The Proper Role of Loyalty Programs

Hardly a day goes by when you don’t visit a store, restaurant or supermarket and have an employee ask, “Do you belong to our loyalty program?” Loyalty (or rewards) programs have become ubiquitous — a fact of life in American business. Accordingly, it's helpful to ask what the role of a loyalty program should be in a company’s marketing and customer relationship management efforts.

We can define customer loyalty as a trust-based relationship between a company and the customers it serves. This relationship is developed by consistently executing the company’s value proposition for its customers over time.

Given this definition, the one thing we can say about a company’s rewards-based loyalty program is that it does not create customer loyalty. In fact, it has absolutely nothing to do with loyalty. Rather, loyalty programs are simply a way of “buying” repeat purchases (i.e., “Shop at my store and I will give you a discount for doing so.”). Truly loyal customers come back to you because they want to, not because you pay them to do so.

While, in our opinion, the role of loyalty programs has been substantially overstated, we truly believe that they have an important role to play in a company’s marketing mix. Let me explain why in more detail.

In our research into customer loyalty across a large array of consumer and business-to-business clients, we've found the following:

1. A company’s highly satisfied customers (i.e., a “5” on a five-point overall satisfaction scale) are approximately 40 percent more profitable than that company’s satisfied customers (i.e., a “4” on a five-point satisfaction scale).
2. Companies that correctly market to their highly satisfied customers can increase their value by an additional 30 percent. Each member of this subset of a company’s highly satisfied customers is thus worth over 80 percent more than a satisfied customer (1.3 x 1.2 = 1.82).

In our experience, concerted and refined efforts to target existing highly satisfied customers represent the single best marketing opportunity a company faces. In spite of this, we're amazed by the number of our clients that spend their time either trying to bring back “escaped customers” or calming down complainers when their real (and easiest) opportunity lies with their existing base of highly satisfied customers. And, in fact, efforts to appeal to less-than-satisfied customers often serve no purpose other than to ostracize those customers who like you the best.

So let me briefly describe how you can transform your loyalty program in order to take full advantage of this significant growth opportunity.

Through a well-designed market segmentation study, a company can identify those segments of its customer base that have the greatest percentages of highly satisfied customers. This same study will also identify the key motivations that make these customers visit your stores on such a frequent basis. Through careful data analytics, you can classify the current members of your loyalty program into these various customer segments — with special attention paid to those key segments with the greatest percentages of highly satisfied customers.

This will allow you to use your loyalty program to develop targeted communications and marketing programs designed to appeal to the key motivators that drive visit and purchase behavior among these highly satisfied customers (as identified in your segmentation study). For example, one of our restaurant clients identified a segment of highly satisfied customers who came to its restaurants because they were looking for unique food items they could purchase nowhere else. Every time our client introduced a new product, it would send an email to the customers in its database who belonged to this segment informing them of the new product and offering them a coupon to use on their next visit.

In our experience, such communications and marketing initiatives that focus on the key purchase motivations of a client’s highly satisfied customers will produce a larger increase in profits than efforts targeted at attracting new customers or trying to bring customers back into the fold who have previously purchased from you and have subsequently moved on to other options. Conversely, rewards-based customer loyalty programs that don't take advantage of this opportunity are chasing the least profitable customers rather than grooming the best.

John Larson is the senior partner at John Larson & Company, a pioneer in the field of customer loyalty and the author of "Capturing Loyalty." Prior to starting his own firm, John held positions at McKinsey & Co., Monitor Company, Lieberman Research Worldwide, and J.D. Power and Associates, specializing in the areas of strategic analysis, organizational effectiveness, and customer satisfaction and loyalty.