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National Mail Order Association (NMOA)
Direct Marketing
and Mail Order

Delusions Of Loyalty: Where Loyalty Programs Go Wrong
By Alan Rosenspan

Pan Am had one of the best frequent flyer programs in the business. I know because I ripped it off.

About five years ago, Pan Am advertised that they would give you 5,000 bonus miles each way if you signed up for their program and flew on the Boston-New York shuttle during a special three-week period. At that time, you could redeem 20,000 miles to get a free ticket to Hawaii. I sat down and did the math.

The shuttle ticket was $149 round trip. Two trips would cost $298. but I'd earn enough for a free ticket to Hawaii. However, buying a ticket to Hawaii would cost about $800 -- a savings of $500 per ticket, or $2000 for my family of four.

That Friday night, I took my wife and two children down from Boston to New York -- purely to get the frequent flyer miles. My children loved flying and enjoyed the idea of taking the ride back and forth.

When we exited the plane, I couldn't resist teasing the flight attendants. I turned to my children and said, "You two have misbehaved this entire trip. I've changed my mind. We're not going to New York. We're not going to see Grandma. We're turning around and taking the next flight back to Boston!" The crew was aghast.

We did the same thing on Sunday. (Although this time, we did spend the day in New York). A few months later, we were on the beach at Waikiki. And not long after that, Pan Am was out of business.

I tell this story not to show how clever I was. Or how cheap. But to illustrate how a loyalty program doesn't always create loyalty, but instead can foster the wrong attitude you want from your customers.

Was I a loyal Pan Am customer? I'm sure they thought I was. I often flew them on my trips down to New York. However, I was loyal to the program -- and not the brand. That's why when the Delta shuttle replaced Pan Am and agreed to honor all their frequent-flyer miles, it made absolutely no difference to me.

Was I a good customer? I don't think so. In effect, I used their frequent flyer program to cut my ticket costs by $2000. I would have been far more profitable for them if I had never joined their program to begin with.

The Loyalty Paradigm Has Changed

Loyalty programs have become increasingly more important, because loyalty itself is becoming a rare commodity, in virtually every human situation.

As a society, loyalty seems to have been replaced by mobility. We change jobs, homes, shops and even spouses faster than ever before. Why would we hesitate to change something as trivial as which credit card we use, or which detergent we buy?

Plus loyalty used to be mostly inertia. If a customer was satisfied with your product or service, they generally stayed with your product or service. Today, it's just not true.

Do you remember when you did all your banking with one bank? The rule of thumb was that if a customer had three or more accounts with a bank, they were customers for life. Unless they moved or changed jobs.

Now most of us have savings accounts with one bank, brokerage accounts with another, a home equity line with a third, plus two or three credit cards from banks we have never, ever even seen.

Today, loyalty isn't seen as admirable. It's seen as stupid or lazy.

That's one of the major challenges for any loyalty program -- making the participants feel that they are being smart, or prudent in belonging to it. Or -- just like my Pan Am example -- making participants feel that they are somehow taking advantage of the company. How many times have you heard someone brag, ÅSo then I got triple points for flying on a Sunday. Plus quadruple points for connecting through Chicago, plus extra points renting the car at the airport the following Monday"?

Another factor impacting loyalty is that customers are growing increasingly more savvy and sophisticated, about marketing, about rewards and about the value of their business.

Using the banking industry again, I remember when banks gave out free toasters if you opened an account with them. Now consumers weigh the cost of a premium against the interest rate, or the value of free checking, and determine which is the better deal. Small appliances just don't cut it anymore.

But customers are not only getting smarter -- they're getting more complicated.

Takayuki Miyashita, manager of market development at Toyota, says that "consumer demand has become a rapidly moving target. In the past, we could predict the customer's needs with a fair degree of accuracy based on age and social position. Now we have to be very sensitive to changing customer tastes, and we must be able to respond to increasingly individual desires."

The Customer Satisfaction Trap

If you think you don't need a loyalty program because your customers are satisfied, think again.

Customer satisfaction has become the stated goal of every business. That's what you want to end up with -- satisfied customers. However, it might be only the starting point.

The Ogilvy Loyalty Centre in the U.K. identified what they call the "Customer Satisfaction Trap." They report:

In the automotive business, on average 85% of all people report being satisfied with the cars they've purchase -- but only 40% buy from the same dealer again.

In business to business, 65-85% of defectors report that they were either satisfied or even very satisfied with their former supplier.

So clearly, satisfied customers are not enough to sustain a growing business. And that's why more and more companies around the world are implementing loyalty programs.

It seems that businesses are finally waking up to one of the central tenets of direct marketing -- and that is their profitability depends on repeat business from existing customers. And, as we all know, all customers are not created equal.

A good loyalty program will help you retain your best (most profitable customers); increase the value of your lesser customers; and cost you nothing with your worst customers.

It is important to understand how much potential value each group has, and what kind of an investment you should make in them. It's been called "sharing value" between the company and the customer.

Why Is Loyalty So Important?

Recently, I gave a seminar for the Portuguese Post Office, along with my friend, Erik Van Vooren of the Direct Marketing Know-How Institute in Belgium. Erik gave a great example of the impact of customer loyalty:

"Suppose your company lost 10% of your inventory last month?" he asks, "You would panic. You'd get together your staff, lock the doors and figure out exactly where that inventory went." "However, the same company can lose 10% of their customers without even noticing."

Erik went on to make the point that in many markets, the number of prospects is not growing at a substantial rate. Therefore, keeping and growing customers -- or customer loyalty -- is becoming increasingly important.

What Should Drive Your Loyalty Program

A landmark article in the Harvard Business Review, "Do Rewards Really Create Loyalty?" May-June 1995, by Louise O'Brien and Charles Jones, identified the five dimensions of loyalty programs. Let's take them one by one:

1. Value. The customer must perceive value or the loyalty program won't work. Value doesn't have to mean only premiums or prizes.

One of the most successful loyalty programs in the States is the Emerald Aisle campaign for National Car Rental. It's a frequent-renters program, with rewards and prizes. However that's not why I belong. The reasons that I belong are: I don't have to wait on line to get my car, and at certain locations, I can rent a Porsche, a Rolls-Royce, a Ferrari and other cars I can't afford to own. (Or my wife won't let me)

2. Choice. I call this one involving the customer. The Frequent Flyer programs are waking up to this one, by offering you the opportunity to use your points for magazine subscriptions, hotel offers or gift certificates.

American Express led the way by changing it's highly successful Membership Miles program to the even more successful Membership Rewards.

3. Aspirational value. AT&T's True Rewards loyalty program sputtered when the rewards were simply free long distance calls. How aspirational is that? Today, they also offer you frequent flyer miles.

I learned this lesson from my sweepstakes experiences. When we offered a $10,000 prize, we gave customers lots of exciting suggestions on how to spend it. From exotic vacations to creating a fantasy room in their house to designing a lavish garden.

The winners invariably used the money to help pay off their bills.

4. Relevance. This has to do with two factors. One, are the rewards something that the consumer really wants? You may wish to do some customer research before you launch your loyalty program to ensure this. (Or if you already have one, you can use the research to enhance the rewards).

Two, is it really possible to get them? Most loyalty experts recommend that the first level of rewards be low -- so that people feel they can easily achieve it. And also so they get into the habit of redeeming.

5. Convenience. Even the mighty Air Miles failed in the U.S. because people perceived it was too hard to get points and too hard to redeem them. Fatal flaws.

To these five dimensions, I add a sixth one:

6. Communication. Unless your loyalty program is communicated to your customers and potential prospects in a clear and compelling way, it's not likely to make much of an impact on your business.

Ever wonder why AT&T's True Rewards program hasn't prospered? Only 10% of AT&T's base even knew they were on it. AT&T True Rewards was also a "passive" rather than an "active" loyalty program. It was automatic. You didn't have to sign up for it. You got the rewards whenever you spent $25 or more a month in long distance service.

The Problems With Most Loyalty Programs

There are exceptions, but many loyalty programs are really bribery programs. They "reward" frequent or higher purchases with points that are good for merchandise or extended services. That creates three problems:

1. You may be rewarding the wrong type of behavior.

Loyalty programs are usually based purely on purchase -- but that's a rather narrow definition of loyalty.

Some customers may be buying from you only because they have to, not because they're loyal. And they may not be prepared to do more business with you, generate referrals, or add value in any way. Even the most generous loyalty program may have no effect on these customers.

2. You may be rewarding the wrong type of customer.

Loyalty programs are often positioned as "extra benefits for things you would be doing anyway." In other words, you have to fly to Cleveland on business. If you are a member of Delta SkyMiles, why wouldn't you take Delta airlines? And why wouldn't you stay at a hotel and rent a car where you earn extra miles? You have to do these things anyway.

However, by their nature, loyalty programs tend to attract customers who are more interested in making a deal, or getting an advantage, than in using your product. These are the customers who will most likely leave when a competitor offers them something more. So, unless you want to keep raising the stakes, don't count on their loyalty. These may also be the least profitable customers.

3. You may be rewarding loyalty to the program, not the brand.

In his speech, "The Frontiers of Direct Marketing", Lester Wunderman talks about Motorola. The company has developed a mass-customized production system for its Bravo pager. It has 29 million variations -- any one of which can be produced immediately.

A Motorola salesman can partner with a customer to design pagers exactly suited to the customer's needs. The order and specifications are communicated electronically through four different computer systems in different locations to 27 different robots which begin to manufacturer the pagers. 20 minutes from the time the customer and the salesman designed the pager system, the first one is manufactured. Within an hour, it has been inspected and packaged for shipment."

Do you think Motorola needs a loyalty program? Do you think they should offer discounts, or 1 free pager for every 10 you buy? Do you think they have to?

Should you start a loyalty program?

The answer is almost certainly "yes" -- particularly since I'm willing to wager that your competition either has one, or is currently thinking about launching one.

It doesn't even matter what business you're in. We've seen successful programs for grocers, dry cleaners, bus companies, packaged goods companies, hotels, car rentals companies, casinos, and even brothels.

However, loyalty programs do not necessarily foster good feelings towards the product or service; help generate referrals; or even affect attitude.

In fact, a badly done loyalty programs can actually hurt attitude. For example, have you ever tried to redeem your frequent flyer miles and have been told that the times you want to fly are blacked out? Or that there are no frequent flyer seats available? That is why, before you start a program, you need to ask some hard questions:

1. What behavior do you think you can impact with a loyalty program?

You need to quantify exactly what you want to accomplish with your program and set some benchmarks for success. How will you know if your program is working? How will you know if the money you invest in it is well-spent?

Many loyalty programs are launched with soft targets such as "We want to retain more customers." rather than "Our goal is to reduce customer attrition 10% in the first year by the following tactics." Which one do you think will be more successful?

2. What is the value of that behavior?

The answer to this will help you determine how much you can spend on a loyalty program. Don't underestimate. Besides the actual rewards, there are enormous amounts of database costs, tracking costs, administration costs and communication costs to consider.

The wrong rewards structure can cost you a fortune -- and outrage your customers when you have to withdraw it.

3. How will the program be segmented?

You will obviously want to design your program so that your most valuable and profitable customers will get the highest rewards. However, you will also need to build in a way for the next tier of customers to progress to a higher level.

4. What are your plans for year 2? Year 3?

Loyalty programs are hard to discontinue after they've been launched. In fact, a smart way to launch one would be to position it as a "test" with a time limit, and maybe only to a small group of customers at first.

You'll also need to determine an exit strategy; a communications strategy; plus a schedule of enhancements to the program. Loyalty programs tend to fizzle out unless they are refreshed with new rewards or new ways of earning rewards on a regular basis.

Unfortunately, most loyalty programs are not well-thought out or well-planned. To quote Shakespeare, they're "full of sound and fury, and signifying nothing."

Finally, you may want to ask yourself this all-important question:

Does loyalty cut both ways?

About a year ago, I gave a speech to the Bank Marketing Association on customer loyalty. I began by asking the audience how loyal their customers were. Everyone in the audience answered that, yes, their customers were loyal.

However, when I started asking specific questions -- people began looking a little more uncomfortable. You may want to ask yourself the same questions I asked them:

Would they switch to save money?
Would they switch for a new product?
Would they switch for better service?
Would they switch because someone asked them to?

This last point may not seem important, but AT&T's research showed that significant number of people switched away from AT&T simply because MCI or Sprint asked them to.

After establishing that most of their customers weren't really loyal, I then challenged them by asking, "How loyal are you to them?"

Do you give existing customers preferential treatment?
Do you ask them if they're satisfied?
Do you make them feel that you care about their business?
Do you thank them for their business?
Do you really know them?

I related the story of my experience in trying to refinance my home loan with the same bank, to take advantage of lower interest rates.

"Now, Mr. Rosenspan, there's a $200 application fee."

"I'm not applying for a new loan. I just want to adjust my existing loan"

"Sorry, it's bank policy. We also need to do an assessment of your house."

"It's the same house I've lived in for 11 years -- the same one you've already assessed."

"Sorry, it's bank policy. The interest rate is 7.3%"

"But that's the same rate you give to everybody. I've already proven I'm a good customer. I've paid back my loan on time every month for all these years."

"Sorry, it's bank policy"

"You want to charge me a fee. You want to re-assess my house. You won't give me any special consideration even though I've been a good customer for 11 years. Then why on earth would I want to re-finance with you?"

"But Mr. Rosenspan, you're one of our loyal customers!"

Now that's a delusion of loyalty!

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