What makes loyalty program work? The Effects of Introducing and. Terminating Loyalty Programs.

Transcription

1 What makes loyalty program work? The Effects of Introducing and Terminating Loyalty Programs. Submission to the Research Translation Competition. Valentyna Melnyk* *This document is based on the academic article: Melnyk, Valentyna and Tammo H.A. Bijmolt (2014), The Effects of Introducing and Terminating Loyalty Programs, European Journal of Marketing, accepted and forthcoming. The Problem. Despite firms across the globe spend billions of dollars on loyalty programs, actual consumer loyalty has been on the decline since 2008 (The Deloitte Shift Index, 2011). Thus, it is not surprising that many firms have reconsidered the value of their loyalty programs. And while some have decided to terminate or modify their existing programs, other firms are concerned that terminating their program may backfire. These rises the following key question: 1) whether loyalty programs actually enhance customer loyalty, 2) what happens if a loyalty program is terminated and 3) which types of program s design elements enhance effectiveness of loyalty programs. Method. Our study is the first study to empirically differentiate the loyalty program s introduction and termination stages and identify how loyalty program designs characteristics (that are in control of a manager) influence loyalty program s effectiveness at each of the stages. The empirical evidence is based on a large-scale dataset involving 9,783 consumers rating 24 different loyalty programs across eight industries. The distinction between introduction and termination stages is crucial for companies that have recently introduced, modified or terminated a loyalty program or those who are considering doing so. Not only do we empirically investigate the effects of loyalty program termination, but we do it by simultaneously estimating effects of those programs at the introduction to take

2 into account the effects of the whole life cycle, in a bivariate hierarchical linear model. This econometric method allowed us to empirically investigate to what extent the effects of introducing and terminating a loyalty program depend on 1) its monetary and non-monetary design elements, 2) customer characteristics and c) competition, as we elaborate below. What are Design elements? A loyalty program may have monetary (e.g. savings, discounts, etc.) and/or non-monetary elements (e.g. extra service, preferential treatment, etc.). In this research we focus on the most common monetary elements of a loyalty programsavings points and discounts. Other less frequently used forms of monetary rewards may include cash rewards or combinations of those with savings (e.g., using saved points as currency- like Air NZ s airpoints). Irrespective of the type, all monetary design elements have one aspect in common: they create monetary benefits for customers which presumably increase switching barriers and thus enhance loyalty. The problem with these elements is that they are usually very costly for the company, while the effects of terminating such loyalty programs are still unclear. In contrast to monetary elements, our knowledge of more recent non-monetary elements is limited. While customer relationship management (CRM) literature emphasized that implementing relationship-oriented strategies may enhance behavioral loyalty, the types of those specific measures and their effectiveness are not clear. Based on our research, we identified two distinct non-monetary elements: differentiation between members and nonmembers and customization. Non-monetary differentiation means that a firm treats its loyalty program members differently from non-members by offering them extra services and special events (e.g., extra shopping evenings for members only, demonstration, etc.) that do not provide direct monetary benefits. Non-monetary customization means that the non-monetary rewards are adapted to the individual s needs rather than being standardized across all members. Hence, it captures differentiation among members (e.g., elite members of airlines

3 board a plane first). Farmers s Club card (NZ) represents an example of a loyalty program with differentiation between members and non-members because they e.g., organize special day for card holder. In contrast, Tesco (UK), is a classic example of customizations- they send up to 2000 different version of customized correspondents to its members. Both types of non-monetary elements may make a customer feel special. In the case of differentiation between members and non-members, the psychological benefits to consumers may come from their sense of belonging to the in-group, while in case of customization, it may come from a sense of being recognized and treated as an individual. To be able to estimate the effectiveness of those design elements, in this research we have separately cataloged and coded the designs of each of the 24 loyalty programs in our dataset. Namely, we included the saving rate the loyalty program offers (in our dataset the value of the points being saved ranged from.5% to 6.1%), the depth of the discounts (the discount percentage ranged from 2% to 10%, with an average of 4%), and whether the program has differentiation and/or customization elements. Under half of the loyalty programs in our dataset used customization or differentiation (11 out of the 24 programs), while 8 programs had them both. In addition to the effects of the design elements, we simultaneously account for the effects of competitive environment in the industry (i.e., share of the firms in a given industry with loyalty programs) and a number of customers demographics. Findings and Implication for Loyalty Program Management Overall, we find that while the characteristics of loyalty programs designs are more important in influencing customer behavior when they join the loyalty program, the competitive environment and the duration of membership in a loyalty program are the

4 primary drivers of customer reactions to loyalty program termination. We elaborate on those below. Loyalty programs should ideally have a positive effect on customer loyalty at their introduction, and this effect should be sustained (and definitely not decrease below the preprogram level) if the program is discontinued. Our results suggest that realistically managers can expect a significant drop in customer loyalty in cases of loyalty program termination. Ideally, companies should build their loyalty programs taking into account all the stages of its lifecycle from the start. Loyalty Program Introduction. When a firm considers introducing a new loyalty program or the modernization of an existing loyalty program, our results suggest that nonmonetary differentiation between members and non-members seems to be the most effective tool in building customer loyalty. This is because it significantly increases customer loyalty after entering a loyalty program and can be sustained if the program is discontinued. While saving elements are common in those programs, offering a relatively low saving rate is a viable way to keep costs down, because the savings percentage does not significantly affect loyalty. For the same reason, firms can also consider reducing the depth of the loyaltyprogram based discounts. The results regarding customer characteristics also suggest an additional consideration for the loyalty program designs- companies should find a way to minimize the privacy concerns of their customers. One possible strategy is to give a choice between two cards. One is anonymous and one is personalized, which provides special tailored offers. Loyalty Program Termination. When a firm considers terminating a loyalty program, our study suggests the following considerations. The competitive environment and the duration of membership in a loyalty program are the primary drivers of customer reactions to loyalty program termination. These imply the following considerations. First, although the

5 termination of a loyalty program is likely to especially backfire in industries with a higher share of other firms with loyalty programs, it is relative safe if there are not many other stores/firms in a given industry with loyalty programs. Second, termination of an older loyalty program based on a savings feature (which is likely to have a higher share of longterm customers) is going to have the highest negative impact. One thing that managers can do to soften the impact of such a loyalty program termination is to ensure that customers can still redeem all of their saved points as it may help to soften the negative effect of the termination, especially because redemption also leads to lower churn. Yet, as simple as it sounds the practice shows it is rarely done. Consumer Characteristics. Regarding consumer characteristics, firms with larger share of male customers should be especially careful. While it appears to be relatively easy to enhance loyalty for men by introducing a loyalty program, the corresponding size of the decrease in retention for men if the program is discontinued is about twice higher. At the same time, extra caution with female customers is needed when terminating a loyalty program with a customization feature. Firms with a high concentration of price-sensitive customers (e.g., low-price grocery stores in poorer neighborhoods) should be aware that for these customers, the potential decrease in loyalty in case of a loyalty program termination may very well outweigh the corresponding gain due to the program introduction (as the decrease is about actually about 2.5 time higher). Highlight. On the positive note, one of the most intriguing findings of this research is that taking into account the whole life cycle of a loyalty program, a simple, non-monetary differentiation between members and non-members is a more powerful tool in creating customer loyalty than offering higher discounts or saving points. Importantly, the effect of this differentiation on loyalty sustains when a loyalty program is terminated.