Trends: Loyalty Programs

By M H Ahssan

Nearly 75 percent of shoppers in the U.S. now belong to at least one loyalty program—but how well do they work? The short answer: not as well as they might. We look at why, and analyze how advances in customer data collection are helping three compan
There are frequent-buyer programs, frequent-flier programs, frequent-player cards and frequent-dining coupons. There are points-at-the-pump schemes, turkey giveaways at Christmas (along with $100 copper roasters in which to cook them) and, as of November 2003, donations to charities for people who use their Starbucks loyalty card to buy coffee.

There are plastic cards, smart cards, thermal cards and magnetic strips. Virgin Mobile Australia, a wireless arm of U.K.-based Virgin Group, is using 802.11: Flash your mobile device at a reader as you whiz through checkout at a Virgin music store, and you'll get a couple of dollars knocked off your bill.

Call it the loyalty craze. According to Jupiter Research, more than 75 percent of consumers now have at least one loyalty card, and the number of people with two or more is estimated to be one-third of the shopping population. Cap Gemini Ernst & Young CTO John Parkinson says his family has 37 loyalty cards, and surveys by information technology analysts Gartner Inc., Forrester Research Inc. and META Group Inc. suggest the data-for-dollars explosion is showing no signs of letting up anytime soon. According to Gartner analyst Adam Sarner, U.S. companies spent more than $1.2 billion on customer loyalty programs in 2003, and he expects that to increase next year.

What's up? While loyalty cards and prizes have always been, first and foremost, a cheap way for businesses large and small to start tracking their customers' shopping habits, more customers than ever now consider themselves entitled to special treatment, a marketplace psychology spawned in the 1970s by the airline industry's invention of frequent-flier miles, one of the first modern-day loyalty programs. Originally devised to generate better data on the most popular routes, the airlines broke what was a one-price-fits-all standard and introduced a some-people-are-more-special-than-others psyche that has changed the American, and global, marketplace forever. Says Brian Woolf, president of the Retail Strategy Center in Greenville, S.C., and author of Loyalty Marketing: The Second Act, "Loyalty programs are now a price of doing business."

But do they really work?
The short answer: not as well as they might. To be sure, it's all in the execution. Ohio grocer Dorothy Lane Market Inc., Harrah's Entertainment Inc., eBay Inc. and a handful of others say their loyalty programs are key to new revenue growth. Thanks chiefly to the kind of data they've reaped, these companies boast retention rates and profit-per-customer numbers among the highest in their respective industries—despite tough economic times and cutthroat markets. But the majority of companies are still struggling to get it right.

Satisfaction versus Loyalty
Consider the survey data. Shoppers polled over the past 12 months by Walker Information Inc., the Indianapolis-based customer research firm, indicate there's still a yawning gap between the percentage of people who say they're satisfied with a business and those who consider themselves "loyal" to that business—intent on maintaining the relationship and continuing it into the future. "Many companies have figured out how to deliver satisfaction, but they've not yet figured out how to earn loyalty anywhere near those levels," says Jeff Marr, group vice president for Walker.

This so-called loyalty gap can be particularly pronounced in industries where competition is harshest and growing. For example, while 75 percent of customers in the financial services industry said they're satisfied with the business they most recently patronized, only 34 percent of those same customers said they're "truly loyal." In other words, they want to maintain their relationship with the company. Telecom carriers fared even worse: While 75 percent of those surveyed said they were satisfied, only 28 percent said they don't want to switch carriers. Retailing is almost as dicey. "Some 43 percent of Americans say they feel 'trapped'—likely to continue doing business with the top retailers, but less than pleased with the relationship they now have with them," Marr says. That means retailers can count on less than half of their customers being loyal.

Where do most companies go wrong?
Frederick F. Reichheld, a vice president at consultants Bain & Co. in Boston and author of The Loyalty Effect, a 1996 analysis of loyalty programs, says most company loyalty programs don't slice data finely enough to distinguish between customers who would recommend a particular business to friends and those who would not. Knowing this, he says, could mean millions of additional dollars in revenue for companies. "The tendency of loyal customers to bring in new customers—at no charge to the company—is particularly beneficial," Reichheld says.

Many companies also tend not to do enough with their loyalty program data to make Joe Sixpack feel special, too, says Woolf of the Retail Strategy Center. According to Carlson Marketing Group, a Minneapolis-based customer research firm, rewards programs cost companies, on average, between 2 percent and 10 percent of a customer's total spending at a given store. "Once they've identified the top 20 or 30 percent of their customers, many companies tend not to market to the bottom tier because it's not economical," Woolf says—and end up leaving a majority of their customers frustrated or unable to accrue enough points to make participation in these programs seem like a real advantage.

But don't underestimate the value of trying. Woolf says food retailers, for example, lose up to 40 percent of their new customers within three months. One of the big benefits of a successful loyalty card program, he says, is that stores can quantify new-customer losses and introduce programs designed to retain or woo back the most profitable. "Without a loyalty card, one has no clue about the size of the inflow and outflow of new customers," Woolf says. What does this mean for the bottom line? According to Marr, learning to play the loyalty card game better can help companies reap big cash rewards. Walker's surveys show that "truly loyal" consumers are 15 times more likely than high-risk customers to increase spending with a particular store.

Reichheld takes it one step further. He says profits rise as a customer's relationship with a company lengthens. "Customer defections have a surprisingly powerful impact on the bottom line," he says. "When defections are cut in half, the average growth rate more than doubles. A 5 percent change in the rate of customer retention swings profit increases from 25 percent all the way to 100 percent."

The clear message, says Marr: "It's not enough to have CRM. You need the hearts and minds of the customers to close the loyalty gap." And CIOs, he says, are in the best position to help companies figure out new ways to do that. "IT needs to take the lead in loyalty programs because it's just about the only department that can coordinate between business processes, external data-analytics vendors and the executives who can translate output into action," says Bob Chatham, an analyst at Forrester. Adds Arthur Middleton Hughes, director of database marketing strategy for DoubleClick Data Management Solutions: "What doesn't work anymore is treating all customers alike."

Here's a look at four companies that are translating their loyalty data into dollars—and creating new business strategies.