Royalty Programs and Data Mining

Loyalty Programs

Popularity of loyalty programs is increasing, both in terms of the number of programs offered by merchants and in participation by customers. Yet, it seems that both groups remain ill informed of how the programs actually work and the true benefits and costs. This paper explores the reality of loyalty programs and concludes that they can be beneficial for all parties provided that they fully understand what the programs accomplish.

Do Loyalty Programs Work?

Research suggests that the demand-side success of loyalty programs is less than promised. It is difficult to change established patterns of repeat-purchase behavior and competition quickly develops counter responses that mitigate the impact of the program. However, it is possible to reap advantages from loyalty programs such as maintaining customer loyalty and brand share, improving accessibility and brand awareness, and offering incentives expected by customers.

Customers are apt to join the programs of the brands they buy if they desire rewards for their loyalty. However, the program must reinforce the value proposition of the brand instead of just building loyalty-program equity. Improved accessibility and brand awareness can result from obtaining more shelf space and promotions from retailers, taking advantage of opportunities to converse with customers and selling brand extensions to customers. Further, there is a huge me-too pressure to offer programs to consumers and, once a company introduces them, customers may react negatively if the programs are discontinued.

3.0 Benefits to Merchants and Consumers

Despite popular percption, increased sales from loyalty programs is unlikely. In October, 1999, the consulting firm McKinsey and Company conducted a study of consumers in sixteen product categories and found most loyalty programs did not increase sales. And, McKinsey and Company discovered that customers who enjoy benefits without increasing spending typically constitute up to fifty percent of all loyalty program membership. So, one may wonder if loyalty programs actually offer any benefits to the merchant. The answer is yes, with the following possibilities:

Customer retention: Even if customers spend no more than they would have without a program, a loyalty program may keep them from doing business with a competitor.

Maintain spending habits: Loyalty progams can induce customers to keep their current level of spending.

Rewarding customers: Making customers feel appreciated can be a powerful tool for maintaining customer spending and loyalty.

Information gathering: One benefit of loyalty programs is finding out what your customers -- individually as well as collectively -- want and to selectively market products based on buying habits.

Data mining aids in the exploration and analysis of large volumes of information by using automatic means to discover meaningful patterns and rules. For example, direct-mail catalog company Fingerhut uses data mining to segment millions of U.S. customers into groups who exhibit similar purchasing characteristics and then tailors mailings of the 130 different catalogs that it sends to customers each year. Data mining's biggest contribution has been in cutting costs but allowing companies to focus promotions s on the customers most likely to buy.

All customers can benefit from loyalty programs through rewards, special treatment and/or specialty offers and discounts. As many as half of all members of loyalty programs are free riders, enjoying benefits without spending more at the store that provides them.

This group receives more and gives nothing in return.

4.0 Costs to Merchants and Consumers

Loyalty programs are very expensive for merchants. There are establishment costs such as advertising and promotional activity, enrollment costs, IT hardware, database creation and maintenance costs, servicing costs, management costs, editorial and production costs of loyalty magazines, the direct costs of rewards, and the opportunity costs of spending money on a loyalty program instead of on other marketing initiatives.

In the supermarket industry, where loyalty programs are relatively mature, they cost from 1% to 1.5% of revenue, and in other industries they cost between 2% and 5%.

With regards to consumer costs, it's important to remember that loyalty programs are designed to make the customer do what the company would like them to do such as shopping during specific times or increasing total purchases. And, some loyalty programs can actually cost the customer more money. One example is a supermarket clubs card. Wall Street Journal shoppers visited stores in Dallas, Chicago, Brooklyn, Atlanta and San Francisco. In each city, they shopped a store using its discount card, and afterward went to a nearby store that didn't have a card and bought the same things. In all five of their comparisons, they wound up spending less in a supermarket that didn't offer a card, in one case 29% less.