Loyalty programs and profitability – part 4 – Understanding the economic traps and conclusions

As explained in my previous posts, loyalty investment does not always mean success. As an example we can mention some companies across Europe that spend large amounts of money on loyalty programs that do not appear to be very successful. This should be an alert for telecom operators: handle with care your loyalty investment and rely on customer lifetime management practices as much as possible, as these programs mean money, and not succeeding will unveil financial inefficiencies. Ineffective programs often fall into one or more of the following traps:

A) Investing too much in Free riders
As many as half of all members of loyalty programs are free riders, enjoying benefits without spending more for the operators that provides them. Since these free riders get more and give nothing in return, the incremental SAC from program members who do spend more must cover the costs of the program not only for themselves but also for the free riders.

B) Design a reward scheme which maximizes the motivation of the customer to make the next purchase of your product.
Most existing reward schemes achieve this only indirectly because they don’t account for the customer’s current situation. The point here is that whatever type of reward scheme you adopt, it needs to be designed with the profitability of different types of customer in mind.  Ideally, you hope that this will motivate the most profitable type of customer to give you a higher share of their business. But realistically, in a competitive market where copy-cat schemes are inevitable, the aim may be no more than to ensure you maintain market share (with the attendant level of loyalty and divided-loyalty).

C) Blindness over the full cost of the loyalty program.

There are a number of highly visible costs such as those associated with launching the program, database creation and maintenance, the value of rewards claimed, and issuing regular activity statements (anything up to twelve a year to have a meaningful impact). These can be very high as evidenced by an estimation that the costs of loyalty programs are typically between 3% and 6% of an operator’s revenue. Many other loyalty costs are less visible, namely, the opportunity cost of managers’ time spent on the loyalty program rather than on other (marketing) activities, and the effectiveness of the loyalty program compared with an alternative use of the funds. Very few operators fully account for these incremental costs—especially for the marketing support required to sustain awareness of the programs as well as their momentum and impact

There are three main lessons from the research and examples cited in this set of post published regarding loyalty.

First, it seems that in practice, competitive considerations are a major reason for the launch of many customer loyalty schemes. They may seek to preempt a competitor (and possibly secure first-mover advantages), or respond to a competitor’s scheme (as evidenced by most of the operators loyalty clubs).

Second, apart from purely defensive reasons, if a loyalty program does not support the product/service value proposition, then it might be justified if it can entice more distributors to handle the product—a demand pull effect. As noted earlier, for many products and services, there is a positive relationship between distribution coverage and market share.

Third, the behavioral loyalty research reviewed in this paper suggests that brand loyalty is more likely to be the outcome of the type of market in which the provider operates and the type of brand in place, rather than the outcome of an add-on customer loyalty program.  In other words, in the majority of cases, all that a customer loyalty program will do is cost money to provide more benefits to customers—not all of which will be relevant to the brand’s value proposition and/or positioning.  It is unlikely to significantly increase the relative proportion of loyal customers, or profitability.

These lessons suggest that customer loyalty programs which (i) directly enhance the product/service value proposition, or (ii) broaden the availability of the product/service, or (iii) neutralize a competitor’s program, may be worthwhile, although competitors are sure to counter with something of equally perceived value.

Prepare to act against competitor’s offering a price cut, making the value of this immediate reward may be more motivating than the promise of just a handset-renewal reward.  If they counter with a similar loyalty program, then it is likely to be better than yours in the hope of winning back any defecting customers. But this is another topic.


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