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Loyalty programmes Strategy
Updated August 1999

Introduction

In the Global Retail environment, customer 'lock-in' through loyalty schemes is becoming more prevalent as intense competitive pressures force marketers to seek ways to differentiate their core offer.

This trend towards loyalty schemes over the last ten years has been underpinned by the development of four technology initiatives that have transformed the customer service capabilities of retailers.

• Telemarketing has evolved from the combination of computers, software, switches and networks to allow companies to establish call centres capable of handling very large numbers of calls to and from customers.
• Plastic cards (bar coded, magnetic and smart) have allowed retailers the ability to accept pre-validated customers in a broad variety of retail transaction environments. Consumers have been allowed to interface with retailers via networks and will eventually be able to conduct purchase transactions via Internet based and interactive media.
• Customer Databases have allowed retailers to collate, store, perform analysis on large volumes of customer transaction and selected data fields. The end game from this expensive investment has been the promise that it will permit retailers to understand and recognise individual customers.
• Network technology to allow fast access and movement of large amounts of data has been a cornerstone of developing the three initiatives outlined above.

The New Consumer

Marketing in the new Millennium is forecast by many respected 'futurologists' to be characterised by:

• Emergence of 'super portals' as the means of access to internet based consumer marketing
• Accelerated disintermediation of wholesalers and retailers through the process of electronic commerce.
• A trend to merging of retailing and entertainment: bookshops, food shops, clothes shops etc will increasingly offer customers coffee bars, entertainment and 'theatre' to encourage customer retention.
• Extensive use of data base information will be common amongst most retailers. Expect some consumer backlash to 'Big Brother' style monitoring of their behaviour.
• Retailers will increasingly open channels for customer communication inwards. This will allow customers to dictate the marketing agenda and specify their requirements in a form of 'mass customisation' retailing.
• Brand stretch, cross sell and up sell will all become much more significant as improved techniques of customer retention will make it increasingly more difficult for new customers to be acquired by competitors.
• Improved understanding of individual customer profitability will result in more polarised marketing along the 80/20 rule. The best customers will be marketed and serviced in ever more detail whilst the low value customer segments will only obtain basic level retail service.
• Customer lifetime value will be the norm for most forms of retail thinking and a long-term view of investment/payback per customer will be the normal cost/benefit calculation.
• Advertising and mass market approaches to communication will become increasingly redundant in the era of interactive multi-channel television. Transparent and 'permissive' marketing will be the only way to access more affluent and educated consumers.
• The general pace of change and customer 'generation gap' will have shrunk from a 20 year perspective down to five years or less.
• The main growth areas over the next ten years are considered to be in Telecommunication, Fashion, Travel and Leisure (especially Sport), Education (Student, Child and Adult Retraining), Interactive TV and Media.
• The most likely consumer trends will see growth in demand for Eating Out, Entertainment, Sports, Lottery, Domestic help, Senior Citizen care facilities, Financial Services, Travel and Education/Community Care events.

Loyalty programmes - current status

The majority of the existing card based schemes are utilising magnetic stripe or chip based plastic cards with customer collection of points related to their purchases of goods and services. Typical costs of the existing programmes is 0.5-1% of sales, break even economics for these programmes is averaging 5-7% of sales. These schemes are positioned as 'added value' benefits and the construction of the programmes is delivering an "easy to collect, simple to redeem" offer. Recent developments in chip card technology are encouraging some operators to follow the lead of Boots' Advantage Card and take the smart card route.

The seductive logic of continually satisfied and even 'delighted' customers who then form a virtuous circle of loyalty to the brand and positive referrals has influenced many companies to invest heavily in customer loyalty schemes. These are expensive to both launch and maintain but often poorly conceived in terms of objectives and even more frequently inadequately measured for return on investment. Two distinct schools of thought are emerging: the 'pro-loyallists' and the 'anti-loyallists'. Both claim the moral high ground of consumer interest; both have valid positions.

Loyalty defined

"Exchange of customer information for added value goods and services in a mutually beneficial long term relationship."

Based on this classic definition of loyalty programmes the majority of schemes currently operating are more accurately described as long term promotions.

Any definition of loyalty should focus on behaviour since it is customer behaviour that determines a retailers bottom line profit benefit. The unreliability of customer attitude as a predictor of future sales is clear from the experience of the motor and airline sectors. Both have relatively high levels of customer satisfaction reported but this does not translate into repeat sales.

A consistent view has been developed within academic studies and recent case history example to support the proposition that it is cheaper and more profitable to retain existing customers than recruit new customers. A reduction in brand defection combined with maintenance of customer recruitment should result in business growth and enhancement of brand equity.

Conflicting evidence supports the difficulties of actually reducing customer defection and the fact that customers actually purchase from a selection of brands (the Dirichlet model). Network coverage and primary location advantage continue to offer the main influence on customer brand selection.

Most schemes also tend to treat all customers equally despite clear evidence that customers are not equally profitable.

Do loyalty schemes work?

Several recent studies have drawn attention to the overall cost of loyalty programmes, generally at least 1% of sales, and the lack of real hard evidence to support their effectiveness. The number of such schemes within a market like the UK and the generally small rewards associated with them is leading to an emerging problem of 'loyalty fatigue'.

Amongst retailers within the service sector, retention of customers ie their loyalty over time, has been the area of most research. A consistent view has been developed within academic studies and recent case history examples to support the proposition that it is cheaper and more profitable to retain existing customers than recruit new customers. A reduction in brand defection combined with maintenance of customer recruitment should result in business growth and enhancement of brand equity.

It also provides the platform for brand extension such as supermarket retailer moves into financial services.

Against this approach is evidence of the difficulties of actually reducing customer defection and that in some retail sectors any customers gained may have a similar value to those lost.

Professor Andrew Ehrenberg from South Bank University has studied evidence of loyalty in over fifty product categories in order to answer four questions.

• Is there such a thing as loyalty?
• Is loyalty predictable?
• Does the degree of brand loyalty differ much between brands?
• Are highly loyal buyers worth having?

He concluded from the evidence of his research that loyal behaviour does exist since people buys brands repeatedly. Their loyalty however is polygamous since they tend to buy from a repertoire of brands. The question of loyalty being predictable was also defined from behavioural data. The pattern of variation in loyalty is predictable from market share.

Key issues for the future of loyalty schemes

• Recent work by Templeton College Oxford, under sponsorship from KPMG has identified a classification system for loyalty schemes and stresses the importance of strategic 'fit' with the overall marketing objectives.
• Develop a Database? Potential access to better customer information could be a major strategic benefit from loyalty schemes generally.
• Ownership of loyalty schemes? Effective control need not require ownership but supplier, partner and alliance relationships are becoming more difficult to predict in a dynamic retail environment.
• Loyalty fatigue will reinforce the need to add real differentiation to the schemes offers
• Multiple currency and multiple redemption schemes are being cited as the potential end game scenario for loyalty schemes generally. Experience other retailer attempts at this approach highlights the difficult strategic and brand support issues this type of development create.
• Leverage of cost is essential to maintain programme competitiveness and retain customer value

Conclusions

All loyalty schemes, whether plastic card based or service focused, are intended to increase turnover through increasing loyalty to the brand. To increase customer frequency and spend is the ultimate rationale for all variants of loyalty programmes. Loyalty can mean three different approaches to customers:

• It can encourage a more positive disposition to the brand
• It can mean buying the brand more than competitive brands in the same category (although the Ehrenberg research tends to refute this assertion)
• It can improve allegiance to the brand over a long period

Whilst it may seem reasonable to assume that these approaches will all correlate with each other, the evidence from several recent studies suggests that this assumption may be flawed. The key to understanding the relative success of loyalty schemes is not simply the mechanic or the offering but the positioning to consumers and its linkage with their perceptions of the brand.

As we come to the end of the 1990s and marketers shift their focus to the challenge of meeting customer expectations in the 21^st century. A trend is emerging in mature retail markets for greater 'openness' and transparency with customers. Many well known brands have already established a higher level of trust with consumers than more traditional institutions. This situation will create the opportunity for selected brands to build consumer trust and emotional loyalty by the development of channels for greater customer communication. This communication will need to be a two way process since the consumer in most mature markets is increasingly sophisticated and demanding of real value in their relationship with suppliers. The true value of customer loyalty programmes to suppliers in the future may be their ability to offer marketers the conduit to better and more frequent customer communication. Customers dictating the terms and conditions under which they will elect to do business with suppliers is the likely scenario for retailing in the next decade. Well thought out and implemented loyalty programmes can be an important strategic marketing technique to assist retailers in this new environment.