Loyalty programs, with their giveaways and perks, can seem like a charming game to consumers. But it's a game that too often businesses are losing, according to a Boston Consulting Group report.
"In general, most consumers are satisfied with the programs. But when you run the numbers, they don't make money for the enterprises. The ROI is quite limited for most programs," Dylan Bolden, a partner with the company based in Dallas, said in an interview.
The return on investment can be quite variable. But usually it's below 10 per cent, and often negative, although some companies can get as high as 25 per cent. To grab those higher returns, you have to understand the profitability of various approaches and consider the scale at which you will operate. "To make money, you must pull the right levers," he said.
The first lever is the choice of program, from three general types:
Earn and burn
This is the classic frequency program, such as when a sandwich shop offers you a free sandwich on your 10th purchase; or customers earn points and redeem them for free products; or members of the program receive price discounts. It's straightforward, and the customer has a fairly good idea of what he or she is gaining.
Valuable repeat customers are eligible for a reward based on some factor, such as total amount of money spent over a certain period with the company. These programs are commonly seen in the travel industry. High-spending customers can get upgrades or quicker service in a special queue. There might be a branded membership for this group, and higher recognition by company staff. The programs can be tiered, with different rewards for different levels. In earn-and-burn programs, everyone gets the same reward: Buy nine sandwiches, and you get one free. In this approach the company segments its customers and delivers a higher percentage of the value they wish to distribute to top spenders, focusing on the ones they most need to retain.
Customer relationship management
This approach uses purchase data captured via membership cards to prepare special offers tailored to the card-holder's interests. These programs often go beyond rewarding loyalty, bleeding into more general marketing. Interestingly, Mr. Bolden notes that many depend on earn-and-burn mechanisms to generate the data for analysis. The targets can vary. Perhaps you want to spur your highest-value customers to spend more. Or perhaps the weekend customer can be lured to a weekday visit. "Without loyalty programs the data you have on consumers wouldn't be rich enough to make such targeted offers," Mr. Bolden said. "Data from the point of sale are not enough. But consumers know when they sign up for these programs, in return they will be giving more information to the company."
Ideally, your company's loyalty program should be a mixture of all three types of programs..
Determining the effectiveness of the programs starts with assessing the loyalty margin, which is a function of how much of a particular product or service a company gives away, how quickly it does so, and what the apparent value is to the consumer.
Airline and hotel reward programs have high loyalty margins because they can give a lot of value to the consumer for little cost. The cost of a room upgrade to a customer booking in late at night at a half-empty hotel is nil, while the value can be rated quite highly. On the other hand, the customer calculates the discount on that 10th sandwich at 10 per cent, with no extra perceived value.
"The perceived value must be greater than the costs," Mr. Bolden said. "If your program is just earn and burn, the loyalty margin is low. If the reward is $10 and the cost is $10, then the program didn't create value. ... Ultimately you want to get high value and spend very little."
The second factor to consider in grappling with a program's ROI is incremental share. "If a program gives away rewards but fails to cause customers to spend more, it becomes no more than a recurring marketing cost – and not a very effective one at that," he explains in BCG Perspectives with colleagues Patrick Hadlock and Keith Melker.
Finally, the program's size will help determine success. When a new program is being set up, the company doesn't know what the optimal loyalty margin will be, or what incremental share it can achieve. So consultants advise that you start small enough to minimize the impact of any design flaws. You also need to have a trial period during which the economics can be ironed out before scaling up.
"Loyalty programs are here to stay. They can create tremendous value for a company. But proceed carefully," Mr. Bolden said. "There is a tremendous upside, but also a tremendous downside."
Harvey Schachter is a Battersea, Ont.-based writer specializing in management issues. He writes Monday Morning Manager and management book reviews for the print edition of Report on Business and an online work-life column Balance. E-mail Harvey Schachter