Do Customer Loyalty Programs Really Work

03/05/2017 Do Customer Loyalty Programs Really Work?
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Do Customer Loyalty Programs

Really Work?
Magazine: Summer 1997 Research Feature July 15, 1997 Reading Time: 31 min
Grahame R. Dowling and Mark Uncles
Giventhepopularityofloyaltyprograms,theyaresurprisingly
ineffective.Tostandthebestchanceofsuccessintoughmarket
conditions,programsmustenhancetheoverallvalueofthe
productorserviceandmotivateloyalbuyerstomaketheirnext
purchase.
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Customer loyalty schemes have attracted considerable interest as
companies practice one of marketings most familiar strategies If
you see a good idea, copy it. Some banks have offered regular
customers credit cards with a range of valuable benefits. In business-to-
business markets, loyal customers have traditionally been treated better
than those who buy on the spot market. Other well-known customer
loyalty schemes are the frequent-flyer programs of the major airlines.
These and other well-patronized programs were originally hailed as
imaginative ways to instill and maintain loyalty, but, over the years,
more and more doubt has been cast on them. Both the academic and
trade press have criticized the programs with headlines such as: A Failure in Competitive Strategy, War
in the Air: The Scramble for Points Hits Turbulence, Frequent Flyer Offers Fail to Boost Loyalty. 1
http://sloanreview.mit.edu/article/do-customer-loyalty-programs-really-work/ 1/17
Loyalty programs that seek to bond customers to a company or its products and services by offering an
additional incentive pose an interesting dilemma. Although these schemes often attract widespread
customer interest, they are difficult to support, using our current knowledge of competition and buyer
behavior. This research suggests that most schemes do not fundamentally alter market structure. They
might help to protect incumbents and might be regarded as a legitimate part of the marketers armory, but
at the cost of increasing marketing expenditures.
Many senior managers now ask their marketing departments to measure the potential contribution of any
program developed to implement loyalty marketing. Do these programs really create extra loyalty beyond
that which is derived from the relative value of the product or service? Do they encourage customers to
spend more? Or do they merely bribe a customer to buy again? In a competitive market, is it really feasible
for every organization to increase customer loyalty by implementing a loyalty marketing program?
Underlying the increasing interest in these programs are some marketing managers widely held beliefs
about customer loyalty:
Many customers want an involving relationship with the brands they buy.
A proportion of these buyers are loyal to the core and buy only one brand.
The hard-core, loyal buyers are a profitable group because there are many of them and they are
heavy or frequent buyers.
It should be possible to reinforce these buyers loyalty and encourage them to be even more loyal.
With database technology, marketers can establish personalized dialogues with customers,
resulting in more loyalty.
We encountered such beliefs in the rhetoric of relationship marketing, direct marketing, database
marketing, and so-called 1:1 marketing. 2 However, in this paper, we compare these beliefs with growing
research that challenges their accuracy. First, we describe the origins and aims of loyalty marketing. We
then review research that examines empirical patterns of behavioral loyalty. We also consider psychological
research on rewards, a major component of most loyalty programs. These two sections provide the context
for our comments on frequent-buyer loyalty programs such as those of the major airlines. Finally, we
suggest how to design a customer loyalty program that avoids the common traps undermining the
effectiveness of many existing schemes.
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Why Companies Introduce Customer Loyalty

Programs
In the 1970s, European researchers studying business-to-business
marketing discovered that suppliers who form close working
relationships with their customers tend to have better customers. 3
That is, the customers are more loyal to their suppliers and often give
them a greater share of their business. The customers also reported
having better suppliers. In short, it is a win-win arrangement.
Subsequent research claimed that loyal customers are more profitable

to a firm. 4 This profitability was thought to be generated by reduced
servicing costs, less price sensitivity, increased spending, and favorable
recommendations passed on to other potential customers by loyal
buyers. Add to this the claim that it costs much more to entice a new
customer to do business with a company than to get a current one to
purchase again, and the strategy of gaining and maintaining loyalty
seems like the source of sustainable competitive advantage. 5
For a company to practice loyalty marketing, however, it must first

know who its loyal customers are, which is a lot easier for many
business-to-business marketers than for most consumer good
marketers. As the number of customers increases, companies have to
use database marketing and market research in the absence of personal
knowledge. As computerized database technology becomes more
sophisticated, so does a firms ability to monitor its customers
behavior. Retailers and packaged-goods manufacturers use these
techniques to efficiently target products and services and allocate marketing resources to achieve the
maximum return. 6 In business markets, companies conduct customer profitability analyses and calculate
the lifetime value of their customers. However, the processes are complex and costly.
What began as a strategy for small businesses, business marketing, and catalogue selling has evolved into a
new industry. Direct marketing practitioners are creating loyalty programs that tie the buyers of a wide
range of consumer goods and services to a particular brand or supplier. But do customers for these
products want a relationship with the supplying company? In a small business deal or for a risky purchase,
the answer may be yes. For low-involvement products and the types of brands sold by, say, Nestl, Procter
& Gamble, Shell, or Unilever, it is unclear whether customers really want a relationship.
Press releases about launches of frequent-buyer or customer loyalty programs suggest that companies
expect these schemes to achieve various objectives or practical measures of success. The most common
objective is to retain existing customers and in so doing: (1) maintain sales levels, margins, and profits (a
defensive outcome to protect the existing customer base), (2) increase the loyalty and potential value of
existing customers (an offensive outcome to provide incremental increases in sales, margins, and profits),
and (3) induce cross-product buying by existing customers (defensive or offensive). Usually these desired
outcomes refer to specific target segments, for instance, heavy buyers or high-net-worth customers. The
underlying belief is that a small percentage of customers generate most of a companys sales and that these
customers can be locked in forever. Companies often invoke the 80/20 law in support of this viewpoint.
The 80/20 law states that about 80 percent of revenue typically comes from only 20 percent of customers.
With such a skewed distribution of customers, it makes sense to concentrate most marketing resources on
the 20 percent. The problem for loyalty programs is that the best 20 percent are not necessarily loyal
buyers, especially in the sense of exclusive loyalty. As we describe in the next section, there is reliable
empirical evidence to suggest that many or most heavy users are multibrand loyal for a wide range of
products and services. That is, a companys most profitable customers will probably be the competitors
most profitable customers as well.
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For companies with poor data about their customers, an additional benefit of customer loyalty programs is
that members can identify themselves at the point of purchase or service delivery. Membership cards are a
quick, efficient way for customers to signal that they deserve special attention. As a by-product, the
company gains market research information another espoused benefit of loyalty schemes. However, such
a self-selected group is unlikely to represent all a companys potential customers. Hence, it is only one
source of market research information.
Companies openly discuss all these espoused benefits in public announcements. In practice, however, their
decision to launch a program is often motivated as much by fears of competitive parity as anything else,
which companies rarely state publicly. Therefore we add the following tactical motives to the previous list:
(4) attempting to differentiate a parity brand, (5) preempting the entry of a new (parity) brand, and (6)
preempting a competitor from introducing a similar loyalty scheme.
Most airlines and many leading companies, such as American Express, General Motors, Holiday Inn,
Toyota/Lexus, John Deere, and Shell, have found enough merit in customer loyalty programs to implement
such schemes. While they do not seek all the above benefits from each program, at least some benefits must
occur for the scheme to pay off when the full cost is compared to other marketing alternatives. But, does a
customer loyalty program offer a better return than an alternative such as a price cut, a move to everyday
low pricing, increased advertising, or increasing distribution coverage? For many programs, the answer to
this question lies in some interesting academic research that we review in the next two sections.
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The Leaky Bucket Theory versus Polygamous

Loyalty
Ehrenberg, in what he dubbed the leaky bucket theory, observes that

many marketing strategies seem to be designed to replace disloyal
customers who leak away with new ones in order to keep the sales level
steady. 7 But, while the marketing strategies of customer loyalty
programs appear to be designed this way, is the underlying leaky bucket
theory true?
To address this question and to establish norms of consumer behavior

for different markets, Ehrenberg and his colleagues gathered data from
various markets in Britain, continental Europe, Japan, and the United
States over more than twenty years. Their research describes peoples purchase habits of products like
coffee, ready-to-eat breakfast cereals, newspapers, aviation fuel, toothpaste, laundry detergents, gasoline,
television programs, airline tickets, ethical drugs, and even repeat purchases of management development
programs at business schools. Their focus was on peoples observed behavior, not their needs, motivations,
personalities, or attitudes toward a brand. 8 Gordons subsequent research provided qualitative support for
the emergence of these behavioral norms. 9
Typically, the researchers measured five types of behavior over certain time periods: (1) the percentage of
consumers buying a brand, (2) the number of purchases per buyer, (3) the percentage who continue to buy
the brand (repeat buyers), (4) the percentage who are 100 percent loyal, and (5) the percentage who also
buy other specific brands (duplicate buyers). From these data, a company can determine how much of a
buyers requirement for the category is met by a specific brand. Using statistical analysis, it can predict
norms for each type of behavior in a competitive market. 10
The empirical facts make it difficult to be enthusiastic about using a loyalty marketing program to create a
large group of 100 percent loyal customers. The empirical record and the predictive norms show that only
about 10 percent of buyers for many types of frequently purchased consumer goods are 100 percent loyal to
a particular brand over a one-year period. 11 Even in service situations, exclusive loyalty is confined to a
small number of buyers. Moreover, 100 percent loyal buyers tend to be light buyers of the product or
service.
The research of Ehrenberg and his colleagues indicates that in stationary markets, customer loyalty is
divided among a number of brands, as if there were long-run propensities to buy brands A, B, and C, say,
some 70 percent, 20 percent, and 10 percent of the time. 12 Hence, invariably, customers do not buy only
one brand. Polygamous loyalty better describes actual consumer behavior than either brand switching (a
conscious once-and-for-all change of allegiance to another brand, as if propensities were 100 percent or
zero) or promiscuity (the butterfly tendency to flit from brand to brand without any fixed allegiance, when
there are no long-run propensities, only next-purchase probabilities).
Polygamous loyalty is readily apparent, for instance, in the soft drink and breakfast cereal markets but
extends well beyond to car rentals, fast-food outlets, and business airline travel. It is also evident in
customers multiple memberships in loyalty schemes. For example, surveys of European business airline
travelers show that more than 80 percent are members of more than one airline loyalty scheme. In 1993,
the average membership of airline loyalty clubs was 3.1 per traveler, and the figure seems to be rising. 13
Many reasons for the generalized patterns of divided loyalty or polygamy are straightforward. For example,
people buy different brands for different occasions or for variety. Or the brand may have been the only one
in stock or may have offered better value because of a special deal. Most buyers who change brands are not
lost forever or disloyal; usually, they prefer to buy a number of brands rather than one particular brand.
Given the amount of research that supports these patterns of buyer behavior, it seems unlikely that a loyalty
program could fundamentally alter this behavior, especially in established, competitive markets (where
copycat responses are most likely). Even a path-breaking scheme may alter only short-run probabilities.
Once the market has settled down again, or a competitor has launched a similar scheme, patterns of divided
loyalty reemerge. Then the issue is whether the longer-run propensities settle at old or new levels.
In a market in which competitive response occurs quickly, the market is expected to settle at its old levels.
For example, at the beginning of 1995, there were no national loyalty schemes in the British grocery market,
but once one retailer broke rank, all others followed within months. Despite the amount of loyalty building,
market shares have been reasonably steady. Much the same had happened ten years earlier when American
Airlines launched the first frequent-flyer scheme; within weeks, other carriers began to follow suit. 14
When aggregated across many product and service markets, these research results suggest that the
marketing mix of a brand (its product or service formulation, price, promotion, and distribution)
determines its market share, and, once this settles down, the level of brand loyalty is strongly correlated
with market share. Consequently, although marketers might give brands some fancy names, it is better to
think about them as either big or small, rather than strong or weak in terms of loyalty (see Figure 1
(http://sloanreview.mit.edu/files/2008/12/3846ex1lo7.png)). 15
A secondary effect is that big brands tend to have more buyers, and somewhat more of these buy slightly
more frequently. Equally, small brands suffer double jeopardy in that there tend to be fewer buyers who
buy the brand less frequently. 16 If a loyal buyer is one who again purchases the brand frequently, the bigger
the brand, the larger the number of more, loyal buyers. Add to this the empirical fact that some large-share
brands may have a slightly higher proportion of heavy users and loyal buyers than predicted by the double
jeopardy phenomenon, and there is more bad news for loyalty marketing programs designed to rescue
small brands.
Most brands lie along the double jeopardy line (see Figure 1
(http://sloanreview.mit.edu/files/2008/12/3846ex1lo7.png)). 17 However, there may also be big
brands that exhibit some signs of super loyalty; i.e., they have more frequent buyers than double jeopardy
would predict. At the other end of the scale, a niche brand is small, with a relatively higher proportion of
buyers who are more loyal than predicted by double jeopardy. In its early days, the ecological Body Shop
was a good example of a niche brand, but as it increased its distribution and appeal, it became a normal
brand. As with most so-called niche brands, those that survive and prosper end up along the double
jeopardy line, and they cease to be a niche.
The change-of-pace brand is one with a higher than expected market share but a less than expected
proportion of loyal buyers. Many low-alcohol beers fit this description; people may buy them only when
they are in a special situation such as before driving a car. Or they may have a premium beer as a predinner
drink in a restaurant. The significant point is that super-loyalty, niche, and change-of-pace brands are
much less common than big or small double jeopardy brands. Any of these brands can be profitable,
because profit is determined by margin, not by the type or size of the brand.
A more effective way to grow a brands market share or become big is to get more people to buy the brand
rather than try to get current customers to buy it more often. Fader and Schmittleins research suggests that
one of the most effective ways to get more buyers is to gain more distribution outlets. Its as simple as
that. 18 Leading global players like British Airways, Coca-Cola, and Ford are only too aware of this, which is
why they strive so hard to protect their air routes, distribution channels, and dealerships. Loyalty programs
and other marketing tactics such as price cuts and promotions are effective only in the long term, to the
extent that they entice more distributors to stock the brand or build presence in the marketplace.
In summary, research implies that, in many established, competitive markets, purchasing of products and
services is characterized by a number of empirical regularities. Given that these regularities are so
widespread, it is difficult to increase brand loyalty above the market norms with an easy-to-replicate add
on like a customer loyalty program. We do not deny that companies can have a short-term lucky break, or
that they may be forced to act because of competition. But, for any customer loyalty program to be as
effective as possible, given the prevailing competitive conditions, it must leverage the brands value
proposition in the eyes of customers (that is, the balance of benefits relative to price).
Linking Customer Rewards to Loyalty Programs

Products and services provide functional, economic, and psychological benefits or solutions to buyers.
These are the prime sources of customer value. As research suggests, the relative amount of customer value
and distribution coverage drives market share and the number of loyal customers that a brand will acquire.
The rewards that many customer loyalty programs offer are designed to alter this relationship.
To explore loyalty programs potential to alter normal patterns of behavior, we need to examine three
psychological effects: (1) the extent to which loyalty is to the brand (a direct effect) or to the program (an
indirect effect), (2) how buyers value the rewards offered, and (3) the effect of timing. We consider each in
turn.
Direct or Indirect E ect.
Rothschild and Gaidis have used behavioral learning theory to suggest that the type of incentives that many
customer loyalty schemes offer may induce loyalty to the program (deal loyalty) rather than to the core
product or service (brand loyalty). 19 The extent to which this is desirable depends on the buyers level of
involvement with the product. For many low-involvement products, the incentive and not the product can
become the primary reward, especially if the incentive is exotic and out of proportion to the money spent.
This might create a point of product differentiation, but once the incentive is taken away, the prime reason
for purchase disappears. Many gasoline company loyalty schemes are caught in this trap, locking them onto
a treadmill of continuous promotions.
However, for high-involvement products and services, which are typically accompanied by a small
incentive, the product and not the incentive is the primary reward. For example, in the General Motors
rebate scheme (the GM card), which allows participants to build up savings toward the cost of a new GM
car, the car and not the accumulation of a discount is paramount. This seems to be more desirable because
the creation of a point of difference reinforces the longer-term value proposition of the product itself.
In this way, we can classify customer loyalty programs by whether their explicit rewards directly support
the value proposition of the product or service offered to customers (e.g., the GM card), or whether the
rewards are designed to motivate loyalty by a more indirect route (e.g., free air travel from gasoline
retailers). We suggest that loyalty programs that directly support the value proposition and positioning of
the target product better fit the goals of loyalty marketing.
How Buyers Value Rewards.
Psychologists have long been interested in the role of rewards in behavior modification and learning. They
have developed numerous cognitive-learning theories that give insight into how the rewards of customer
loyalty programs might help to achieve loyalty to the product rather than the program. OBrien and Jones
suggest five elements that combine to determine a programs value: (1) the cash value of the redemption
rewards (e.g., the ratio of the cost of an airline ticket to the dollar purchases necessary to accumulate
frequent-flyer points), (2) the range of choice of these rewards (e.g., choice of flight destinations), (3) the
aspirational value of the rewards (e.g., exotic free travel is more desirable than a cash-back offer), (4) the
perceived likelihood of achieving the rewards (e.g., how many points are required to qualify for a flight),
and (5) the schemes ease of use. 20 To this, we add the psychological benefits of belonging to the program
and accumulating points.
Timing.
The potential of a loyalty program to attract members depends not only on the value of its rewards but also
on when the rewards are available. Research in psychology suggests that when a loyalty programs
redemption rewards are delayed, they are less powerful. 21 Many accumulating benefit programs, such as
frequent-flyer schemes, try to alleviate this problem by regularly sending their members a statement of
accumulated points. Typically, the statements are accompanied by promotional material about the
aspirational value and ease of achieving various rewards.
We suggest that more immediate rewards are preferable to delayed rewards, and that direct support of the
target products value proposition increases the chance that the program will build loyalty for the product
and not just the program. We classify different types of loyalty schemes according to the rewards support of
the product or service value proposition and the rewards timing (see Figure 2
(http://sloanreview.mit.edu/files/2008/12/3846ex2lo7.png)). From the customers perspective,
the instant gratification programs (in sections one and three of the figure) should be preferable to those
with delayed gratification (in sections two and four). However, from the sponsors perspective, programs
that make an explicit link between product and program and have a bearing on long-term behavior (in
sections one and two) should be preferable to those with indirect rewards (in sections three and four). From
either perspective, those in section four appear to be least preferable, yet many current loyalty schemes fall
into this category, for example, the Australian Fly Buys frequent-buyer program.
Sponsors offer membership in the Fly Buys program at no cost. Members accumulate points toward free air
travel and hotel accommodation by using a bank credit card and/or a magnetic-strip membership card with
the schemes sponsors a major retailer, a car rental company, and a gasoline company. Within a year of
launch, 1.7 million Australians had taken this free option, which represented 10 percent of the Australian
population, with one member in every four households. 22 The customers immediate rewards are
psychological, namely, a feeling of participation, the anticipation of future rewards, and a sense of
belonging. The delayed rewards are a bimonthly summary of accumulated points and sometimes the
qualification for a reward.
A customer cost-benefit analysis helps explain why the least desirable loyalty program (according to Figure
2(http://sloanreview.mit.edu/files/2008/12/3846ex2lo7.png)) has attracted so many members.
On the cost side of the equation, joining the program is free, and each transaction is handled with an easy-
to-use magnetic strip card. Many people perceive rewards, however, as very difficult to achieve, so the
sponsors have run a TV ad campaign to counter the perception. 23 On the reward-benefit side, many people
value the aspirational aspect of air travel, and others just like being part of a program.
With such a huge market penetration, this program would seem to be a runaway success. But, while the
sponsors had hoped that rewards would be sufficient to increase sales volumes, in practice, they have been
fairly elusive. 24 Also, with so many members, the scheme is expensive to maintain.
Both the Fly Buys case and the research on rewards suggest that designing a loyalty program to disrupt
established patterns of behavioral loyalty is difficult. Despite these difficulties, many schemes have recently
been launched. In the next section, we review some claimed benefits.
The Claimed Benefits of Loyalty Programs

Advocates of loyalty programs contend that they are profitable because:
The costs of serving loyal customers are less.
Loyal customers are less price sensitive.
Loyal customers spend more with the company.
Loyal customers pass on positive recommendations about their favorite brands or suppliers.
These alluring benefits go far to explain the interest in customer loyalty programs. But, with one notable
exception, 25 there is little well-documented empirical research to substantiate these claims. As we have
outlined, evidence from behavioral loyalty and reward research suggests the opposite. Hence, before
willingly accepting that customers in loyalty programs are always more profitable, lets examine each source
of increased profitability.
When there are specific start-up costs involved in serving a new customer, such as prospecting, credit
checks, and entering the customers account details in a database, the costs exceed those of serving a repeat
customer. However, it is not at all clear why the costs of serving a very regular, loyal, repeat customer
should in principle be different from those of serving any other type of repeat customer. Why some
transactions will differ in cost has more to do with the type of transaction, not the loyalty of the customer or
his or her membership in a loyalty program. The key variables driving cost are first purchase versus repeat
purchase, size and type of order, special versus standard order, and so on, not loyal versus divided-loyal
customers.
Why would loyal customers be less price sensitive? They may be, but then again, they may not. It depends
on how important they think price is and on the value proposition that the brand offers. Although one
frequent claim of brand-equity researchers is that brand loyalty and higher prices are positively correlated,
this does not automatically mean that more loyal buyers are less price sensitive. 26 It may simply mean that
these people buy a brand at a higher price because they perceive it to be better. For example, usually a
brand is clearly in only one price category. Less price-conscious people then have the opportunity to buy at
either the cheaper or higher price depending on whether the brand can offer a good reason (functional or
psychological) to justify its higher price. It is perceived brand value, not brand loyalty, that drives price
insensitivity.
Alternatively, loyal customers may come to expect a price discount or better service. In other words, what
are the rewards to the customer for his or her loyalty? If we consider the double jeopardy relationship, these
loyal customers are likely to be slightly more frequent buyers and hence may expect a volume discount.
The next assumption is that loyal customers spend more with the company. This may be simply because
they buy more of the product category than less loyal customers (e.g., business air travelers versus holiday
travelers). As such, it is the weight of purchase that matters most, not necessarily customer loyalty. And, as
we argue in the next section, this is more likely to be a function of the better value offered than of any add-
on loyalty program.
The last assumption contends that loyal customers pass on favorable comments. While this seems a
sensible assertion, there is little research to indicate what percentage of loyal customers help a company to
market its products. The interesting question here is whether only loyal customers, or only those in a loyalty
program, are likely to do this, or is it simply that satisfied customers are the ones that say nice things about
good products and services. If satisfaction is the key driver of positive recommendations, any satisfied
customer should provide this benefit. The only way that a loyalty program can give extra leverage to a
companys word-of-mouth marketing is if the loyal customers offer substantially more, or more effective,
positive comments. We are not aware of research that demonstrates this.
In short, the contention that loyal customers are always more profitable is a gross oversimplification. Each
company needs to use its customer data to determine the truth of these assertions. Here is where the
behavioral loyalty research has relevance. If a particular brand fits the market conditions under which these
research findings hold, there are some interesting implications for the introduction of a customer loyalty
program. The market conditions are:
There is open competition.
Products and services are functionally equivalent in broad terms (and are therefore substitutable).
There is little tendency for any brand to uniquely appeal to a particular subgroup of consumers
(despite brands within a product category being superficially different).
There is little dynamic variation over time in competing brands market shares (despite
considerable marketing activity under the surface to maintain these shares). 27
We can hear your sighs of relief. This doesnt apply to our brand!, you say. But are you sure? Certainly
there are some products and services those for state monopolies, highly innovative new products, and
products whose success depends on fad and fashion that do not appear to match these market
conditions. Moreover, some trivial differences certainly seem to affect choice. 28 However, most airlines,
banks, beers, executive education programs, frozen foods, hardware stores, instant coffees, mineral waters,
gas stations, plastic pipes, cars, stationery suppliers, TV soap operas, and so on compete directly with each
other within their product category. This usually means that when specific products and services are not
conveniently available, most people will not hesitate to buy a similar brand or may deliberately seek variety.
Our argument is that these market conditions hold more often than you may think. Given these effects, in
the next section, we make some suggestions for designing a loyalty program that offers the best chance of
providing a positive return on its investment.
How to Design an Effective Loyalty Program

Here we focus on loyalty programs that attempt to lock in a customer by offering an accumulating benefit,
which increases the switching costs to the buyer over time (the programs in section two and four of Figure 2
(http://sloanreview.mit.edu/files/2008/12/3846ex2lo7.png)). In economic terminology, they
try to change the customers choice process from operating in a spot market to operating in a multiperiod,
contractual relationship market. The programs are potentially dangerous because they require a companys
long-term commitment and funding. The programs in section one and three of Figure 2
(http://sloanreview.mit.edu/files/2008/12/3846ex2lo7.png) are short-term promotions; they
might well stimulate sales for the duration of the promotion but do not have any long-term behavioral after-
effects. 29
For frequent-buyer loyalty programs, the level of customer involvement is an important consideration. For
a high-involvement purchase, the consumer is likely to be involved with both the category purchase
decision (Will I fly or go by train from London to Paris?) and the brand choice (Will I fly British Airways or
Air France?). For low-involvement decisions, the level of involvement is likely to be low for both decisions,
although somewhat higher for the category purchase decision. We suggest that loyalty programs will be
more effective for high- than low-involvement products and services, primarily because low-involvement
products are often bought by consumers out of habit, while, for high-involvement products, consumers
might form a relationship with the supplier (the difference between the habitual purchase of Nescaf, say,
and joining Club-Med).
In either case, to maximize the programs chances of success, the following guidelines are helpful:
1. Designtheloyaltyprogramtoenhancethevaluepropositionofaproductorservice. To the extent that

frequent-flyer clubs and the GM card enhance the value of the airline or car, these schemes are more
worthwhile than a frequent-buyer scheme, such as Fly Buys, which does not. In this respect, probably the
least useful rewards for customer loyalty are free gifts such as lottery tickets; these are nice to receive but
tend to be only short-term tactical froth that can devalue the brand.
2. Fullycosttheloyaltyprogram. There are a number of highly visible costs, such as those associated with
program launch, database creation and maintenance, value of rewards claimed, and issue of regular activity
statements. The costs of frequent-flyer programs are reportedly between 3 percent and 6 percent of an
airlines revenue. 30
Many airlines peg their advertising spending at approximately 3 percent of revenue. Many other loyalty
costs are less visible, namely, the opportunity cost of managers time spent on the loyalty program rather
than on other marketing activities, and the effectiveness of the loyalty program compared with an
alternative use of the funds. It is wise, therefore, to be cautious in allocating the marketing budget to a
loyalty program. If competitors make a countermove, resources will be needed for a robust response.
3. Designarewardschemethatmaximizesthebuyersmotivationtomakethenextpurchase. Most
existing reward schemes achieve this only indirectly because they dont account for customers current
situations (Are they light or heavy buyers? How many reward points have they accumulated?).
In many reward schemes, for each dollar spent, a participant gains the same number of points (see Figure 3
(http://sloanreview.mit.edu/files/2008/12/3846ex3lo7.png), section A). In the Fly Buys
program, the more a member buys, the more he or she flies. Airlines often use a variation of this scheme; an
economy class air-fare results in 1 point per mile or dollar spent, business class 1.5 points, and first class 2
points. The incentive is to spend enough to gain access to different reward levels. Some other reward
schemes are more transparent to the buyer (see section B). They offer more reward points for each
additional dollar spent so that the next purchase is increasingly more valuable to the buyer. The three zones
(1, 2, and 3) in the response function are designed to balance the costs to the company of having too many
unprofitable participants with the customers motivation to participate in the scheme.
In zone 1, light buyers may join but will not gain many rewards. Unless a company can be extremely
effective in cross-selling other products and services to these buyers, it doesnt want them in a loyalty
program. Maintenance of a database and regular communication with too many of these buyers can be
costly; however, it is important not to alienate them. They may not think of themselves as light or
insignificant buyers. The response function is steepest in zone 2. Here the aim is to motivate the midsize
buyer to continue buying and to allocate more purchases to the product. These customers are likely to be
the most profitable type, big enough to be profitable to serve, but not so big that they request a volume
discount. The response function is flat in zone 3, which implies a company should limit the rewards
available to super-heavy buyers. The value proposition is already good for these customers, and their
current level of buying suggests that it will be difficult to entice them to buy even more, unless the company
enhances the value proposition itself or gains wider distribution.
The point here is that whatever reward scheme a company adopts, it should design it with the profitability
of different types of customers in mind. Ideally, this will motivate the most profitable customers to give a
company a higher share of their business. But realistically, in a competitive market where copycat schemes
are inevitable, the aim may be no more than to ensure that the company maintains market share (with the
attendant level of loyalty and divided loyalty).
4. Considerspecificmarketsituationsinplanning. (For some typical situations, together with comments

on whether a customer loyalty program is appropriate, see Table 1
(http://sloanreview.mit.edu/files/2008/12/3846ex4lo7.png). Because the situations are usually
interrelated, our comments are guidelines, not inviolate prescriptions.)
Conclusion
There are three primary lessons from the research and examples we cite here.
First, a major reason for the launch of many customer loyalty schemes is competition. Companies may want
to preempt a competitor (and possibly secure first-mover advantages) or respond to a competitors scheme
(as in most of the frequent-flyer clubs).
Second, apart from purely defensive reasons, if a loyalty program does not support the product or service
value proposition, it might be justified in enticing more distributors to handle the product, a demand-pull
effect. As noted earlier, for many products and services, there is a positive relationship between distribution
coverage and market share.
Third, the behavioral loyalty research we reviewed here suggests that brand loyalty is more likely to come
from the market in which a company operates and the brand it has already than from an add-on customer
loyalty program. In other words, in most cases, all that a customer loyalty program will do is cost money to
provide more benefits to customers not all of which will be seen as relevant to the brands value
proposition and/or positioning. The program is unlikely to significantly increase the relative proportion of
loyal customers or profitability.
These lessons suggest that customer loyalty programs that (1) neutralize a competitors program, (2)
broaden the availability of the product or service, or (3) directly enhance the product or service value
proposition may be worthwhile. But they also suggest that (4) it is probably a mistake for a company to
introduce a frequent-buyer program if it is selling a parity brand in a competitive market and merely add a
me-too scheme. Competitors are sure to counter the move with something of equal perceived value. If they
offer a price cut, the value of such an immediate reward may be more motivating than the promise of a
potential but delayed reward. If they counter with a loyalty program, it is likely to be a better program in the
hope of winning back defecting customers.
We have reviewed a body of research that indicates that many programs widely discussed in the business
press may be seriously flawed. Like some recent management strategies or fads, many customer loyalty
programs seem to have been adopted too quickly, without much thought. 31 Our aim here is to generate a
more critical analysis of the schemes, especially those added on to prevent the gradual loss of customers.
ABOUT THE AUTHORS

GrahameR.Dowlingisanassociateprofessor,AustralianGraduateSchoolofManagement,UniversityofNewSouthWales.MarkUnclesisaprofessor,School
ofMarketing,UniversityofNewSouthWales.
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03/05/2017 Do Customer Loyalty Programs Really Work?

Do Customer Loyalty Programs

Grahame R. Dowling and Mark Uncles

Why Companies Introduce Customer Loyalty

Subsequent research claimed that loyal customers are more profitable

For a company to practice loyalty marketing, however, it must first

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The Leaky Bucket Theory versus Polygamous

Ehrenberg, in what he dubbed the leaky bucket theory, observes that

To address this question and to establish norms of consumer behavior

Linking Customer Rewards to Loyalty Programs

Direct or Indirect E ect.

How Buyers Value Rewards.

The Claimed Benefits of Loyalty Programs

The costs of serving loyal customers are less.

Loyal customers are less price sensitive.

Loyal customers spend more with the company.

There is open competition.

How to Design an Effective Loyalty Program

1. Designtheloyaltyprogramtoenhancethevaluepropositionofaproductorservice. To the extent that

4. Considerspecificmarketsituationsinplanning. (For some typical situations, together with comments

ABOUT THE AUTHORS

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