Sunday, April 8, 2007

If You Want Loyalty, Get a Dog

Every so often, someone will talk to me about the merits of various customer loyalty programs. One of the benefits they will point to with a loyalty program is the ability to use “differential pricing,” which is a fancy way of saying that some customers will be charged more for the same product than others.

So then, my first question to them is “Who deserves to have to pay more for the same product?” If you make the light users of your company pay more, you will get them upset with you and they will go somewhere else, so you lose the chance to convert them into eventual heavy customers. Over time, it is not a good idea to alienate potentially good future customers because you are cutting off your growth and older customers will eventually need to be replaced.

In addition, if your best customers start paying too little for your offerings due to special loyalty discounts, you are making your best customers no longer your best customers, for they can start to become a financial burden. For example, if all the airline frequent flyer points were suddenly redeemed, the airlines would go bankrupt. If you need to have your non-loyal customers pay even more to subsidize the discounts to the loyal, then you probably have a non-sustainable model.

But let’s say you do it the other way. You give large discounts to get new customers into your program and have your loyal customers pay more. Loyal customers will be upset that their loyalty is not being rewarded. It could cause them to take their loyalty elsewhere.

People will find out that others are getting charged different rates on the same product. Just ask Amazon. They tried an experiment on differential pricing. People caught on very quickly and the internet buzz against Amazon occurred almost immediately. It wasn’t long before Amazon abandoned that experiment and issued an apology.

So again, I ask them, “Who deserves to pay too much for the item.”

At this point, they usually change the topic and say something like, “Well, there are other benefits to loyalty programs…”

“Loyalty” is a big word in business circles. We want to create loyal customers, because loyal customers supposedly spend more, making them more valuable. As a result, there are a lot of companies out there who will try to see you something to help you create a loyalty program for your business. Most of these programs involve giving someone some form of personal identification so that we can track their behavior. In return for this data, we give them some form of discount—everything from paying lower prices on your products to getting points that can be redeemed on things you do not sell.

It all sounds well and good until you start asking a lot of questions, like I do. Some of the claims do not stand up under tough scrutiny. This blog will try to expose some of the problems with current loyalty programs.

Listed below are a few principles you should consider about loyalty programs.

1) There is a Difference Between Loyalty and Bribery
A lot of programs called loyalty are really about bribery. In most of these programs, you are providing a financial incentive to participate. In my mind, that is a bribe. If these people were truly loyal to you, then you would not have to bribe them. The mere fact you have to bribe them shows that they are not loyal—at least not loyal to you. What they are loyal to is their own personal greed. As long as your bribe is the biggest, their loyalty to greed will belong to you. But if someone offers a bigger bribe—away they go.

Studies have shown that the people who are most likely to carry a loyalty card for one retailer also are people who typically carry a large number of loyalty cards for competing retailers. The cards don’t create loyalty. The just create fatter wallets full of cards.

Bribery is a useful business tool. Sometimes we call it a “sale.” Sometimes it is called an “Introductory Offer.” Other times it is a coupon. I’m not against the occasional legal bribe. But don’t mistake a bribe with loyalty. A bribe is a good tool to get people to experience what you are offering. Once they get to experience your offering, you have a shot at converting them into a regular customer. But getting customers through bribery is not the same as creating loyal customers.

2) Loyalty is the Wrong Goal
In its strictest terms, loyalty is a lot like unconditional love. It is the expectation that someone will give you preferential treatment just because of who you are. In this day and age, it is unrealistic to think that you can create a great deal of loyalty. There are too many choices and there is too much information out there causing people to question each decision. It is increasingly rare to find a consumer who patronizes a retailer blindly out of some sense of loyalty.

As the old saying goes, if you want loyalty, get a dog. If you want profitable customers, look for symbiosis. Symbiosis is about two entities coming together because there is something mutually beneficial that occurs when they are together. The biology example people like to use for symbiosis is the Plover and the Crocodile. The plover is a bird that eats harmful entities that get in between the teeth of the crocodile. In this relationship, the plover gets an easy meal, while the croc gets healthy teeth. The croc does not open his mouth for the plover out of a sense of loyalty. He does it to get a benefit. The same goes for the plover.

If you truly want to succeed, you are better off looking for opportunities for symbiosis than opportunities for loyalty. In other words, what benefits can I offer a group of customers that will make them so happy that they are willing to give me something that I want in return? This is not about slapping a bribe on top of my current offering. It is about changing the offering itself—the bundle of goods, services and the attributes associated with the transaction (convenience, price, atmosphere, image, etc.).

3) Sometimes we get the relationships reversed
Loyalty programs can be very expensive to operate. Some of the expense is related to the size of the bribe. Some of the expense is related to the computer technology and the analytics that go along with it. To help justify the expense, people compare the spending of the “loyal” customers to the non-loyal customers. In most cases the “loyal” customers spend more than the non-loyal. Then, these people make the assumption that the loyalty program caused these loyal customers to spend more than then non-loyal, and use the incremental difference in spending to justify the cost of the program.

I would beg to differ with this math. In many cases, the relationship is actually the reverse of this. The program did not make the people spend more. Instead, it is the people who were already spending more than average who have more to gain from the bribe. Therefore, they have a greater incentive to join the program. In other words, instead of creating people who spend more, all the program does is help you identify who is already spending more. Yes, there is value in knowing who these people are, but you cannot use all of their above average spending to justify the cost of the program. Most of that higher spending was already occurring.

In fact, a lot of that higher spending was already occurring prior to the new bribes put in place with the loyalty program. Therefore, the program has actually made many of these customers less profitable, rather than more profitable. When you look at programs this way, the high costs become much more difficult to justify.

4) Loyalty programs work best when the customer base consists of people with widely different needs
If you are essentially a mass marketer who appeals to a large sector of the population which behaves relatively similarly, then there is little need for spending the money to identify your customers. Instead, just find out what are the most important universal needs and desires of the masses and do the best at offering them to everyone. Even if you are in a small niche business catering to a small sector of the population, if that niche tends to be similar in their needs and wants, then you will not get much benefit out of the costs of identifying them as individuals.

I’ve seen a lot of mass retailers, like grocery stores, go after these loyalty programs. In the end, there doesn’t seem to be much loyalty going on. The people carry cards from multiple grocers, so it really doesn’t impact their behavior all that much. There isn’t enough difference in behavior to cause the grocer to go to the trouble of treating each customer differently when they enter the store, just because of who they are. The only real purpose in getting to know them appears to be so that they can use the data to get manufacturers to pay them to offer targeted coupons.

In the end, however, the biggest profit boost for the mass retailer might come from getting a few extra pennies from the person who is too lazy to get a card. Although I have noticed at one of the large drug store chains that even if a customer does not own a card, the cashier will swipe a generic card at the register, so that everyone gets the discount, card or no card. Like I said earlier, in the world of mass retailing, the differentiation is of dubious value.

However, if your business caters to a wide variety of customers with vastly different needs and who are looking for vastly different solutions, then a loyalty program makes sense. The program allows the company to keep track of which segment you are in so that you can offer the right bundle of goods and services to the right people. A good example of this tends to be the banking industry. There is a wide variation in the way people use banks and their variety of services. It is often worth the effort of getting to know which type of bank customer a person is, so that you can more efficiently channel your resources in serving them.

Although the idea of loyalty programs sounds good, once you dig in deeper, one finds out that they may not be as good as they sound. Some thoughts to keep in mind:

1) Bribery is not the same as loyalty. Bribery is only effective when you pay a bigger bribe than someone else.

2) If you want loyalty, get a dog. If you want more profitability, create symbiosis with your customers.

3) Loyalty programs often do not create as much extra business as we think. Instead, they may just be a way for us to identify the people who were already larger than average spenders.

4) Loyalty programs tend not to work cost effectively with mass markers or with companies catering to customers with similar needs/desires. Instead, the programs are best suited for firms selling a variety of goods and services to customers with vastly different needs.

At the end of the day, if you have the most compelling offering and execute it well, you are usually better off than trying to cover up your weaknesses with bribes.

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