Leveraging the Loyalty Margin: Rewards Programs That Work

Leveraging the Loyalty Margin: Rewards Programs That Work

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Leveraging the Loyalty Margin: Rewards Programs That Work

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    Three Loyalty Levers

    Companies offer many different types of rewards in their loyalty programs. Most programs generally pull one or more of three kinds of loyalty levers.

    • Earn-and-Burn Levers. Customers reap the benefits of their purchasing activity (earn) with rewards at preset thresholds (burn). Earn-and-burn programs include classic frequency programs (a customer buys ten sandwiches and gets one free), points programs (customers earn points and redeem them for free products), and discount programs (members receive price discounts).
    • Recognition Levers. Repeat customers are eligible for differentiated services earned on the basis of, for example, total account balance or total amount spent. These programs are particularly prevalent in the travel industry, which uses them to attract and reward high-value customers. Some of the more common forms of recognition include free perks, such as upgrades or the ability to jump to the front of the line at restaurants, branded membership cards and bag tags, expressions of personal recognition during the service experience (“Thank you, Mr. Smith, for your loyalty; you are one of our best customers.”), and progressively elite rewards tiers. Some rewards programs combine earn-and-burn programs with recognition programs.
    • Customer Relationship Management Levers. CRM levers use purchase data that is captured and mined to develop tailored communications and targeted offers. These programs often do more than simply reward loyalty, and many depend on earn-and-burn mechanisms to generate the data for CRM analysis. Examples include members-only promotions (such as special quarterly points programs), targeted promotions and circulars, targeted communications (such as e-mail that touts specific hotels on the basis of customers’ previous travel records), and tailored website content developed on the basis of earlier visits and searches. Retailers, which are often limited in their ability to offer rewards because of the low-margin nature of the business, have been shifting to more CRM- and recognition-based plans as these programs become more sophisticated. CRM data is also valuable far beyond shaping the optimal loyalty design. The data can inform broader business decisions, including new-product development, merchandising, pricing, and store design.

    Many programs employ, or rely too heavily on, only one of the three main loyalty levers (most commonly earn-and-burn), inhibiting effectiveness. Each lever has its shortcomings. The high cost of earn-and-burn program rewards undermines the loyalty margin. Recognition-based programs limit the number of participants. CRM-based programs can undercut both incremental share and program size. The best programs use a combination of all three approaches and invest in the incentives that increase incremental share while maximizing the loyalty margin. This dynamic depends on the market and the customer needs of the brand. The companies with the most successful programs continually adjust the levers to meet evolving circumstances.

    As in other aspects of their business, companies do have to spend money to make money. The rewards-program break-even point is not easily reached, but in many cases, the returns rise rapidly after that. For example, our research shows that a loyalty program that costs 3 percent of revenues breaks even at a 10 percent incremental share and generates 100 percent returns at a 20 percent incremental share. Consider a company with a 35 percent gross-profit margin. A customer who spends $100 a year before becoming a loyalty program member generates $35 in profit. Once part of the program, a member increases his or her spending by 10 percent to total $110. That increase contributes an additional $3.50 of profit before the cost of the program. With a program cost of 3 percent, expenses eat up most of the incremental profit (in this case, $3.30 of the $3.50). So the company essentially breaks even on the program, and the customer’s net-profit contribution is still $35. If, however, the new member spends $120 (a 20 percent incremental share), the additional contribution is $7 of profit, and the additional cost is $3.60. The company makes $3.40 on a $3.60 investment, or almost 100 percent.