Designing Effective Loyalty Programs

• Satisfaction-loyalty-profit chain

• Loyalty programs

• Key objectives of Loyalty Programs

• Examples of Loyalty Programs

• Design Characteristics of Loyalty Programs

• Reward Structure

Topics

Product Performance

Service Performance

EmployeePerformance

Customer

Satisfaction

Retention /

Loyalty

Revenue /

Profit

Satisfaction-Loyalty-Profit Chain

Source: Strengthening the satisfaction-profit chain”, Eugene W Anderson, Vikas Mittal. Journal of Service Research, Nov 2000. Vol 3, Iss.2, p 107

• 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

Source: “Strengthening the satisfaction-profit chain”, Eugene W Anderson, Vikas Mittal. Journal of Service Research, Nov 2000. Vol 3, Iss.2, p 114

The link between Satisfaction and Retention

• Link between satisfaction and retention is asymmetric:

– Dissatisfaction has a greater impact on retention than satisfaction

• Even if the level of satisfaction is high, retention is not guaranteed • If customers are dissatisfied, other products become more enticing • The link is nonlinear in that the impact of satisfaction on retention is

greater at the extremes

• The flat part of the curve in the middle has also been called the “zone of indifference”

• Factors like the aggressiveness of competition, degree of switching cost, and the level of perceived risk influence the shape of the curve and the position of the elbows

The link between Satisfaction and Retention (contd.)

The link between Satisfaction and Retention

Source: “Why satisfied customers defect”, Jones, Thomas O, Sasser, W Earl Jr. Harvard Business Review. Boston: Nov/Dec 1995. Vol. 73, Iss. 6

The figure shows the variability in the relationship between satisfaction and retention across industries. Loyalty was measured as the customer’s stated intent to repurchase

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

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

• Loyalty can also be induced through marketing plans and programs from the firm

• 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

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

Building True Loyalty

• Encompasses both attitudinal and behavioral components of loyalty

• Greater commitment to the product or organization through the building of true

loyalty

• Function of true value provided to the customers

• Involves degree of involvement in the product category, visibility of the product

when using it, or value expressive nature of the product

• Goal of many customer clubs

• Difficult in the case of a low involvement category– e.g.: grocery shopping

CRM at Work: Supermarkets - Difficulty in Building True Loyalty

• Despite spending hundreds of millions of pounds on price-cutting campaigns and loyalty card schemes, supermarkets have only persuaded a small minority of shoppers to stay loyal

• According to a report from Mintel Research:– Only 15% of all grocery shoppers are completely loyal to the store where they

do their main grocery shopping

– 29% use one other store

– 22% use two others

– Men are more likely than women to be loyal to a single store

– 46% of men shop in just one or two main stores

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

Value Alignment

• Goal of aligning the cost to serve a particular

customer with the value he/she brings to the firm

• Allows firms to serve their most valuable customers in the best manner

• The goal of value alignment is particularly critical when there

is great heterogeneity in the customer’s value and in the cost

to serve the customer

Example: the airline business, the hospitality industry and the

financial services industry

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

• Sponsorship (existence of partner network, network externalities)

– Single vs. multiform LP

– Within sector vs. across sector LP

– Ownership (focal firm vs. other firm)

Reward Structure

• Hard vs. soft rewards

– Financial or tangible rewards (hard rewards) and those based on psychological or

emotional benefits (soft rewards)

– Hard rewards: price reductions, promotions, free products and preferred treatment

– Soft rewards: psychological benefit 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 – Allows LP member to redeem points for products that are completely unrelated

to the focal firm’s offering

• Example: British Petroleum’s LP users may redeem

points from their gasoline-related purchases for

merchandise such as first-aid kits, photographic films,

coffee mugs, and Barbie dolls

Reward Structure (contd.)

• Aspirational value of reward – Consumers prefer hedonic goods as opposed to utilitarian goods when receiving

a gift or a LP reward

• Mercedes Benz’s LP makes it possible to transform

points against a flight in a MIG 29 combat aircraft

• 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

• Tier-ing of rewards– Rewards based on asset accumulation response function - how

assets or rewards are accumulated as a function of spending behavior

Change in Cumulative Spending with Two Different Response Functions

Cumulative $ spendings

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Cumulative $ spendings

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In case 1, the buyer receives the same amount of rewards per $ spent, regardless of the spending level

In case 2, the buyer receives a larger amount of rewards per $ spent, with increasing spending level. Here, the program is relatively more attractive for buyers who are high spenders. Many airline programs follow this pattern

Reward Structure (contd.)• Timing of Rewards

– Determined by minimum redemption rules, type of reward given out, and reward rate

– Longer the timing to build up to a certain reward level, the greater the “breakage” (the amount of rewards that are never redeemed)

– “Lock-in” effect - firm creates redemption rules that favor long accumulation periods, thereby impacting customer retention

– Customers build up assets that function as switching cost

LPs Based on Sponsorship • Single vs. multi-firm LP

– Single: LPs that reflect only the transactions with its own customers – Multi-firm: LP member may also accumulate assets at organizations associated

with the focal firm’s LP

• Within sector/across sector – Supply side dimension of multi-firm LP design-degree of cross sector partners

• Example for within sector: The STAR Alliance of SAS, Lufthansa, United Airlines, Varig

• Example for across sector: The LP of AOL and American Airlines, with its 2000 or so partners, spans many different industries

• Ownership– For multiform LPs, the ownership dimension characterizes who owns the LP

within the network; whether it is the focal firm, a partner firm or a firm whose sole purpose is to manage a LP

Summary

• Satisfaction-profit-chain (SPC) needs to be implemented at a disaggregate level or individual level than aggregate, firm-level

• Link between satisfaction and retention is asymmetric, i.e., dissatisfaction

has a greater impact on retention than satisfaction, and nonlinear

• Reinartz and Kumar demonstrated that loyalty is not the only path to profitability

• The success or failure of a loyalty program (LP), whether contractual or motivated through incentives, is determined by profitability from the customer

• 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