The Value of Loyalty Programs

The customer’s use of a loyalty card gives us the data required to identify our biggest spenders. Yet some years ago the president of one of our client companies refused to use customer data to segment most valuable customers, telling me in no uncertain terms, “I want our people to treat all of our customers equally.” Of course, all customers should be treated with respect, but treating them all equally can lead to missed profit opportunities.

Profit Opportunity

How important is this? There is more to it than Pareto’s Law (20 percent of the buyers account for 80 percent of sales volume). Garth Hallberg in his excellent book, All Consumers Are Not Created Equal, points out that for twelve of the twenty-seven packaged goods brands analyzed by MCRA Information Services, leaders in consumer behavior research, high-profit category buyers who bought the brand numbered less than 10 percent of households. In soft goods, heavy category buyers of sixteen of the eighteen apparel and footwear brands totaled less than 5 percent of households; the average below 2 percent. Five percent of households buy 85 percent of Levi’s blue jeans and three percent buy 82 percent of L’eggs pantyhose.It’s not just U.S. packaged goods brands. In our global work with companies of every size in most major industries we see the same pattern. The biggest spenders always represent a small share of the customer universe—so small in fact that company management is always shocked by the fact. One small retailer with a database of 70,000 customers found that just 456 customers—less than one percent—accounted for 10 percent of total sales. How much is too much to invest to makes these customers’ lives easier?

Biggest spenders and most frequent shoppers are generally the most profitable. In Seklemian/Newell’s work with banks, supermarkets, and other businesses, we have consistently found that top spenders often generate more profit than the firm makes in total. Low spenders and occasional shoppers are often a drain on profits.

Garth Hallberg gives us another example of this with a packaged goods firm he disguises with the name YopleX. YopleX’s annual net profit from its high and medium profit customers totaled $13.1 million; its low- and no-profit customers produced a net loss of $3.9 million, reducing the firm’s total net profit to only $9.2 million.

Value to the Customer

In many businesses the real value is in the customer information that loyalty card customers provide voluntarily. Voluntarily is the critical word. When customers volunteer personal information in return for expected benefits, the question of privacy goes away.

Some years ago Richard Barlow, founder and CEO of the loyalty marketing advertising services company, Frequency Marketing, Inc. (FMI), and publisher of Colloquy.com, established this definition of relationship to be used by the teams at FMI in their work with clients: “The voluntary exchange of information and value between the buyer and the seller, with the mutual expectation of gain.”

He says that as consumer privacy concerns enlarge, and formal and informal mechanisms are put in place to secure privacy, relationships in which customers volunteer to be known will be essential, since without such volunteered information, customers will become increasingly invisible and difficult to reach. He says,

Loyalty programs demonstrate daily that customers gladly trade information for value. Aside from actively assuring that all their purchase activity is tracked, loyalty program members respond to surveys enthusiastically. Response rates are routinely above 20 percent, and sometimes exceed 50 percent. That’s because members have learned over the years that program sponsors turn information into value for members—more points or miles, which convert into more free rewards and special treatment.

Value to the Retailer

Point-based loyalty programs offer other advantages for the retailer. Brian Woolf lists more than a dozen of these advantages in Customer Specific Marketing:

• Creating simplicity: Points are a very simple way to skew rewards in favor of best customers.

• Targeting groups: Points permit easy targeting of groups for short-term promotions.

• Targeting departments or categories: Extra point offers can spur sales of specific items or from selected departments.

• Strengthening price image: Bonus points can replace price reductions as incentives.

• Avoiding price wars: Points can become the tie-breaker when you do no more than meet a competitor’s price.

• Encouraging multiple purchases: Points can be used to encourage multiple purchases of items: extra points for three or more, and so forth.

• Building incremental sales: Points can be used to build incremental sales by offering bonus points for cumulative sales in a given time period.

• Enhancing school-funds programs: A points reward scheme is more flexible than the typical tapes-for-schools program, which assures a percentage of each customer’s total spending for the schools.

• Offering special rewards: Points can be used as rewards for customers who attend special store functions.

• Promoting quality control: Some stores award points to customers who discover quality control problems. Woolf gives the example of an Irish supermarket that gives customers 100 program points if they encounter one of fifteen quality problems, such as finding an outdated item on the shelves or discovering a squeaky wheel on their shopping cart.

• Generating employee rewards: Besides being very well received, these point awards benefit the company because the employees’ experience makes them very knowledgeable when answering customers’ questions about the program.

• Building partnerships: Building partnerships with other companies allows cardholders to accumulate points at a faster rate.

• Preventing defection: As customers build up points balances, approaching even more attractive rewards, they are less likely to abandon the program.

• Differentiating: Given price parity, points can be a very powerful differentiator for a retailer.

• Encouraging card carrying: An incentive for the customer to show the card with every purchase.

There is no question that point-based loyalty programs do have value. The question is have they become so commoditized that they have lost some of their earlier punch? Barlow, a recognized expert on loyalty programs, has developed data that show more than 60 million Americans belong to frequent flyer programs. In one major market, three out of four households belong to at least one grocery frequent-shopper program, with half of those households belonging to two.

McKinsey research found that about half of the ten largest U.S. retailers in each of seven sectors have loyalty card programs, with a similar rate in the U.K. The research also found that 53 percent of U.S. grocery customers and 21 percent of the customers of casual apparel retailers are enrolled in card programs.

Credit cards with reward components are the fastest growing segment of the credit card business, and reward programs increasingly are attached to debit cards. Barlow points out, “Consumers can earn miles while they eat, with their mortgage payment and on their phone bill.”

With all these opportunities to earn benefits, card reward programs create greater value for customers, but do they really build loyalty?