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Loyalty programs
abound, but most of
them don’t accomplish
much. If you want yours
to perform, here are the
five mistakes to avoid.
counts ranging from 3% to 7.5%. Online that an old customer retained is worth
phenomenon eBay quietly pulled the more than a new customer won. The
plug on its Anything Points program for concept of rewarding frequent buyers
members of the Spend & Save program. served that a loyalty program offering purchase data. Initiatives like Tesco’s re-
Once they’ve spent £400, they save 10% a free wash after eight purchases led quire a dedicated staff of analysts and
on the rest of their purchases that year. drivers to wash their cars more often as substantial investments in data man-
Consider the incentive that creates for they got closer and closer to earning the agement and augmentation. And even
a homeowner who spends about £800 reward. This same effect has been ob- then, a company’s customer data, taken
per year on DIY supplies. If he splits his served by other researchers studying in isolation, may not yield many novel
purchases evenly between Homebase coffee shop purchases, and it would no insights. We were reminded of this
and one of its competitors (spending doubt apply to small luxuries like tan- when we worked with Twentieth Cen-
£400 at each outlet), he receives £8 back ning and spa sessions, as well. The com- tury Fox Home Entertainment. Few
from each retailer (assuming that the mon thread is that these are goods and would suspect that online purchasers
competitor has a similar program), for services for which consumption is flex- of X-Men movies would be prime tar-
a total of £16 in savings. But if he spends ible and can be increased easily. A ser- gets for 1930s-era Shirley Temple movies.
the entire £800 at Homebase, he re- vice station might therefore create a re- But indeed, we discovered that action
ceives £48 back. ward program for oil changes and see film fans with kids were especially re-
Prompt customers to make addi- overall sales rise; using it for snow tire ceptive to pitches for the young actress’s
tional purchases. We’ve been describ- changeovers probably would not work movies. How could Fox Home Enter-
ing situations where competing for out as well. tainment determine which of its custom-
a customer’s purchases is a zero-sum Yield insight into customer behavior ers had children? Only by combining its
game. The expectation is that the cus- and preferences. A benefit of loyalty own data with information purchased
tomer will buy just so much and no
more, and the objective is to capture the
largest portion of that amount. But a If food, beverage, fuel, insurance, and other
loyalty program needn’t set its sights
so low; it can also create incremental
expenses are factored in, a 25,000-mile reward
demand, spurring purchases that would costs less than $15, on average, to fulfill.
not otherwise be made.
This is a common effect of multi-
tiered loyalty programs (those with, say, programs that has gained prominence from third-party provider Equifax. The
Silver, Gold, and Platinum levels), where in the past decade is their ability to point is, it isn’t sufficient to collect loy-
each tier brings additional benefits. provide useful data about customers. alty program data and expect that ef-
Customers who are on the cusp of at- The data can both produce insights fective marketing moves will sponta-
taining the next status level – or in dan- about general buying behavior and neously suggest themselves; one must
ger of slipping to a lower one – will of- allow the seller to target promotions to have a marketing objective in mind and
ten spend more in order to secure the individual customers. Tesco, the UK then seek the data.
higher ground. To cite one of the most grocery store chain, is often cited for Turn a profit. Some loyalty programs
extreme examples we’ve seen: A friend its expertise in using the data collect- can even function as profit centers. Con-
of ours in Los Angeles found himself ed from its Clubcard members. Card- sider American Airlines’ AAdvantage
3,000 miles short of United Air Lines’ holders receive a quarterly mailing program. Even as the airline racks up
Premier Executive status with just a with offers so carefully customized billions of dollars in debt, the AAdvan-
few weeks remaining in 2005. He took that Clive Humby, one of Clubcard’s ar- tage program turns a tidy profit selling
the least expensive qualifying flight, to chitects, told Promo magazine in 2004 miles to other businesses to use as re-
the frigid destination of Buffalo, New that Tesco prints about 4 million varia- wards for their customers. AAdvantage
York, where he stayed less than 24 hours tions for each mailing. As data collec- clients range from huge concerns like
before returning. tion and maintenance become easier Citibank to small businesses like Ariake,
Even when status levels are not part and cheaper, we are witnessing a prolif- a sushi restaurant in Los Angeles. Con-
of a program, a valued reward can lead eration of companies offering to pro- sumers of Kellogg’s breakfast cereals
consumers to accelerate their purchases, vide marketing insights based on loy- get thanked with American Airlines
and that can add up to increased over- alty program data. miles; so do subscribers to USA Today.
all consumption. Working with a chain Yet one must be careful not to over- Together, U.S.-based airlines sell nearly
of car washes on the West Coast, we ob- state the benefits of collecting consumer $2 billion worth of miles to more than
22,000 businesses.
Joseph C. Nunes (jnunes@marshall.usc.edu) is an associate professor of marketing at This may seem like a loyalty pro-
the University of Southern California’s Marshall School of Business in Los Angeles. gram’s crowning achievement, a gambit
Xavier Drèze (xdreze@wharton.upenn.edu) is an assistant professor of marketing at the available only to the long established
University of Pennsylvania’s Wharton School in Philadelphia. and mature. In fact, it was the function
of the earliest broad-based program, where people exchanged their stamps course, these types of ventures, while
S&H Green Stamps. Thomas Sperry for merchandise. generating additional revenues, also in-
(the “S” in “S&H”) did not create Green Today, any company with a broad cus- volve all the complexity of running stand-
Stamps in 1896 to reward customers of tomer base and excess capacity could alone businesses. A critical concern is
a business S&H owned. The system was consider leveraging its loyalty program arriving at the right price per reward
conceived as an independent business in the same way. Marriott has done so point. In the airline business, for exam-
that would sell stamps to merchants, with its Rewards program, enabling cus- ple, the average mile sells for about two
along with the books to paste them in. tomers to collect points for a future hotel cents, although it goes for significantly
S&H’s only direct trade with consum- stay by shopping at Target, the Gap, less to high-volume customers like Citi-
ers was through redemption centers Lands’ End, Macy’s, or Best Buy. But of bank. This means the airline sells the
right to 25,000 miles for about $500 in in-
cremental revenue. In most businesses,
economics like this would be disastrous,
The Effect of a Jump Start but airlines are able to keep the true in-
cremental costs quite low. They can limit
In April 2004, we staged an experiment in a car wash business in Los Ange- the availability of qualifying seats, and
les. The business distributed 300 stampable cards that promised a free car they count on a certain portion of miles
wash after eight paid visits. The cards, however, took two forms. Card 1 was going unredeemed. If food, beverage,
a straightforward buy-eight-get-one offer. Card 2 presented itself as a buy-ten- fuel, reservations processing, liability in-
get-one offer, but customers were told that, as a special promotion, they surance, and other miscellaneous ex-
were being given the first two stamps free. Essentially, then, the economics
penses are factored in, the 25,000-mile
reward actually costs less than $15, on
of the two programs were identical. The question was whether those two
average, to fulfill.
stamps, by framing the quest as one that had been undertaken rather than
We’ve outlined five benefits a com-
one not yet begun, would have an effect on sales.
pany can gain from a loyalty program,
The “endowed progress effect,” as we termed it, turned out to be substan- and the corollary should be clear: Any
tial. First, total redemptions were higher. While only 19% of the customers given program must be designed to
with Card 1 stuck with the program and claimed the prize, 34% of Card 2 cus- serve specific goals, and priorities must
tomers did so. Card 2 customers also came back at a faster rate, as reflected be set among them. It’s unreasonable
in the diagrams below (which represent only the customers who got all to expect to design a program that
their stamps and earned the free wash). As this comparison shows, the aver- equally pursues several distinct objec-
age elapsed time between visits was less for Card 2 than for Card 1. Finally, tives. Rather, it makes sense to focus
under both programs, purchasing accelerated: The time between visits be- on a couple and design the optimal
came shorter and shorter as the customer got closer to the payoff. But note
program to serve them. (If additional
benefits can then be layered onto that
that the rate of acceleration was greater with Card 2. The time between vis-
design, fine–but only if that can be done
its compressed more along the way.
without compromising performance in
For details on this study, see our article “The Endowed Progress Effect:
the key areas.) The unfortunate reality,
1 2 3 4 5 6 7 8
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
WEEKS
PURCHASES WITH CARD 2
1 2 3 4 5 6 7 8 Average elapsed
time between visits:
2.9 days less
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 than for Card 1
WEEKS
however, is that many loyalty programs award waste. They see a low-divisibility olute. Because they have not yet made
seem to have no distinct targets squarely program as having such a high thresh- any progress, the rewards seem far away.
in their sights. old for rewards that it deters them from Worse, they have little sense of how easy
ever embarking on the quest. By con- it will be to achieve the goals. Rather
The Levers of Loyalty trast, managers don’t like offering highly than lose a customer’s interest right out
On the face of it, designing a loyalty divisible programs because they are not of the gate, the best designed programs
program is a straightforward exercise. effective at creating consumer lock-in. provide what we’ve termed “endowed
It must be attractive to customers and If one can redeem 5,000 points, why progress,” a little push to get things mov-
not too expensive. Both sides of that strive to accumulate 10,000? As always ing. We learned how effective endowed
equation, however, are easier said than is the case when the desires of compa- progress can be when we staged a field
done. Our study of programs in practice nies and those of consumers collide, a experiment at a metropolitan car wash.
suggests that several components are compromise must be struck. The right (See the exhibit “The Effect of a Jump
especially important and difficult to level of divisibility will factor in the ex- Start” for details.)
design well. pected yearly program usage and the Let us quickly offer a caveat, however.
Divisibility of rewards. First, there is amount of company differentiation. Customers must see the endowment as
a careful balance to strike in what we Our research shows, for example, that earned or warranted by their behavior,
would term “divisibility,” or the number in a grocery store setting (high usage, or the tactic will have little effect. In-
of discrete reward-redemption oppor- low differentiation), a $50 reward for deed, if it smacks of cynicism, it may
tunities a program provides. A pro- every $500 spent engenders greater cus- produce a negative one. Even if the en-
gram that allows members to redeem tomer loyalty than either a $10 reward dowed progress is simply cast as a sign-
points in clusters of 5,000 is twice as di- for every $100 spent or a $100 reward ing bonus for new program members, it
visible as one that allows people to re- for every $1,000 spent (too much and should give them a sense of established
deem points only in clusters of 10,000. too little divisibility, respectively). momentum.
Managers and their customers often di- Sense of momentum. Research has Nature of rewards. Research about
verge in their preferences on this mat- proven that the further along members the compensation of professional sales-
ter. Customers prefer highly divisible are in a loyalty program, the more they people has shown that they respond
programs because they provide many use it. By contrast, at the outset of their more dramatically to performance in-
exchange opportunities and thus reduce membership, their involvement is irres- centives that promise pleasure (like
luxe vacations and, in decades past, fur one-free program is to give away a prod- and a copayment of 5,000 frequent-
coats) than to purely utilitarian incen- uct unnecessarily. After all, a customer flier miles than with a straight payment
tives (like cash bonuses). In the same way, who likes a product enough to buy it of either $300 or 30,000 miles. Small
consumers love to be given a treat they ten times could probably be expected amounts of miles seem trivial to the
would not splurge on with their own to purchase it again. By making the consumer, as they make most mileage
money. And so the most successful loy- 11th time free, the company effectively rewards seem too far away. Thus, being
alty programs often feature less func- gives the habitual buyer a quantity dis- able to spend these alternative curren-
tional and more pleasure-providing re- count. (Subway’s Sub Club used to do cies in smaller amounts (accompanied
wards. When Maritz Loyalty Marketing, exactly this.) More valuable to a com- by cash) is more appealing than spend-
which operates loyalty programs for pany is a program that expands the con- ing lots of precious miles on a cheap
various merchants, analyzed the reward sumer’s repertoire of purchases. For flight. An expensive flight, however, is
redemptions for its clients in 2005, it example, instead of giving an 11th cup another story. (See the exhibit “The Case
found that American consumers pre- free, a coffee shop might make the tenth for Currency Combinations.”) More sim-
ferred the latest electronics (televisions, a larger size or throw in a free pastry. As ply put, companies stand to gain incre-
video games, stereos, DVD players) to well as being a more hedonic reward, mental sales when they’re flexible in
household goods (appliances, furniture, the sample might introduce the con- how they allow customers to combine
art) by a factor of almost two to one. But sumer to a new product and induce currencies.
the benefit of offering nonutilitarian higher future sales. This is one reason
rewards is not simply that they get peo- airlines are happy to fill empty seats in Mistakes to Avoid
ple excited about the program. In expe- business or first class with members We’ve been reviewing the finer points of
riencing the reward, people come to spending frequent-flier miles for an up- loyalty program design – the elements
have pleasant associations with the grade. It gives the traveler the taste of that, when carefully managed, separate
brand. Note what happened with Nec-
tar, a UK-based reward program that
serves customers of various retail out- The typical grocery store loyalty program does not
lets. Its members collected more points
reward loyal behavior; it rewards card ownership.
(in other words, spent more at program-
affiliated stores) during the month im-
mediately following a point redemption a better experience that he might find the best programs from mediocre or
than during other months – and the ef- difficult to live without in the future. bad ones. It’s easy to come away from
fect was even greater when the points In fact, Subway’s current plans are to such research with the strong sense that
were redeemed for a hedonic reward offer franchises a new reward program, the devil is in the details. But in truth,
such as theme park admission. featuring a magnetic card that will allow when we reflect on the programs that
American Express Incentive Services customers to trade points for cookies were outright failures, we see that the is-
is well aware of this element in its pro- and other extras. sues were not all that nuanced. Loyalty
gram design. It divides rewards into Combined-currency flexibility. A pro- programs typically founder on some
two types: sticky and slippery. Sticky gram in which consumers never redeem simple mistakes. Allow us to offer five
rewards stick in the recipient’s mind, points would be very inexpensive to basic pieces of advice.
Therefore, managers must ensure A 1K cardholder is asked her choice of they compare extremes with extremes.
that their loyalty programs are incen- entrée before a Premier or Premier Ex- That is, they notice the speed of service
tive compatible, designed so it is in cus- ecutive cardholder. It costs the airline only when they are not being served
tomers’ best interests to be loyal. A nothing to bestow this honor, because promptly. Our research suggests that,
program should reward the use of the the numbers and types of meals taken on average, airline luggage marked as
card over time rather than on a given on board do not change. Similarly, “priority”tends to come out of the plane
purchase occasion, and it should dis- Citibank does not answer the customer faster. Many airlines even have a spe-
criminate between more and less loyal service calls it receives in the order they cial container for these bags. Yet we
customers in the size of its rewards. are received; rather, wait time is a func- have also found that, frequently, a good
For example, at the women’s clothing tion of the callers’ assets. Many manag- number of nonpriority bags are deliv-
chain Chico’s, customers become Pass- ers refer to this type of preferential ered before the last priority bag comes
port members after spending $500, en- treatment as customer recognition. Call out. If too many nonpriority bags are
titling them to discounts and targeted it what you like – it effectively rewards delivered before priority bags, the pre-
communications. the most valuable customers. mier passenger begins believing that
Don’t reward volume over prof- Even if managers cannot make cus- the promise of superior service has
itability. Gauging loyalty solely on the tomer rewards costless, they can often been broken. Managers need to ensure
basis of such rudimentary measures as lower the costs. A classic way to achieve that the lower bounds of premium ser-
purchase quantity can be very mislead- this is to provide coupons rather than vice never look worse than standard
ing. Instead, Harrah’s Entertainment, straight discounts. Baby Club’s 10% dis- service.
for instance, tracks the types of gam- count, for example, was given in the
bling that people do and focuses on its form of Baby Bucks that could be re- Keep the Faith
most profitable customers. Its loyalty deemed for $10 vouchers that them- We began this article with a litany of
program recognizes, for example, that selves could be redeemed for groceries failures, a sampling of loyalty programs
roulette wheels have a different house at ABCO. When interviewed, club mem- that were dumped for not delivering.
take than slot machines. Thus, when a bers showed real enthusiasm for the In a way, this is the good news, because
customer calls to book a night at one “10% discount” they received. However, many other programs that should get
of its properties, Harrah’s is able to when we looked at the liability to the canceled continue to limp along.
generate a spot price for the room store, we found that the low redemp- Yet loyalty programs are ingenious
based on customer profitability as well tion rate coupled with the profit margin marketing tools when they are de-
as availability. Profitable customers on the sales of the items bought with signed and executed well. In a wide va-
might stay for free while others might the coupons reduced the liability from riety of industry settings, they’ve proven
be charged hundreds of dollars for the 10% to a mere 1.72%. their ability to reduce churn, increase
same room or even be told that no Don’t promise what you can’t de- sales and profitability, and yield the
rooms are available. liver. When a loyalty program pledges to kind of insight that allows a company
Frequent-flier programs are begin- reward customers with preferential to provide more valued service to its
ning to follow suit. American Airlines treatment (shorter lines, expedited de- customers.
revamped its entire AAdvantage system livery, special toll-free numbers), it Making sure that a company’s loyalty
to track members according to their must ensure that the services provided program will carry its weight begins
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