research on how customers redeem: Though
redemptions are critical elements of loyalty programs, we
do not really know why loyalty program members redeem,
or why they do not (Bijmolt, Dorotic, and Verhoef 2010, p.
224). Our results can be used to improve communication
strategies to encourage redemptions and may also provide
insight into why even in nonlinear programs, some cus
tomers persistently stockpile beyond explicit requirements.
The remainder of this article proceeds as follows: We first
describe the data set to motivate both the theoretical and the
empirical parts of the research. Then, we mathematically lay
out the MA model and explain how it captures each motiva
tion. We specify an empirical version of the utility model
and demonstrate its performance, along with the other
specifications of the 2 x 2 framework. We then apply the
MA model to characterize the heterogeneity in customer
motivations and assess policies that may potentially
increase redemptions by addressing each of the three moti
vations. We conclude with a summary and directions for
further research.
PROGRAM DESCRIPTION
Our empirical setting is a linear loyalty program that has
operated for more than 20 years in a prominent supercenter
chain in Latin America (the chain has asked to remain
anonymous). It is the market leader in several countries for
a range of high-end product categories similar to those
offered by Target, Bed Bath & Beyond, and Home Depot.
For example, the product categories it offers include flatscreen televisions, beds, hardware items, toys, kitchen
appliances, home decor items, gardening tools, and camping
equipment.
The data track the behavior of a cohort of customers who
first signed up for the retailers loyalty program in January
2008. For each visit of each individual, over a 43-month
period, we observe the basket price, how many points were
earned or redeemed, and the date. From these data, we are
able to infer the available stockpile of points each person
had at the time of each purchase.
Consistent with our introduction and motivating example,
the loyalty program offers a linear reward policy. In our set
ting, customers cannot get the satisfaction of paying without
any cash (i.e., they cannot pay 100% with points). Stock
piled points can be redeemed anytime to reduce up to 50%
of the basket price (not including items on sale) at a con
stant and easy-to-remember points-to-cash exchange rate.
We observe that this cap potentially affects 40% of redemp
tionsthat is, those in which a customer had more points
than 50% of the basket price. When the cap is nonbinding,
customers, on average, redeemed points equal to 22% of
their basket price.
Furthermore, redemption is a low-effort activity. Cus
tomers who want to redeem points simply show their loy
alty card and tell the cashier they want to redeem. While
256
DATA DESCRIPTION
The data set contains 346 customers who signed up for
the program in January 2008. We tracked their 10,219 pur
chase occasions from January 2008 through July 2011. We
use each customers first purchase occasion in January 2008
to calculate initial stockpile levels but then exclude it from
our analysis because no redemptions could have taken place
during the first purchase (i.e., customers did not have any
points to redeem yet).
Table 2
HETEROGENEITY IN CUSTOMER BEHAVIOR
Quantiles
0%
25%
50%
75%
100%
0
1
17
0
0
11
2,106
26
0
22
4,519
49
1
41
9,331
91
15
253
211,743
1,285
257
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{ aiwx
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REDEMPTION MODEL
In this section, we formalize the MA model described
previously. We begin by developing the two dimensions
(shape and number of accounts), and then we describe how
258
Figure 4
AVERAGE MONTHLY POTENTIAL SAVINGS
35-,
30
25
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Figure 5
COMPARISON OF RUN-LENGTHS
10
20
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u y ( yjj
= O) = E y
w(-mjj)
+ v(mijrhi) + y.
U ij(y ij = l ) = E y +
w (-m y + S y )
cash loss: discounted price
v ( Syhj)
- C y + e jj.
z ( s y ,m y ) =
w(-my
259
+ Sy) - w ( - m y ) + v ( - S y h i )
(6 )
S i j ) -w ( - my )
w (-m y +
cash saved
> [v(mijrhi) +
forgone new points
cy]
-v (-sy h ;).
Redeemable Points
260
+ Cii
Bayesian Specification
Next, we discuss the Bayesian specification. We com
plete the empirical specification by modeling individual dif
ferences through a hierarchical Bayes framework, which
allows for heterogeneity across customers in how they value
points relative to cash (Rick, Cryder, and Loewenstein
2008). A hierarchical Bayes model is ideally suited to ana
lyze behavior at the individual level in this case because it
leverages data on rare redemption occasions across cus
tomers. A prior distribution on the individual-level parame
ters allows the model to partially pool data across individu
als. For the MA model, let [3; represent a vector of the
transformed individual-level parameters: 3 = [log(kwi - 1),
log(kvi - 1), logit(awi), logit(avi), logit(h;), c j. These trans
formations restrict the loss-aversion parameters to be
greater than one and the curvature parameters as well as the
conversion rate h; to be between 0 and 1. The vector P; is
(,
3The error term eys corresponds to e'j and e from Equations 1 and 2.
Table 3
SUMMARY OF EMPIRICAL SPECIFICATIONS
Model
Redeemable Points
MA
SA
SLA/MLA
logit(pij)
c , - M m y - s sj)awi + T ^ m ^ - ^ ( S j j h i ) 3" - ( m y r h i ) ^
- C j - ^ ( m y - S y ) i + ?qm jj - 7 # ^ ) * - (m y rh i)*
- q + PsiSy + Pnuffly
Pi ~ MVN(p, Q).
Model
MA
SA
SLA
261
Table 4
Table 5
dzJds
Model
dz/dm
MA
SA
SLA
262
si(j+i)
Table 6
DEVIANCE INFORMATION CRITERION AND
(-LOG-MARGINAL DENSITY)
MA
SA
SLA
In-Sample (2008)
In-Sample (2009+)
Out-of-Sample
698.0 (352.9)
734.8 (372.3)
646.3 (310.6)
1,139.5 (577.5)
1,187.0 (597.3)
1,065.2 (506.2)
945.9 (872.5)
866.8 (1,209.7)
2,998.8 (2,052.3)
263
Figure 8
BIMONTHLY REDEMPTIONS
Figure 9
REDEEMING CREDIT C AR D S POINT STOCKPILE AT AM AZON.COM CHECKO UT
Item s (1):
Table 7
POSTERIOR DISTRIBUTION OF THE MA MODELS
POPULATION-LEVEL PARAMETERS
kw
kv
aw
av
h
c
...........
Order Summary
$22.07
Parameter
M
1.21
1.78
.347
.020
.523
1.79
2.5% Bound
1.07
1.28
.273
.007
.172
.937
97.5% Bound
1.45
2.74
.415
.042
.865
2.50
$34.99
These indicators are used to segment customers using Kmeans clustering. Table 8 shows the standardized indicator
means of three segments of size 142, 117, and 87, respec-
264
Figure 10
INDICATOR
A: Forgone Points and Fixed Costs
Segment
1
2
3
Economic
Cognitive
Psychological
Forgone
Points
Fixed
Costs
Account Exchange
Differences Rate
-.67
.73
.12
.44
.51
-1.41
-.43
-.57
1.47
-.25
.77
-.62
-2
Fixed Costs
B: Forgone Points and Account Differences
Account Differences
C: Fixed Costs and Account Differences
-1
Account Differences
265
Figure 11
Table 9
Policy
Points
Redeemed
Rate
Current
3.5%
Economic
4.1%
Cognitive
21.0%
Psychological 6.6%
a
a.
u
o
4,549
5,499 (+21%)
16,382 (+260%)
9,643 (+112%)
Change in
Redeemed Points/
-Change in
Points
Outstanding
Outstanding
Points
15,966
14,892 (-7%)
2,360 (-85%)
10,439 (-35%)
N.A.
.75
.87
.92
55
at
Segment
Segment
GENERAL DISCUSSION
Complicated program rules and undesirable rewards are
often blamed for low redemption rates. However, these
explanations cannot describe why, even in a linear program
with simple rules, redemptions are relatively rare. More
generally, research to date has not successfully addressed
why more than $48 billion rewards issued in the United
States each year are never redeemed (Hlavinka and Sullivan
266
267
Table B1
PARAMETER RECOVERY EXAMPLE
Parameter
Kv
K
aw
av
Actual
Estimated
1.18
1.74
.35
.05
.52
1.80
1.40
1.51
.28
.08
.56
1.86
Error
.22
-.23
-.07
.03
.03
.06
2.5%
Bound
97.5%
Bound
1.08
1.18
.20
.03
.20
1.29
2.18
2.00
.35
.14
.89
2.36