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Professor Nanda Kumar
Professor of Marketing
Naveen Jindal School of Management
University of Texas at Dallas

ABSTRACT

Many loyalty programs award consumers a proprietary points currency that accumulates over time and can be redeemed for future purchases, effectively giving firms two pricing instruments: a dollar price and a points price. We study how this two-currency structure reshapes competitive pricing incentives in a two-period Hotelling model where a fraction of consumers enroll in loyalty programs and receive a point endowment in period 1. In period 2, firms simultaneously set prices in dollars and points. We characterize subgame-perfect equilibria and identify a simple organizing principle: points become an active strategic instrument when the firm-side value of redeemed points exceeds consumers’ effective opportunity cost of spending them. When this condition holds, points soften price competition in both periods relative to a no-rewards benchmark, raising equilibrium prices and total discounted profits. When it fails, the program collapses to a one-currency benchmark and generates no strategic pricing advantage. We show that this two-currency mechanism differs fundamentally from behavior-based pricing, which intensifies competition, and from switching-cost models, which create exogenous consumer lock-in. Extensions incorporating point expiration, endogenous reward endowments, and heterogeneous point valuations reinforce the central mechanism. Our results offer a conditions-based explanation for why some loyalty programs are highly profitable while others are not.