Sunday, November 9, 2014

The Myths of a Loyalty Program

Yash B. Bhambhwani | IIM Shillong

It was always believed that for a retail outlet the biggest competitive advantage was its location, but with passing time this did not stand true as consumers had a large number of options available. Once location has played its part, retailers end up in a struggle of maintaining low margin and high costs. In such kind of businesses, price wars can’t be avoided. 
In this business differentiating on basis other than price is a challenge as it requires a lot of innovation and as time passes the price war continues to increase. It is therefore not surprising that many retailers have adopted loyalty programs as a convenient mechanism of meaningful differentiation.
Businesses grow by either customer acquisition or by getting more business from their existing customers. Customer acquisition is invariably expensive. For every successful promotional activity (spending money and gaining a new customer) there is a vast amount of wasted promotion. Attendance at a business exposition may involve hundreds of hours of expensive staff time to yield a few dozen good prospects of whom a mere handful can be converted into profitable customers. Firms that search for new customers by unsolicited catalog mailings are often delighted if the response rate is any more than just 1 percent. That is, 99 percent of the costs of printing and mailing are a dead loss. 
It is much cheaper, then, to get more business from existing customers. Firms do this in two ways: Getting customers to buy more when they buy or by getting them to buy more frequently. Getting customers to buy more usually involves some kind of sales promotion such as a bundle with an attractive package price (for example, season subscriptions to theater or concerts) or promotional discounts for quantity purchases. “Buy more” can also involve “upselling” the customer once they have made a decision to buy. Examples of upselling are add-ons such as selling spa services to a hotel guest or getting a firm that has agreed to purchase software to also pay for staff training. The second way to get more business from existing customers is to get them to buy more often. This is where Customer Loyalty Programs are most successful. 

Although various forms of customer loyalty programs have probably been around for millennia, Leadership in the modern form is largely credited to American Airlines AAdvantage program begun in 1981. American’s charismatic CEO, Robert Crandall, moved the airline from thinking about selling tickets to thinking about their relationship with specific customers. 
Crandall noted that the airline business exhibits an extreme form of the “80/20 rule” (that 80 percent of profits come from 20 percent of customers). In the airline business more than half of all passengers may take only one trip a year, whereas the top 5 percent of customers may buy more than 20 round-trip tickets a year.
After segmenting the market for airline tickets into leisure travellers and business fliers, Crandall noted that the frequently-flying business customers are delightfully price-insensitive. While leisure travellers are brand disloyal and always search for the best deal, business fliers are concerned primarily about schedule convenience. The costs of airline tickets are relatively small compared to the full cost of sending an executive on a business trip, especially when the cost of the traveller’s salary are included, and are very small as compared to the benefit hoped to be earned by taking the trip. American airlines knew from marketing research that some of its best customers were disloyal: Since major airlines offered a largely generic product flying identical planes with only superficial differences in service, if an American routing offered a slightly less favourable time or the need to change planes on a cross country flight, good customers would choose a flight from a competing airline. 
The points awarded by the AAdvantage program were meant to tip the balance towards always flying with American. For each mile flown, a customer would accumulate points. When a threshold was reached, the customer could trade those points for a free trip. The motivation to always travel on American Airlines then became this: for a modest amount of schedule inconvenience, a business traveller could earn points from business trips (paid for by his or her company!) And then use those points for a vacation trip. The motivation was compelling. 
All said and done these loyalty programs play a significant role in the business world today. In spite of all its advantages there exist certain myths about loyalty programs. 

The feasibility and profitability of loyalty programs has been debated highly in marketing literature but there still exists an element of uncertainty, ambiguity and doubt if it is sustainable.
A major part of this doubt can be explained through three myths: (1) architecture of shopper reward (size and convexity of rewards), (2) architecture of retailer rewards (horizontal competition) and (3) type of retail sector (frequently versus infrequently purchased goods). 
We discuss each of these myths in turn.
Many grocery stores believe that the size of the reward does not matter when it comes to generating loyalty. Chains like Reliance Fresh, More etc. believe that their 1% to 2% payback are sufficient to build loyalty. This does not stop them from executing their loyalty programmes. This type of a reward is actually a “thank you” to the customer from the store for the privilege of collecting a loyalty card. Can such small rewards lure a customer to favour one retailer over another? Will the customer show his support by spending a major part in the particular store for 1% to 2% payback?

The rewards can be categorized in to two broad categories:
 a.Turbo charged vouchers: These vouchers provide a particular multiple value at different locations like partner hotels and resorts etc. 
b.Tailor made coupons: Based on the data collected about the customer we make tailor made coupons for them
So, from the perspective of the customer the value of the above loyalty rewards is more than the 1% to 2% payback. This makes them reconsider their decision of switching from one retailer to another. Therefore the fact that the total value of the reward is not significant is a myth. 

Convexity of rewards refers to the fact that all loyal customers cannot be treated similarly and so we need a stratified loyalty program for it to thrive. One approach to achieve this convexity in rewards is to create loyalty systems that are tiered. It is often debated that tiered rewards, such as those offered by hotels, airlines, casinos are necessary for loyalty programs to thrive. The idea behind this is that the customer should realize what he is losing if he does not accumulate points at a particular chain. Furthermore, tiered systems can stimulate customers to in- MARKETING crease their purchases to reach the next stage-and therefore more and better rewards-in the hierarchy of loyalty classes. 
The belief that loyalty programs lacking explicit tiered reward structures are ineffective is a myth. It is considered to be a myth because many retailers do not provide tiered loyalty programs but are still successful as they provide tailored offers to loyal customers. This is of more value to them than being a gold or platinum customer. 

“I am very loyal to my store; I have loyalty cards from various retailers!”
 In retail of grocery the shoppers hold loyalty cards of multiple retail changes. This poses a challenge to the success of the loyalty program as the share of consumer’s wallet is distributed. Therefore there exists a common belief that the loyalty programme fails in this case.
However, it is a myth to believe that loyalty programs are ineffective when consumers hold loyalty cards from multiple stores. Though the customer hold loyalty cards from multiple stores he spends about 2/3rd of his budget to purchase items from his favourite store. For the shopper, the dominant store will have an informational advantage over less patronized stores. 
There also exists an unmentioned cooperation between these retail chains. As observed above that there exists the concept of a favourite store which has the advantage of information availability over the other retailer. Therefore the competitor does not try to attack the customer base of the other retailer as it may attract retaliation from the retailer who is being attacked. 
The condition for a favourable equilibrium for all loyalty driven retailers is that all players are reasonably satisfied with their current market share. If some retailers want to gain market share at the cost of reducing profitability, this will inflict a price war in the market. This will hurt the profitability, but with a result where the least priced retailer will earn the maximum market share which will benefit the customer but will hurt the market on the whole. 

Many industries including retail believe that if the purchase of the product or service is not frequent by the consumer the loyalty program may not be effective. Considering the example of an airline company, airline companies provide frequent flier miles which can be accumulated and be redeemed for a free travel once a certain amount of flier miles are accumulated. In this case if the consumer is a business traveller who frequently uses the airline, this loyalty program will be successful in gaining this customers loyalty as he believes that he can accumulate sufficient miles to redeem them. In case of irregular flier who probably uses the airline once in a year the target is not achievable and the loyalty program will not affect his decision while making a second purchase. 
This myth has been found to be true but various businesses have found their way around it. In today’s time these retailers associate with other services where these points can be redeemed. This makes these points more useful for the customer. The other alternative is to provide levels in the loyalty program and as the consumer proceeds to different levels it becomes easier for him to accumulate these points. These solutions are being tested in various chains and the results are yet to be analysed. 
One new recommendation that is being appreciated by the industry is partnerships. In this process the business finds a sponsor to sponsor the loyalty program from which he can accumulate data of prospect customers for his own business and profit. This has been tested and in the time of big data is being seen as a lucrative source of data by companies. 

Many retailers are hesitant to adopt loyalty programs as they doubt that it will be sustainable. Retailers also doubt the profitability and returns of these loyalty schemes as they already run on low margins. 
But as we have proved, these myths not really true, and a variety of these programs can be refined by retailers to achieve differentiation and increased profits. When location, location, location does not suffice to attract customers, a loyalty program that apprecia te s their loyalty will be.

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