Wednesday, March 9, 2011

Money Isn't Everything

In reviewing some older research there was some interesting research documented in 2004 by Xavier Dreze and Joseph Nunes regarding the concept that loyalty points are often worth more than money. (Using Combined-Currency Prices to Lower Consumers' Perceived Cost"). They postulate that "combined currency-points" transactions may have more appeal to customers than money or points individually.

They point out that there hasn't been much research on the underlying principles that make a loyalty program work of not work for a firm. The authors of the research examined different kinds of currencies that consumers can accumulate and spend. Consumers generally have points gathered from airlines, hotels, car rentals and individual credit card points. The hypothesis behind the research is that there may be a best combination of points and currency that would be more appealing to the consumer than using either one separately to purchase additional products or services from the firm.

The authors present a mathematical proof that outlines the conditions under which a price delineated in multiple currencies (points and dollars) can be superior to a single method of payment. One of the outcomes of the research was the combined currency pricing can bring in more revenue for a company and pricing can either lower the psychological or perceived cost associated with the pricing scheme or raise the amount of revenue collected given a perceived cost.

Another interesting outcome was that consumer preference for the combined currency indicated that each point or dollar spent is not valued equally. They conclude that it would be preferable for a company to charge a combined currency when two conditions exist; namely, the consumer does not value each unit within a currency equally and the perceived cost function of one of the currencies is "convex." Convexity implies that the value of one of the currencies is not linear. Using airline miles as an example, the number of frequent flier miles for a free flight is worth more than twice the value of one half the number of miles for a free flight. If it takes 25,000 miles to get a free flight, that is worth more than twice the value of having only 12,500 miles. This seems to be true since people don't appear to value miles or points the same way they value money.

The bottom line is we get a first glimpse into the psychology of point value versus money from this research. Although many researchers would not think about finding a model that maximizes consumer satisfaction with a loyalty program by mixing reward points with currency to get a "best" solution, there is now some evidence that such is the case. When both the company and the consumer win in a transaction that includes the loyalty program, we are taking another step to demonstrate the value of loyalty programs.

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