Intrinsic and Induced State Dependence in Frequency Reward Programs

This paper is now under 3rd review in Marketing Science. We develop a comprehensive dynamic structural model of purchase behavior that incorporates response to reward, state dependence and forward-looking behavior and consumer heterogeneity. We apply the model to a unique panel data set on a buy-ten-get-one reward program administered by a tea cafe chain. We 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. The results also reveal a dynamic interaction effect between the induced and intrinsic state dependence, highlighting a multi-fold effect of the reward program. Counterfactual studies are performed to analyze the value of the reward program and the profit implications of structural changes to the program.