MARK 7397

Spring 2007
Customer Relationship Management:
A Database Approach
Class 9

James D. Hess
C.T. Bauer Professor of Marketing Science
375H Melcher Hall
jhess@uh.edu
713 743-4175
Loyalty Programs Membership Growth
1100 USA 6% 3.6
1051

973
 Design Elements of Loyalty Programs

• Satisfaction-loyalty-profit chain

• Loyalty programs

• Key objectives of Loyalty Programs

• Examples of Loyalty Programs

• Design Characteristics of Loyalty Programs

• Reward Structure

Next Week: What makes a loyalty program effective?

 Satisfaction-Loyalty-Profit Chain

Product
Performance
Customer Retention / Revenue /
Service
Performance Satisfaction Loyalty Profit
Employee
Performance

What do we know about this conceptual chain?

The link between Satisfaction and Retention
Customer Sub-Types
 Customer Loyalty

• Loyalty to a product or service by repeat purchases can be due to

customer’s natural satisfaction and preference for the products’
features and benefits, but it can also be induced through marketing
plans and programs from the firm.
• Definitions of Brand Loyalty
• Behavioral loyalty: the observed action that customers have
demonstrated towards a particular product or service
• Attitudinal loyalty: the perceptions and attitudes that a customer has
towards a particular product or service
 Results of Customer Satisfaction-Profit
Link Studies
• Direct link suggests, that as customers experience greater
satisfaction with a firm’s offering, profits rise

• Improving customer satisfaction comes at a cost and once the cost

of enhancing satisfaction is factored in, offering “excessive
satisfaction” doesn’t pay

• Marginal gains in satisfaction decrease, while the marginal

expenses to achieve the growth in satisfaction increase

• There is an optimum satisfaction level for any firm, beyond which

increasing satisfaction does not pay
 The link between Loyalty and Profits
• Reichheld’s hypotheses

– Long term customers spend more per period over time

– Cost less to serve per period over time
– Have greater propensity to generate word-of-mouth
– Pay a premium price when compared to that paid by short-term
customers

• Does not hold true in a non-contractual relationship

– Revenue stream must be balanced by the cost of constantly

sustaining the relationship and by fending off competitive attacks
– Efforts at increasing customer satisfaction and retention not only
consume a firm’s resources but are subject to diminishing returns
 Lifetime Duration-Profitability Association

• Reinartz and Kumar: Across the different firms,

– there is a segment of customers that is loyal but not very
profitable (due to excessive resource allocation)
– there is a segment that generates very high profits although it
has only a short tenure
– Since these short-term customers can be very profitable, it is
clear that loyalty is not the only path to profitability
Association of Profitability and Longevity
of Customers
 Loyalty Programs

• A marketing process that generates rewards to

customers based on their repeat purchasing

• Consumers who enter a loyalty program are expected to transact

more with the focal company, giving up the free choice they have
otherwise

• In exchange for concentrating their purchases with the focal firm,

they accumulate assets (for example, ‘points’)

• Points are exchanged for products and services, typically but not
necessarily associated with the focal firm

• CRM tool used by marketers to identify, award, and retain profitable

customers
Key Objectives of Loyalty Programs

• Building true (attitudinal & behavioral) loyalty

• Efficiency profits

• Effectiveness profits

• Value alignment
 Efficiency Profits
• Profits that result from a change in customer’s buying
behavior due to the loyalty program

• Change in buying behavior can be measured, in:

• Basket size
• Purchase frequency acceleration
• Price sensitivity
• Share of category requirements (SCR) or share-of-wallet
• Retention
• Lifetime duration

• Measured in terms of the immediate profit consequences as

compared to profit consequences without loyalty programs – net of
the LP cost
 Effectiveness Profits

• Measured in terms of the long-term profit consequences realized

through better learning about customer preferences over time

• Allows sustainable value creation for customers through

customization of products or communication

• Most likely to generate sustainable competitive advantage since it

produces the highest profits in the long run

• The strategy of using a LP to learn about customer preferences may

result in impressive gains for both customers and organizations

• Customers get more of what they truly want, and firms are safe in
terms of not having to engage in a costly mass marketing exercise
 Examples of Loyalty Programs
• Volkswagen Club and Card
– Customers collect points from Volkswagen (VW) for servicing
their car or buying accessories and from partners of car rental
companies and tour operators
– The points can be redeemed for dealer services, price
reductions on car purchases, and catalog merchandise
• Star Alliance Frequent Flyer Program
– Any flight on any Star Alliance airline counts towards a members
frequent flyer program
• Neimann Marcus
– Offers its LP ‘InCircles’ to all customers. Using a shopping card,
customers accumulate points that can be redeemed for
exclusive rewards
• Club Bally Member Rewards
Design Characteristics of Loyalty Programs

• Reward structure

– Hard vs. soft rewards

– Product proposition support (Choice of rewards)
– Aspirational value of reward
– Rate of rewards
– Tiering of rewards
– Timing of rewards
 Reward Structure
• Hard vs. soft rewards

Hard rewards: price reductions, promotions, free products and

preferred treatment

Soft rewards: psychological or emotional benefits of having special

status in addition to receiving preferred customer service
 Reward Structure (contd.)
• Product proposition support

– Reward directly supports the firm’s product proposition

• Example: The US Bagel franchise Finagle-A-Bagel has a LP that
allows participants to redeem their accumulated bonus points for the
firm’s own products – sandwiches and drinks
– Consumers prefer hedonic goods as opposed to utilitarian goods when
receiving a LP reward
• Neimann Marcus, the US luxury retail chain, gives out each year a
new list of “wow and cool” rewards. These unique rewards include a
world famous photographer to come to a customer’s home for
taking pictures
 Reward Structure (contd.)
• Rate of rewards
– Ratio of reward value (in monetary terms) over transaction volume
(in monetary terms)
– How much a consumer is getting in return for concentrating his or
her purchases

• Tiering of rewards
– Rewards based on asset accumulation response function - how
assets or rewards are accumulated as a function of spending
behavior

• Timing of Rewards
- “Lock-in” effect - firm creates redemption rules that favor long
accumulation periods, thereby impacting customer retention
- Longer the timing to build up to a certain reward level, the greater
the “breakage” (the amount of rewards that are never redeemed)
 How can loyalty programs backfire?

• Design can change behavior in a counter-productive way.

• Reduce the profitability of top-level customers

• Increase resentment of customers toward each other

• Attract the wrong type of customer

 Summary

• Satisfaction-profit-chain needs to be implemented at a disaggregate

(individual) level rather than aggregate (firm) level
• Link between satisfaction and retention is asymmetric, i.e.,
dissatisfaction generally has a greater impact on retention than
satisfaction, and nonlinear
• Loyalty is not the only path to profitability
• Most companies need to revisit their business model
– to reflect on the impact of Loyalty Programs on their bottom line
– to determine how customer service initiatives add value to future
revenue streams