Loyalty Program Liabilities and Point Values
Problem definition: Loyalty programs (LPs) introduce a new currency—the points—through which customers transact with firms. Such points represent a promise for future service, and their monetary value thus counts as a liability on the issuing firms’ balance sheets. Consequently, adjusting the value...
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| Format: | Article |
| Language: | English |
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Institute for Operations Research and the Management Sciences (INFORMS)
2021
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| Online Access: | https://hdl.handle.net/1721.1/130502 |
| _version_ | 1826205859131162624 |
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| author | Chun, So Yeon Iancu, Dan A. Trichakis, Nikolaos |
| author2 | Sloan School of Management |
| author_facet | Sloan School of Management Chun, So Yeon Iancu, Dan A. Trichakis, Nikolaos |
| author_sort | Chun, So Yeon |
| collection | MIT |
| description | Problem definition: Loyalty programs (LPs) introduce a new currency—the points—through which customers transact with firms. Such points represent a promise for future service, and their monetary value thus counts as a liability on the issuing firms’ balance sheets. Consequently, adjusting the value of points has a first-order effect on profitability and performance and emerges as a core operating decision. We study the problem of optimally setting the points’ value in view of their associated liabilities. Academic/practical relevance: Firms across numerous industries increasingly utilize LPs. The sheer magnitude of LPs coupled with recent changes in accounting rules have turned the associated liabilities into significant balance-sheet items, amounting to billions of dollars. Managers (from chief financial officers to chief marketing officers) struggle with the problem of adjusting the points’ value in view of these liabilities. Academic work is primarily aimed at understanding LPs as marketing tools, without studying the liability angle. Methodology: We develop a multiperiod model and use dynamic programming techniques and comparative statics analysis. Results: We show that the optimal policies depend on a new financial metric, given by the sum of the firm’s realized cash flows and outstanding deferred revenue, which we refer to as the profit potential. The total value of loyalty points is set to hit a particular target, which increases with the profit potential. We find that loyalty programs can act as buffers against uncertainty, with the value of points increasing (decreasing) under strong (weak) operating performance and increasing with uncertainty. Managerial implications: Setting the point values and adjusting operating decisions in view of LP liabilities should be done by tracking the firm’s profit potential. Loyalty programs can act as hedging tools against uncertainty in future operating performance, which provides a new rationale for their existence, even in the absence of competition. |
| first_indexed | 2024-09-23T13:20:14Z |
| format | Article |
| id | mit-1721.1/130502 |
| institution | Massachusetts Institute of Technology |
| language | English |
| last_indexed | 2024-09-23T13:20:14Z |
| publishDate | 2021 |
| publisher | Institute for Operations Research and the Management Sciences (INFORMS) |
| record_format | dspace |
| spelling | mit-1721.1/1305022021-09-20T19:07:00Z Loyalty Program Liabilities and Point Values Chun, So Yeon Iancu, Dan A. Trichakis, Nikolaos Sloan School of Management Problem definition: Loyalty programs (LPs) introduce a new currency—the points—through which customers transact with firms. Such points represent a promise for future service, and their monetary value thus counts as a liability on the issuing firms’ balance sheets. Consequently, adjusting the value of points has a first-order effect on profitability and performance and emerges as a core operating decision. We study the problem of optimally setting the points’ value in view of their associated liabilities. Academic/practical relevance: Firms across numerous industries increasingly utilize LPs. The sheer magnitude of LPs coupled with recent changes in accounting rules have turned the associated liabilities into significant balance-sheet items, amounting to billions of dollars. Managers (from chief financial officers to chief marketing officers) struggle with the problem of adjusting the points’ value in view of these liabilities. Academic work is primarily aimed at understanding LPs as marketing tools, without studying the liability angle. Methodology: We develop a multiperiod model and use dynamic programming techniques and comparative statics analysis. Results: We show that the optimal policies depend on a new financial metric, given by the sum of the firm’s realized cash flows and outstanding deferred revenue, which we refer to as the profit potential. The total value of loyalty points is set to hit a particular target, which increases with the profit potential. We find that loyalty programs can act as buffers against uncertainty, with the value of points increasing (decreasing) under strong (weak) operating performance and increasing with uncertainty. Managerial implications: Setting the point values and adjusting operating decisions in view of LP liabilities should be done by tracking the firm’s profit potential. Loyalty programs can act as hedging tools against uncertainty in future operating performance, which provides a new rationale for their existence, even in the absence of competition. 2021-04-22T15:23:41Z 2021-04-22T15:23:41Z 2020-03 2021-04-07T11:56:30Z Article http://purl.org/eprint/type/JournalArticle 1523-4614 1526-5498 https://hdl.handle.net/1721.1/130502 Chun, So Yeon et al. "Loyalty Program Liabilities and Point Values." Manufacturing and Service Operations Management 22, 2 (March 2020): 223-259. © 2019 INFORMS en http://dx.doi.org/10.1287/msom.2018.0748 Manufacturing and Service Operations Management Creative Commons Attribution-Noncommercial-Share Alike http://creativecommons.org/licenses/by-nc-sa/4.0/ application/pdf Institute for Operations Research and the Management Sciences (INFORMS) other univ website |
| spellingShingle | Chun, So Yeon Iancu, Dan A. Trichakis, Nikolaos Loyalty Program Liabilities and Point Values |
| title | Loyalty Program Liabilities and Point Values |
| title_full | Loyalty Program Liabilities and Point Values |
| title_fullStr | Loyalty Program Liabilities and Point Values |
| title_full_unstemmed | Loyalty Program Liabilities and Point Values |
| title_short | Loyalty Program Liabilities and Point Values |
| title_sort | loyalty program liabilities and point values |
| url | https://hdl.handle.net/1721.1/130502 |
| work_keys_str_mv | AT chunsoyeon loyaltyprogramliabilitiesandpointvalues AT iancudana loyaltyprogramliabilitiesandpointvalues AT trichakisnikolaos loyaltyprogramliabilitiesandpointvalues |