Don't Confuse A Loyalty Program For Customer Loyalty

In its purest form, a Loyalty Program (LP) is a marketing tool used by companies to bond a small group of its most loyal customers through an exclusive reward or benefit. The concept is to identify one’s most loyal customers and offer them an incentive above and beyond excellent business processes and perceived value as a means of achieving a number of ends:

·      Personal recognition of a loyal customer’s value to the company through a reward

·      Increase sales to existing loyal customers

·      Reduce the risk of attrition of high value customers to competitors

·      Attract and convert high value customers from the competition through additional benefits to garner their loyalty to your brand.

The idea of rewarding loyalty is based on a number of research findings and general beliefs about loyal customers (which may or may not be true in any instance):

• Loyal customers are more profitable to a firm
• Loyal customers are less costly to service
• Loyal customers are less price sensitive
• Loyal customers spend more (80% of revenues come from 20% of customers)
• Loyal customers drive the majority of business profits
• Loyal customers act as consumer advocates to promote the business.

Originally, loyalty programs were developed to identify, personalize relations with, and reward, a small group of highly loyal and profitable customers. Over time, the scope of these programs has widened to influence the behaviour of consumers in general and reward their shopping behaviour. What started off with the requirement of first achieving customer loyalty followed by rewarding loyal customers, has now been transformed into a situation where customers who choose to participate in a rewards program are perceived by businesses as loyal customers.

For the majority of companies with rewards programs, the hard work of earning customer loyalty is no longer on their radar. Instead, the goal is to maximize card holders, which is much easier to measure. Executives often falsely believe and promote the idea that program members are loyal customers. They need to remember that loyalty denotes advocacy and commitment through emotional engagement, not a desire to earn points.

A focus on maximizing customers may in fact be a profit-inhibiting strategy, according to loyalty expert Frederick Reichheld. In his ground-breaking HBR article “Loyalty-Based Management” he argues the case that the road to maximizing profitability includes an understanding of the economics of customer loyalty and the strategy of identifying the benefits and costs of serving different customer segments.

Reichheld identifies and describes four components he sees as foundational to building a loyalty system.

1. Identify the right customers, the loyal customers, who are likely to have long tenure and will be profitable over the longer-term because of personal referrals or willingness to buy at standard prices.
2. Expand offerings to existing customer segments you know well by adding new products and services that anticipate and meet their evolving needs and ensure their retention.
3. Retain the right employees and partners through incentives because they know your customers the best and have build existing bonds of trust and expectations within their relationships.
4. Develop business systems to ensure and understand the long-term economic consequences of changing customer loyalty and the quality of feedback loops that are the foundation of organizational learning and adaptation.

He expounds on the logic of the system as follows:

"The primary mission of a loyalty-based company is to deliver superior value to customers. Success or failure in this mission can be clearly measured by customer loyalty (best quantified by retention rate or share of purchases or both). Customer loyalty has three second-order effects: (1) revenue grows as a result of repeat purchases and referrals, (2) costs decline as a result of lower acquisition expenses and from the efficiencies of serving experienced customers, and (3) employee retention increases because job pride and satisfaction increase, in turn creating a loop that reinforces customer loyalty and further reducing costs as hiring and training costs shrink and productivity rises.

"As costs go down and revenues go up, profits (the third-order effect) increase. Unless managers measure and monitor all of these economic relationships, they will default to their short-term, profit-oriented accounting systems, which tend to focus on only the second- and third-order effects. Focusing on these symptoms––instead of on the primary mission of delivering superior value to customers––often leads to decisions that will eventually reduce value and loyalty."

The loyalty research by Frederick Reichheld supports the old adage that businesses can't be all things to all people. Reichheld's insights into the economics of loyalty mechanisms is a further articulation of Peter Drucker's adage that "the purpose of a business is to create and keep a customer." This is still true,  but the most conscientious executives should focus on the idea that "the purpose of a business is to create a keep loyal customers."