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The Myth of Customer Loyalty

1to1, August 05, 2008 by John Gaffney

The Myth of Customer Loyalty

Are loyal customers truly more valuable? We reveal the hidden costs of poor execution and the real value of loyalty done right.

There has never been a better time to focus on building customer loyalty. Multichannel options and a barrage of messaging have made consumers more fickle than ever. Take retail, for example. The number of customers stating they've been shopping at a retailer for longer than one year dropped in 2005 to 77.2 percent from 88 percent the year before, according to a new report from Adjoined Consulting and SAS.

For those organizations that can capture their customers' loyalty, the rewards are huge. A Bain & Company study shows that companies defined as loyalty leaders grow revenues twice as fast as their competitors, and do so with lower costs.

But like anything in business, execution is the tough part. Our research shows that customer loyalty initiatives need to be retooled and repositioned at most companies. Too often companies mistake offering basic points programs as the sole way to capture loyalty. On their own these dressed-up discounting schemes do little to increase the value of the customer base or increase a company's value to key customers. But well-planned loyalty programs can increase the value and frequency of purchases among your most desired customer groups -- if the overall loyalty initiatives tie themselves to customer value and if they help your company gain incremental revenue. If not, your company is buying into one of several myths about customer loyalty.

Many companies assume that a loyal customer is automatically a valuable customer. Not true. Many companies think that offering a loyalty program guarantees customer loyalty and automatically increases customer value. It doesn't. And many companies believe they can foster loyalty with one program to fit all customers. Wrong again. Worse, many companies consider their points program a complete loyalty initiative. It's not.

Buying into these myths has left many loyalty initiatives in limbo at best. It's time to dispel the myths and create loyalty strategies that drive real results.

Myth 1: A loyal customer is a valuable customer

The most destructive myth is the one that says a loyal customer is a valuable customer. Most companies simply do not examine how loyalty connects to customer value. The problem with not doing so is that a customer who looks valuable on a balance sheet may in fact be a high-maintenance drain on customer service, a bully on contract terms, or even a detractor.

"If you frequently buy from a company, but you're not happy with that experience or with the company, you are not necessarily a valuable customer," says Shelley Symonds, vice president of marketing for Satmetrix. "I may own a car that I drive all the time, and it may even be my second or third purchase, but if I don't like the car, and I tell all my friends not to buy it, I am not a valuable customer. In fact, I am destroying customer value. I am the antithesis to loyalty."

Companies must define "valuable" customers before they define "loyal" customers. For example, Nike's definition of a valuable customer may be a customer who buys direct from the company, either at Niketown retail locations, from its Web sites, or from its wireless commerce touchpoints, because it doesn't have to slice its revenue between distributors and retailers for those purchases. However, a loyal customer for Nike might be someone who buys Nike shoes frequently no matter the channel and tells friends to buy them. Once Nike makes the distinction, it can focus its loyalty efforts on those loyal customers who are also defined as valuable customers.

Myth 2: Offering a loyalty program guarantees loyalty

Some companies feel that any customers who participate in loyalty programs will become loyal customers. Once again, not true. Some people may join out of convenience (e.g., someone who travels out of Seattle may belong to United Airlines' frequent flier program but actually prefer to fly Alaska Air anytime he can). Others may join just to accrue discounts where they sometimes shop.

A 2005 Carlson Marketing Relationship Builder survey showed that consumers have various reasons for joining -- and not joining -- loyalty programs. In the U.K., for example, 52 percent of survey respondents said they do not sign up for loyalty programs because they don't spend enough money with the company to make their effort worthwhile. Thirty-nine percent said the programs did not offer enough rewards. The reasons for joining loyalty programs have changed drastically over the past two years, the survey said. Points and discounts both dropped by more than 20 percent. But special offers jumped 200 percent. This shows that factors like service are gaining importance.

The Carlson research also points out the importance customers place on the benefits that they value. These benefits might be rebates for one customer; they might be prizes for another. Maybe it's a service like exclusive product information, educational content, or free shipping. "When a company engages its customers through such targeted offers, there is a relevant interaction that can help to create an ongoing dialogue. This provides valuable customer insight companies can use to build real loyalty," says Andy Wright, executive vice president, sales and marketing, for Carlson Marketing Worldwide. "Loyalty programs should be held to this standard. If companies can successfully use the data they collect through loyalty programs to meet customer needs, then they will lock in a truly loyal relationship."

Myth 3: Points programs are a complete loyalty initiative

According to the Carlson survey, the top three reasons a customer will remain loyal are value for money, quality of products, and customer service. None of those things have anything to do with loyalty programs. That's why considering strategic loyalty initiatives, rather than only loyalty points or rebates programs, provides an important difference. A loyalty initiative brings all facets of your company in alignment with the goal of keeping and growing desired customer groups. A loyalty program is one important tactic that is part of, not the totality of, a loyalty initiative. A customer can be a member of your loyalty program, but not necessarily be a loyal customer. Customer loyalty is an outcome of your loyalty initiative.

A loyalty initiative is a customer strategy that encourages incremental spending and new spending on other product lines, as well as recommendations. It is also a strategy that works best in a corporate culture with a customer-centric mindset. The company centered on customer loyalty will encourage customer feedback. It will find the finer points of customer experience that result in creating customer evangelists. Think Starbucks or Nordstrom. It is also a company that will extend its concern with customer loyalty to employee loyalty. Fred Reichheld, author and director emeritus of Bain & Company, notes that many loyalty leaders are price competitive, yet pay their employees higher-than-average wages. He cites Enterprise Rent-A-Car, Costco Wholesale, and the Chick-fil-A sandwich chain among them. No coincidence that these companies are ranked high on Reichheld's index of customer loyalty.

Myth 4: Companies can foster loyalty with one initiative to fit all customers

Just as the concept of one-to-one marketing encourages companies to connect with all their customers through customized treatments, loyalty programs should have the same goal. Companies must determine their customers' value and then create the appropriate loyalty initiatives for each customer group. At Saks Fifth Avenue, for example, customers have to spend at least $1,000 a year to be eligible for the SaksFirst program. At the most basic level SaksFirst is a points-based discount program that addresses this customer group's desire for savings. However, at the Privileged level, customers receive enhanced service offerings. If a hot designer has a new line coming out, this level of SaksFirst customers gets an invitation to their local store and free shipping for online purchases. At the Diamond level customers get free fur storage and free valet parking when they visit a retail location.

Considering customer value is just as important when designing a points-based loyalty program. American Express is mentioned most often by experts in the field as having the most sophisticated loyalty program. Examine it and you'll find different rewards for different customer value groups. It starts with the different cards the company offers. The traditional green card offers a straight points program, which is upgraded at the Preferred level for heavier card usage. The gold card offers four levels of rewards based on spending, and gives higher-income customers entry into a partner reward program for travel. The platinum card takes the reward program to another four levels. In total American Express has 24 levels of loyalty based on customer value. No surprise that for its most recent quarter average cardmember spending (organic growth) rose 15 percent over the previous year.

Australia's Virgin Blue airline has recalibrated its loyalty program, called Velocity. Instead of rewarding frequent fliers for the amount of miles they fly, Virgin Blue customers accumulate points based on the price of each plane ticket they purchase. This shows more authentic customer value because it rewards those who fly first or business class and coach fliers who pay full price. Those are valuable customers by Virgin Blue's definition, and Velocity rewards that loyalty.

Focusing loyalty initiatives on customer value will result in more efficient marketing spending. "You can no longer spend the same money across all customers and expect that you will end up with loyal customers," says Mark Goldstein, CEO of LoyaltyLab, a provider of on-demand loyalty programs. "You must Œscore' customers to spend your money efficientlyŠ. Look at the total transaction amount, the frequency of purchases, and whether the customer has referred the company to a friend." This approach can help marketers determine appropriate loyalty programs for different customer groups.

To help accomplish this, companies should address loyalty initiatives through the concept of "informed creativity," Carlson's Wright says. It requires companies to measure customer value, understand the drivers that will increase that value, and take action on them in the form of a loyalty initiative. "Loyalty should produce deeper relationships," he says. "Who are your customers? How do they operate in markets outside of yours? You can only really know the answers by gaining insight into your most valuable customers, determining the groups that are best reached through traditional marketing tactics, and then identifying the groups that can be kept and grown through loyalty programs. Different customer groups need to have different customer experiences."

Myth 5: Loyalty initiatives are all about making customers happy

Loyalty initiatives must address customer expectations, but to be truly strategic they also must achieve the goal of increasing the value of the customer base. Loyalty think tank Colloquy published a report in late 2005 showing how one retailer accomplished this. The report analyzed the data from an unnamed 400-plus store U.S. retailer with annual sales topping $4 billion. The retailer tested five different programs. One simply tracked the purchase behavior of 30,000 customers over a six-month period at the end of 2004. No rewards, no points, no rebates. The second group was offered a points program. The third was offered rebates. The fourth was offered a service package that blended rebates with additional privileges such as exclusive parking areas and discounts at partner companies. The fifth was offered a blend of rebates, service, and points.

At the end of the two six-month tests, the reward, rebate, and combination tests all generated positive revenue lift over the control group. But the combination cell (the fifth group) was the clear winner. In fact, using a blended value proposition surpassed the retailer's goals for revenue change. Using a composite of recency, frequency, and monetary spend measures, Colloquy found that the retailer's blended loyalty customers returned value scores a full 10 percentage points higher than the control group.

The Colloquy report proves that customer value can be positively affected by loyalty programs. This is also the case with strategic loyalty initiatives, but only when those initiatives consider customer value, as well as consider what the customer values.

In fact, truly effective loyalty programs encourage incremental spending from a company's most growable customers, as well as help attract and retain those customers. That approach has gathered momentum, as evidenced by the increasing popularity of paid loyalty programs. Best Buy, Amazon.com, Barnes & Noble, CompUSA, Swissotel, and many other companies have created a top tier to their loyalty programs that requires customers to pay a small fee per year for participation. On the plus side, these programs get companies' biggest "fans" to identify themselves.

"Anytime I can get my most important customers to raise their hand it's a good thing," says John White, vice president of marketing for Adjoined Consulting. "It also creates a new most-growable category, because if customers have paid for a loyalty program, they will also want to make it pay off. That means they will focus their purchases in a particular category on the retailer or service provider they have paid the cost of entry to."

Proceed with caution, however, when it comes to paid loyalty programs. Some experts say customers will only pay to be in an exclusive program once. Often after year one, many will expect for free what they once paid for. So it may be best to consider paid loyalty an identification tactic.

Myth 6: Loyalty programs automatically increase the value of participants

A customer who signs up for a loyalty program may not spend more with your company just because he get rewards for that spending. But few companies consider customer value when creating their loyalty initiatives. The problem here is "rewarding" customers who may not deliver any value in return.

"Companies have to realize that there are certain customers whose loyalty you don't want," says Jim Koppenhaver, group vice president at Echelon Targeting. "A program that simply uses low prices and deep discounts as a reward for shopping is not going to help you increase a customer's investment in your company. You must find the customers who are investing in your company through behaviors that are helping you. You want customers who will pay full price. You want customers who have the spending power to boost revenue and give you a competitive edge."

Neiman Marcus uses its loyalty program to encourage its most valuable customers to spend even more money. The program has 20 levels, with 20 different reward schemes based on customer spending. It starts at $5,000 and ends at $1.5 million. The rewards range from free designer clothes ($5,000) to all expenses paid vacations at remote Caribbean islands ($1.5 million). A customer at the $1 million­plus level gets a gold-plated NM credit card with her name and number etched on it. Not only are the incentives built to separate customers by value, they are built to encourage customers to spend more. For example, the difference between $15,000 and $20,000 in spending is the difference between a Sony MP3 player and a $600 gift certificate for Manolo Blahnik shoes.

But most companies use points, rebates, discounts, and access to exclusive product or event information without any discrimination. The biggest offenders are often companies that actually have the most to gain from value-oriented loyalty. Consider loyalty initiatives in the supermarket business. With the possible exception of housing costs, supermarket spending is most likely a household's biggest monthly expenditure. So attracting, keeping, and earning incremental revenue can make a big difference to a supermarket chain. Dominick's, a 60-store supermarket chain in the Midwest, makes no discrimination in the discounts it offers through its loyalty program. Neither does Stop & Shop, a 355-store chain in the Northeast.

Whether you spend $10 a week or $100 a week, you get the same discounts. On the other hand, consider U.K. supermarket chain Tesco. Its targeted loyalty program is so effective that its "advocate" customers (people who recommend the store to others) spend 60 percent of their supermarket dollars with Tesco, versus an average 30 percent spent by advocates of its competitors.

Like other loyalty leaders, Tesco understands the need to tie targeted loyalty initiatives to customer value. Those loyalty leaders debunk other loyalty myths as well. They know they have to earn customers' loyalty by being relevant, but also by targeting customers who are most likely to increase their spending with the company, to recommend it to others, and to stick around for the long term. Any company that can see through the six myths of customer loyalty and treat it as not merely points to be earned, but a comprehensive strategic approach, is destined to become a loyalty leader.