Designing the Perfect Customer Rewards Program

Last Updated Jul 28, 2011 3:05 PM EDT

Even merchants that don't have formal customer loyalty programs probably have informal ones. They might tip off a preferred client about an upcoming sale, or throw an extra cucumber in the bag on the house.

But having a formal program can pay off in many more powerful ways, says Harvard Business School senior lecturer Jose B. Alvarez, a former CEO of Stop & Shop. Loyalty schemes not only provide the retailer or service provider invaluable data about their customers but they allow a high level of service that provides a point of differentiation.

"A great retailer is the agent for the customer," he tells HBS Working Knowledge. "Loyalty programs and the insight and communication capabilities they provide can help retailers achieve greatness in a crowded and commoditized space."

The difficulty, as he sees it, is that most loyalty schemes are poorly designed, with the result that less than half of the almost 2 billion loyalty memberships in the US (yes, that's an average of almost 14 per household) are in active use. And many customers see them as punitive.

To be truly successful, rewards programs must offer, well, enticing rewards -- discounts, preferred access or services, and access to affinity groups, for example. Tiered programs increase rewards based on the amount of purchases.

In an backgrounder sold through, Customer Loyalty Schemes in the Retail Sector, Alvarez lists 10 characteristics of successful loyalty schemes, including:

  • A clear understanding of the scheme's objectives and design (e.g., what will be the different levels of reward? Which customers will be eligible. How will they be rewarded?
  • Software and hardware systems to capture and access data such as name and address, other demographic info, transactions, etc.
  • Strategy and tactics employing the customer data to better understand customer needs and build loyalty with targeted marketing, point schemes, and the like.
These programs don't come cheaply -- Alvarez cites an industry statistic that maintenance can run 1% to 1.5% of sales annually, and can be easily copied by competitors. But for many businesses, customer loyalty is worth the cost and effort.

How does your business develop customer loyalty? What programs have worked, which haven't?

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(Photo by Flickr user turtlemom4bacon, CC 2.0)
  • Sean Silverthorne

    Sean Silverthorne is the editor of HBS Working Knowledge, which provides a first look at the research and ideas of Harvard Business School faculty. Working Knowledge, which won a Webby award in 2007, currently records 4 million unique visitors a year. He has been with HBS since 2001.

    Silverthorne has 28 years experience in print and online journalism. Before arriving at HBS, he was a senior editor at CNET and executive editor of ZDNET News. While at At Ziff-Davis, Silverthorne also worked on the daily technology TV show The Site, and was a senior editor at PC Week Inside, which chronicled the business of the technology industry. He has held several reporting and editing roles on a variety of newspapers, and was Investor Business Daily's first journalist based in Silicon Valley.