Understanding Consumer Dynamic Decision Making Under Competing Loyalty Programs

The authors develop an incentive-aligned experimental paradigm to study how consumer purchase dynamics are affected by the interplay between competing firms’ loyalty programs and their pricing and promotional strategies. In this experiment, participants made sequential choices between two competing airlines in a stylized frequent traveler task for which an optimal dynamic decision policy can be numerically computed. The authors find that, on average, participants are able to partially realize the long-term benefits from loyalty programs, though most are sensitive to price. They also find that participants’ preferences and levels of bounded rationality depend on the nature of the competitive environment, the particular state of each decision scenario, and the type of optimal action. Accordingly, the authors use an approximate dynamic programming model to incorporate boundedly rational decision making. The model classifies participants into five segments that exhibit variation in their performance and decision strategies. Importantly, they find that participants are able to adapt their decision strategies to the environment they face, and thus the overall market outcome and the performance of each firm are influenced by both the competitive environment and the assumption on the extent of consumer optimality.