Your Loyalty Program Is Betraying You

The Idea in Brief

Companies of all kinds are killing off their customer loyalty programs. Why? Most loyalty programs don't produce the results they promise: lower customer churn, higher sales and profitability, and more valuable insights into customers' behavior.

Yet some firms--including Sprint, Amazon.com, and United Airlines--have designed ingenious loyalty programs that do deliver as promised. Authors Joseph Nunes and Xavier Dreze reveal the secrets of these successful programs. First clarify your loyalty program's goal: Do you want to discourage customers from defecting? Motivate them to buy a broader range of products from you? Spur more frequent purchases?

Then design and execute your program so it fulfills the purpose you've defined--while boosting your bottom line. For example, Harrah's Entertainment rewards customers based on their profitability, not purchase volume. Very profitable customers--those who prefer games that generate a higher profit margin for Harrah's--stay at Harrah's properties for free. Less profitable customers may pay hundreds of dollars for the same room or even be told a hotel is booked.

No loyalty program can ensure unwavering devotion to your company. Yet properly designed and implemented, your programs will yield longer relationships with happier customers--earning you the best kind of competitive advantage.

The Idea in Practice

To design a successful loyalty program, Nunes and Dreze recommend:

Clarify Your Purpose

Decide whether you want your program to:

• Discourage defections. For example, for every dollar long-distance customers spend with Sprint, they earn an airline mile redeemable at any of five different airlines. Rival AT&T doesn't offer such a plan. Result? Members of participating airlines' frequent flyer programs retain Sprint as their long-distance carrier.


• Motivate customers to give more of their business to your company. Amazon.com offers shoppers a credit card that rewards them a penny on every dollar they spend, distributed as Amazon gift certificates. Shoppers who might otherwise alternate among stores now have a reason to favor Amazon.


• Encourage additional purchases. When a car-wash chain began offering a free wash after eight purchases, drivers washed their car more often as they got closer to earning the freebie.


• Gather data about customer buying behavior. U.K. grocery store chain Tesco collects purchase data from members who swipe a Club Card. Then it uses the data to carefully customize its quarterly magazine. For each mailing, Tesco prints product promotions tailored to at least four million different types of customers based on their purchasing habits.


• Turn a profit. American Airlines' wholly owned subsidiary AAdvantage profitably sells miles to other businesses to use as rewards for their customers--even as the airline itself racks up billions of dollars in debt.

Design Your Program

To ensure that your loyalty program is attractive to customers and not too expensive for you, design program components carefully:

• Sense of momentum. Provide a jump-start for new program members: The car-wash chain shortened time between washes even more by changing its "buy 8, get 1 free" program to "buy 10, get 1 free"--and pre-stamping members' first two washes. The car wash did not award any more free washes, but the pre-stamped washes gave members the sense of being farther along in the program than the previous promotion did.


• Nature of rewards. Give customers memorable treats they wouldn't splurge on with their own money. American Express's In:Chicago and In:LA specialty cards award cardholders special dining, drinking, and entertainment experiences at some of these cities' best spots.
• Relationship expansion. Customers who like a product enough to buy it 10 times would probably pay for the 11th purchase too. So don't make it free. Instead, offer rewards that expand consumers' repertoire of purchases. Rather than giving an 11th cup gratis, a coffee shop could offer a free pastry that attracts consumers to a new product and thus promote higher future sales.

Copyright 2006 Harvard Business School Publishing Corporation. All rights reserved.

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Further Reading

Articles

The Mismanagement of Customer Loyalty

Harvard Business Review

July 2002

by Werner Reinartz and V. Kumar

The authors agree that loyalty programs should do more than keep customers from defecting: they must create and reward profitable customers. To ensure that they do, categorize customers according to their loyalty and profitability, then develop a loyalty strategy for each category. To illustrate, avoid bombarding True Friends (profitable and loyal customers) with communications. Instead, reward them with exclusive access to special events and high-quality, limited supply products. With Butterflies (profitable but disloyal), milk them with hard-sell offers for the short time they buy. After their purchasing drops off, stop investing. Offer Barnacles (unprofitable but very loyal) products related to those they've already purchased--if you've determined they have more money to spend.

Loyalty-Based Management

Harvard Business Review

November 2000

by Frederick F. Reichheld

Customer loyalty is closely tied to employee loyalty. When customers are loyal, you gain market share and invest less in acquiring and serving customers. Now you can pay workers more--boosting morale and longevity. Employee experience rises, further enhancing customer service and retention. To drive this virtuous cycle, serve existing customer segments with added offerings that anticipate and meet their evolving needs. Motivate top-performing employees to stay; for instance, by basing bonuses on customer-retention rates. Educate employees on the cost, revenue, and profit consequences of the number of customers who stay loyal for how long. In insurance, for example, cost per policy decreases 15% when customer retention rises just 5%.

Zero Defections: Quality Comes to Services

Harvard Business Review

October 2000

by Frederick F. Reichheld and W. Earl Sasser, Jr.

The authors explain the high cost of losing customers--including reduced profitability and loss of free advertising through word of mouth. To keep customers loyal, find out why defectors are leaving. Then use the information to improve your business. For examples, when Staples customers stop visiting the store, the cessation of membership card activity alerts the company immediately. Staples then calls defectors to get feedback and selectively discounts or targets its catalogs accordingly. In addition to managing defectors differently, teach employees the lifetime value of a customer and defections-analysis methods. Remind employees of the link between loyal customers and their own welfare. MBNA, for instance, prints "Brought to you by the customer" on every paycheck envelope.