Loyalty Programs

One of the most wonderful ways of managing customers is to set up a loyalty program. The basic idea is that customers earn some sort of points or miles based on their purchases, and these points or miles earn them rewards. The best loyalty programs also include status levels. Customers work hard to achieve various status levels.

Those who have read my previous books know how hard I worked to become Gold on American Airlines and how happy I was when I achieved this level. It meant that I got to upgrade to first or business class whenever I flew. I got to go on the planes first, with the little children and the old people. I earned bonus miles. I had a special 800 number just for us Gold folks, and I had Gold printed on all my boarding passes so that flight attendants and others would treat me with the appropriate respect. Readers will be happy to learn that because of all these books, I continue to fly all over the world. I have now become Platinum for Life on American. For some reason US Airways, which had joint arrangements with American for a couple of years, gave me Silver Preferred.

Now what is the effect on me of these loyalty programs? Well, they have me hooked. I never fly United or Delta or any other airline if I can help it. Why would I want to sit jammed into the back of the plane? So the effect of a successful loyalty program is that you get as close to 100 percent of your customers’ patronage as the customer can get. Now that’s customer management.

So how do loyalty programs apply to you, since you are not an airline? This is something that’s worth thinking about. Hotels and rental cars get into the act by awarding airline miles. The effect is not as powerful as it is for airlines, but the loyalty program really helps. Lately I have always sought out Hilton hotels because they let me double-dip. I get both air miles and Hilton points.

But most of the readers of this book are not in the travel business and want to know whether loyalty programs will work for them. I can report that loyalty programs seem to work in a number of areas, including

• Retail stores, such as shoe stores, dress stores, and department stores.

• Supermarkets.

• Car washes, auto lubes, and dry cleaners.

• Hallmark Gold Crown stores and similar establishments.

• Banks— by rewarding customers with high or increased balances and holders of multiple accounts.

• Business-to-business firms.

• Restaurants.

• Telephone companies, cell phone providers, and long-distance carriers.

• Credit card providers. I have three credit cards from Citibank that award American Airlines miles. I use them instead of cash or checks whenever I can.

What do you need in order to get started?

• A valid idea for some easy way to award points when customers spend money with you. This may take some doing in the retail area. At present, most people’s wallets are crammed with various plastic cards. Few people will want to add more. How, then, can you award points? My suggestion is the iDine method discussed in Chapter 9: by getting people to register their credit cards with you. Then you can award them points whenever they use these cards with you.

• Some practical plan for providing benefits. There are really two types of benefits:

  • Immediate rewards, sometimes including preferred treatment

  • Long-term rewards (like air miles), where the customer is saving toward an achievable long-term goal

• A lifetime value analysis that permits you to determine in advance whether the plan will make you more profitable or make you go broke. Some stores, like supermarkets, operate on very thin margins. They can’t afford to give away anything substantial. Yet they have made loyalty programs work very well for them, as we will see.

• Some sophisticated software that maintains the points and redemptions, handles monthly reports to the customers, and reports to you. In most cases, companies have outsourced their loyalty programs. You really should work with a firm that has been through this process before and knows what can go wrong.

• A Web benefits microsite where customers can come to see what they have earned and redeem points for rewards. Try, if possible, to use this Web site for your loyalty program instead of live operators. The customer service costs can eat up the profits from the program if you are not careful.

• Reports to the members that are made available on the Web, or sent by email if your customers prefer it. If you send monthly statements, your report can be printed on the statement. Airlines send statements through the mail and have found them to be quite costly. They are all trying to shift to Web-based reporting.

• A clear expiration date that is announced when your program begins, so that if it is not working out, you can gracefully exit. You can always extend the deadline, but you can get in real trouble if you try to cancel a program while many customers are holding onto hard-earned points.

• A promotion plan that aims at a very high utilization rate. The place to start is with your employees. Enroll them in the plan from the start—with special benefits. You want all your employees to look the customer in the eye and say, “You really should be in this program. It is great. I am in it myself.” Promote the plan in every possible way. The purpose of the plan is to modify customer behavior. You can do that only if customers are enrolled.

• Status levels, if appropriate, with appropriate status rewards. The reason for status levels is to get customers to work hard to achieve them. The Platinum program for American was 50,000 miles in a calendar year. I used to go crazy trying to meet this goal. I would take two legs on an American flight when a direct flight was available on other airlines just so that I did not end the year with 46,000 miles.

Let’s look at some examples of nonairline loyalty programs.

Supermarkets

Most supermarkets today give their customers plastic frequent shopper cards. These are scanned at the checkout counter and permit the supermarket to build a valid database, giving it information on when and where you shop and how much you spend in each department. How do the supermarkets reward loyalty? There are several ways:

• Few of them provide miles or points. The margins in supermarkets are too thin to allow them to give anything away.

• Many of them use straddle pricing. They price many items in the store a small percentage higher than the price charged at other stores, but they let their members have the items at a small percentage below the market price if a loyalty card is used. These items, and there can be hundreds of them in a store, are usually marked with their occasional shopper price and their member price. Some of these member-priced items are things that food manufacturers are trying to promote; others are just items that the store management has decided need a lift. The effect of straddle pricing is to reward loyal customers while making occasional customers who are not members pay for the rewards. It is a wonderful system. A nonmember won’t care that much that his milk costs $1.05 while members pay $0.95. If he does care, he can always sign up for a card and get the price break then and there. Members, of course, see their membership benefits at the bottom of the cash register receipts that are printed out for them: “Today you saved $4.24 by using your VIC card.” The beauty of this system is that the store did not have to provide this $4.24. It was provided by occasional shoppers.

• Stores use their loyalty programs to modify customers’ behavior in other ways. Members get free ice cream on their birthdays. If they spend $50 a week in the 6 weeks before Thanksgiving, they get a free turkey. Members who come in on Tuesday night get an additional saving, since Tuesday is a slow night.

• Members who shop only in the deli and not in the produce department will get a special certificate giving them $1 to spend in the produce department. This will get luncheon shoppers to buy stuff to take home. This $1 is awarded only to the deli-only shoppers. Other certificates will get produce shoppers to use the deli.

• Lapsed members who spent a lot but who have stopped buying for 6 weeks will get a special offer to encourage them to come back to the store.

Specialty Stores

Shoe stores, dress stores, department stores, bookstores, and other types of stores have used loyalty programs with some success. Here, however, the process is more complicated and often less rewarding than it is for supermarkets or travel-related businesses. Let’s take the DSW Shoe Warehouse. I bought four pairs of shoes from its store in Fort Lauderdale. The store gave me a DSW paper card that I could use to get further benefits. I have never used it since—after all, I am not the shopper in our house. Helena is. But what has happened is that I now think of DSW when I think about shoes. It is because of the card, I think. I am sure that this card does affect customer behavior in a positive way. The rewards to the retailer are:

• Some people will return and use the cards to buy more products.

• Some will remember the store because of the card, and may buy more products.

• The store gains a mailing list, and hopefully an email list, that has real value.

• As we know from this book, the store can calculate the value of each customer who gets a card and determine whether this covers the cost of issuing the cards.

Surveys by the Carlson Marketing Group have shown consistently that while only 40 percent of consumers participate in loyalty programs, those who do participate have higher-than-average incomes, and, once they are involved, their behavior is affected by the cards.

Let’s see what a loyalty program could do for a retail store chain. Table 10-7 gives the picture of customers before the program is introduced. It costs $32 to acquire a new customer who makes an average of 1.4 visits per year and spends $50 per visit. The modest lifetime value of $3.00 in the first year rises to $29.42 in the third year.

Table 10-7 : LTV before Loyalty Program

	Year 1	Year 2	Year 3
Retention rate	40%	45%	50%
Customers	200,000	80,000	36,000
Visits per year	1.4	1.6	1.8
Spending per visit	$50	$60	$70
Revenue	$14,000,000	$7,680,000	$4,536,000
Cost percentage	50%	49%	48%
Costs	$ 7,000,000	$3,763,200	$2,177,280
Acquisition cost ($32)	$ 6,400,000
Total costs	$13,400,000	$3,763,200	$2,177,280
Profit	$600,000	$3,916,800	$2,358,720
Discount rate	1	1.12	1.32
NPV of profit	$600,000	$3,497,143	$1,786,909
Cumulative NPV of profit	$600,000	$4,097,143	$5,884,052
Lifetime value	$3.00	$20.49	$29.42

Let’s now plan a loyalty program. We are giving on-the-spot benefits to members in order to modify their behavior. We are seeking to

• Increase the number of visits per year

• Increase the spending per visit

• Increase the overall retention rate

To get these benefits, we are prepared to spend $5 per customer in the first year, with the amount increasing to $10 per customer for loyalists who have been with us into the third year. Table 10-8 shows what could happen. The program has cost us in the first year, but the third-year profits are substantial. Third-year lifetime value has risen to $41.78. The total profits from the program are given in Table 10-9.

Table 10-8 : LTV with Loyalty Program

	Year 1	Year 2	Year 3
Retention rate	50%	60%	65%
Customers	200,000	100,000	60,000
Visits per year	1.6	2	2.4
Spending per visit	$55	$70	$80
Revenue	$17,600,000	$114,000,000	$11,520,000
Cost percentage	50%	49%	48%
Costs	$ 8,800,000	$6,860,000	$5,529,600
Acquisition cost ($32)	$ 6,400,000
Database costs	$ 500,000	$ 250,000	$ 150,000
Loyalty program	$5.00	$8.00	$10.00
Loyalty program costs	$ 1,600,000	$1,600,000	$1,440,000
Total costs	$17,300,000	$8,710,000	$7,119,600
Profit	$300,000	$5,290,000	$4,400,400
Discount rate	1	1.12	1.32
NPV of profit	$300,000	$4,723,214
Cumulative NPV of profit	$300,000	$5,023,214
Lifetime value	$1.50	$ 25.12

Table 10-9 : Gain in LTV from Loyalty Program

	Year 1	Year 2	Year 3
Old LTV	$3.00	$20.49	$29.42
New LTV	$1.50	$25.12	$41.78
Change	– $1.50	$4.63	$12.36
With 200,000 members	– $300,000	$926,071	$2,472,799

If you look closely at these numbers, you will see that a loyalty program is not a sure thing. If it works, we will get $2.4 million pure profit out of it. But for it to work, the number of visits per year has to go up, the spending per visit has to go up, and the retention rate has to go up. Will your loyalty program have these results? You had better test the program on a small scale at one store to see what will happen before you make a big mistake.

A loyalty program is not a lead-pipe cinch. For more on this subject, read Brian Woolf’s excellent book Customer Specific Marketing. A key point that he makes is that without adequate promotion to the customers and adequate benefits, the program will fail. This type of program is really directed at the frequent shopper who is not as interested in long-term benefits, such as a trip to Hawaii, as in immediate rewards.