It’s (almost) never 1%: how to price loyalty rewards

The following quote baffles my mind:

According to IRI Worldwide, 74% of consumers globally choose a store based on its effective loyalty programme.[i]

If 74% of consumers choose a store based on their loyalty program, then why do few loyalty programs have more than 25% of their customers participating?

The answer is simple.

Customers are interested in earning a meaningful amount of value, but the value they receive does not meet minimum expectations – so people quit.

Of course, dishing out ‘value’ sounds scary to a chief financial officer.

But ‘value’ and costs are very different things – and a lot of perceived value can be created, even while reducing investment in loyalty points.

Furthermore, a lot more profit can be created, and a lot of wastage avoided.

To derive far greater profits from loyalty programs, brands should reappraise the way they issue loyalty rewards.

This partly means dynamically adjusting pricing, based on business priorities and rich customer profiles.

It also means building more value into the loyalty program, through personalized offers and partnerships with complementary brands, that make your currency easier to earn, and more rewarding to burn.

This may seem to make rewards pricing more complicated. That’s somewhat true; but there are relatively simple, actionable, tactical steps that brands can take to make step-change improvements in their loyalty engagement strategy.

Anyway – ‘complicated’ is a relative term. It’s high time brands moved on from an exceptionally crude and blunt instrument, which still pervades much of the loyalty industry, and causes a profligate degree of waste.

On the cusp of 2020, 1% is almost never the right amount.

Rewards are transactional; loyalty is emotional

Loyalty programs are effectively a value exchange, in which there ought to be both emotional and transactional forms of value.

In exchange for their data, and for receiving periodic marketing, customers expect to be:

recognized (emotional value)
treated in a personalized way (emotional value)
rewarded with loyalty points (transactional value).

It’s the emotional value which creates real stickiness.

Too often, however, loyalty points are only used by brands as a substitute for failing to create emotional value.

Such ‘loyalty’ programs today are actually just rewards programs: ‘you do this and I will do that.’ This is normally in the form of static rules which apply a flat 1%+/- reward across the board.

Such static rules can create habits, but are often not optimal to maximize brand affinity.

At a business level, this is because they breed short-sighted reporting, drawing undue attention to the immediate transactional relationship, rather than the long-term value of a customer relationship across multiple touchpoints.

But it’s also because the factors that affect a customer’s loyalty are not static, but highly fluid.

For instance, if there is a major service issue, you may lose a customer unless you can recover them (usually through honesty, recognizing the cause of the problem, and offering something of material value to make up for the mistake).

Other times, a competitor may deliver a very compelling offer.

In either case, you may miss a sale or two, but if the customer is emotionally attached to your brand, you will often win them back.

Many loyalty teams understand this, and so recently, a debate has been heating up about exactly how to pursue more emotional loyalty.

There are two main things you need to do.

First, if you want to make the most money, there needs to be a little excitement. Building customer habits is important, but ‘routine’ will lead customers to cease to pay attention to your messages because each message is perceived as always the same. This is giving rise to a trend of dynamic pricing, by some forward-thinking brands.

Second, emotional loyalty involves rewarding your customers for many more touchpoints than just purchases.

Too many brands still only reward customers with points when making a purchase. Too often there are no incentives for referring customers, posting product reviews, sharing campaigns on social media, or answering surveys.

These emotional forms of engagement are really powerful in getting the customer to commit to your brand.

Why 1% in points is often the wrong amount

Of course, emotional loyalty can only work if there is a base of rational/transactional loyalty on which the customer can justify their emotions and behavior.[ii]

This means issuing loyalty points – a tactic which can be highly profitable, if done correctly.

However, brands often make two costly errors in how they issue these points.

One error is simply to give away too little value.

In my case, I estimate what I can get in points value for every $100 spent with a brand. If it is not at least 1%, or I am not able to earn at least $20 per year from my spending amount and frequency, I’ll generally not participate in the value exchange.

Plenti in the USA was a program I joined about three years ago. After the first purchase at Macy’s, I realized I was getting points worth less than .5% of the purchase amount. I didn’t call American Express to close my account, but I never presented the card again at any of their partners. That same reaction by millions of other members led to the program closing a few quarters ago.

It may be optimal that Macy’s only give .5%, but Plenti should have made sure my first purchase was worth much more by offering a bonus, or an offer to earn a bonus with my next purchase. Instead, they just let our potential relationship wither.

The other error is to offer a blanket percentage reward.

At first, customers have very little knowledge about what your points are worth, but they quickly become educated and eventually decide your points are worth collecting (or not).

If a customer knows they will always get 1% no matter what they buy, then they will buy what they want when they want.

Businesses that shake up the amount of points offered can get customers to shop during slow periods by offering bonuses, or increasing the percentage of points on items before those items need to be discounted in order to sell out.

Points awarded dynamically can also increase average basket size.

This can be an effective means to gamify the customer relationship and add some excitement, while driving the specific behaviors or purchases that benefit the brand.

Brands have become much better at this kind of thing; United and Lufthansa are just two airlines to have switched to dynamic rewards pricing in 2019.

Factors that go into calculating how much you should offer, or how much you can afford to offer in points, include:

would the customer have bought the item anyway (little need to provide an incentive)
the margin of the product/service (higher margin items can afford more points)
perishability (increasing incentives for items that could expire or capacity that could go un-used)
competition (the level of competition – in general, or for a particular product/service – may influence the amount of points needed to secure a sale)
apathy or lack of need (impulsive items may require an exciting amount of points)
potential life time value (LTV) of the customer (do they have the profile of your best customers and how do you get them started on the journey to become loyal to your brand?)
profile of the member (based on their frequency, basket size, tier level, etc.).

Across many of these factors, providing the customer with a super bonus for a specific behavior or purchase can feel as good as a great redemption; they got something significantly extra from the brand. And yet, these points may not incur a direct cost to the business until well in the future, so their perceived value can far exceed an immediate discount or the ultimate redemption cost.

It’s also worth considering that, after a customer redeems, they often have few points in their account and know they won’t benefit again for many months (or years). That is when switching costs are at their lowest – and so that’s precisely when you want to offer something amazing to quickly get the customer back to 20%+/- toward their next redemption.

Brands only balk at loyalty because it looks more tangibly like giving away free money. Actually, issuing 10-20% in points on a few transactions may be exceptionally profitable if it helps you get to know your customer better, or if those purchases drive behavior that maximizes lifetime value (LTV).

Many brands have no qualms about paying $17 to acquire a customer on a $150 purchase; or, $1 for a click through to a landing page, with fairly low expectation the customer will convert.

For example, many brands in Europe offer 4-8% in cashback to any customer to encourage a purchase, whereas they are offering members of their loyalty program about 1% in loyalty points.

This behavior is teaching customers that it is more beneficial to be opportunistic.

Correctly managed, your loyalty program can be the antidote to the wastage of other forms of offline or digital marketing: a tightly-run, carefully measured profit center that optimizes ROI.

Higher points value for customers; bigger profits for brands

The value given to customers is not the same as the cost of the points.

The cost of your points is the average redemption cost across your whole catalog.

The value is how the consumer perceives the worth, interest or utility of the catalog items.

Both these factors can be manipulated to drive higher profits – but there are right and wrong ways to go about this.

The right way to optimize points value is to collaborate with business departments or complementary brands to offer desirable redemption options with a low wholesale cost, but high perceived value in the eyes of the customer.

In this way, the perceived ‘value’ of each point can be improved without changing the actual redemption cost.

Ripe opportunities to do this include:

perishability: products that are unlikely to sell and would need to be marked down in order to get customers to buy. If these are offered for redemption, loyalty members may perceive value at the level of the standard price – but your cost is much less, since you would likely have taken a major markdown if the product hadn’t sold easily
under-utilized service capacity: capacity that may go unused can be offered for redemption with a perceived value close to normal selling prices, but at a small actual delivery cost, since the staff are working anyway
partners’ distressed inventory: brands that offer complementary services, in the eyes of the customer, may be willing to offer you distressed inventory at a cost that is far below the customer’s perceived value. Hotel rooms forecast to be vacant would be a classic example
key products as leading indicators: certain products may lead to further purchases, and/or a long customer relationship – and therefore, should be incentivized to get that relationship started. One example that jumps to mind is HP’s low price for printers – that usually won’t work with cheap toner cartridges from other suppliers. You get attracted to a relationship with HP over the low printer cost and then you are stuck paying double for toner
‘steroids’ redemptions: curated content where you can acquire items such as soccer league tickets, hotel rooms, concerts, exclusive events, etc. at low cost, because supply exceeds demand. We call these aspirational redemption options ‘steroids’ because they have very high perceived value, but can be acquired at relatively low cost
adding ‘earn’ partners: increasing the ability to earn your currency by finding partners that will also issue your loyalty points.

All these tactics can create perceived value that’s far greater than the average redemption cost.

In short, you stand to make customers happier – and profit from the greater engagement and appreciation.

Unfair trade

The wrong way is to devalue your points, or to make redemption too hard.

Devaluing your points has a negative impact on all your customers – including the best ones.

I’ve quit many airline programs in the past decade because they made it nearly impossible to redeem the hundreds of thousands of points I earned, that should have been worth a free flight (or four).

Redemption availability among airlines has been a major problem during the past 3-5 years – in part because airlines are selling most of their seats and not allocating sufficient inventory for redemption. This is really burning relationships with people who worked hard to earn their loyalty currency.

Many CFOs traditionally liked breakage – where a customer does not redeem their rewards – because it reduces the effective cost of points issued.

The impact of such tactics may be hard to measure, but undoubtedly, it has produced widespread apathy among all but the most frequent customers.

The Washington Post recently reported,

‘These travelers have spent years, even decades, accumulating miles and points, only to discover that the loyalty only goes one way.’[iii]

It is for exactly these reasons that the Net Promotor Score (NPS) for a brand’s loyalty program is often lower than for the brand itself.

Most departments in a business now recognize that breakage is, in fact, reflective of frustrated customers: where the value of points is not great enough to influence the customer’s purchase decision, and where their relationship with the brand only sours over time.

Loyalty marketing professionals have also misjudged the greatest opportunities for getting less frequent customers engaged in the loyalty program, by refusing to offer the exchange of points with partner brands. In practice, most customers do not exchange out of a program, but they love the idea of having such freedom.

Brands that enable exchange make the currency have value even for customers who simply cannot spend that much on your products or services.

Of course, these brands should control the exchange rate, so redemptions within the program have the highest value. But, there should be some value for everyone – especially if your goal in the first place is to capture customer data.

Losing value because of excessive margins on points sold to partners is also a problem.

Some programs charge 3 cents per point when sold directly to customers, or 2 cents to partners, but when the customer goes to redeem, the points are worth between .15 and 1.0 cent.

The points may be worth about .8 cents when redeemed for a hotel room or airline seat that is forecast to be vacant. They may be worth .5 cents when redeemed for a hotel room outside the program (because the program has to pay cash to the supplier), and they may be worth less than .3 cents when redeemed on merchandise in the rewards catalog.

This practice has generated huge profits in the past, but actually, this level of greed is unsustainable.

That degree of tax (or loss of value) for partners to feed off the mother brand won’t work in the long-run. In fact, such excessive aristocracy led to the Boston Tea Party and the rise of Napoleon.

Today, sophisticated partners such as co-branded credit card issuers will insist on paying no more than 25% above the average redemption value. If a brand wants more partners to allow customers to earn in many more places they shop, they are going to have to offer a wholesale cost on their points of no more than 50% above the average redemption value.

However, this requires a bit of a leap of faith. Reducing margins to increase volume has been proven in selling goods, so it should work. What may make the change easier to digest is recognizing the value of much more data about customers.

A superb example of a program getting this right this is Virgin Australia’s Velocity program.

Velocity Frequent Flyer’s partners in Australia pay for the Velocity points at about the value which the customer perceives. This seems fair. However, many other large travel loyalty schemes charge partners two to three times more than the value when the customer redeems.

Virgin Australia has reaped the rewards for this generosity in their market.

In September, Virgin re-purchased an investor’s 35% stake in the Velocity program, which generated AUD$122 million in ’18/19 and doubled in market cap over 5 years.

So – that is how to profit off loyalty redemptions – not artificially by selling points to partners at a cost above the redemption value.

Collaborate with other loyalty brands

Of course, the right choice of partners lends considerable standalone value.

Steve Hoban said in a recent blog that the impact of adding partners with Pick n Pay (one of the largest grocers in South Africa), and enabling redemption for desirable goods such as fuel, generated ‘a huge increase in share of wallet because customers really valued what they could do with the points.’

This is why coalition loyalty programs typically have much higher levels of customer engagement: because the customer’s frequency across multiple partners can be much higher, especially if groceries and fuel are included.

More effort should go into finding collaborations with complementary brands that may be able to offer products or services at a low cost to your program – if the customer does not know what you paid. But, of equal importance is the additional earning opportunities your customers get and the valuable data insight you can receive.

For example, a hotel room that would be $200 per night, might be forecast to be vacant on a particular night and could be offered to an airline, retail, or rail partner for $60. Therefore, $60 in cost looks like the points are worth $200, the hotel gets a new customer (at $50 above the variable cost to clean the room) and the customer is likely to spend more money in the bar or restaurant, or for parking.

The degree of engagement is often the inverse of the degree of friction in the traditional coalition model. If a middleman charges excessive fees, there is less value for the customer – which reduces motivation because rewards are harder to reach.

Similarly if the exchange rate between programs is poor, customers won’t perceive as much value – which stifles engagement.

We believe the third generation of the coalition loyalty model will involve brands collaborating with each other as peers and connecting with each other, via a low-cost technology partner that enables rapid integration and effective collaboration management tools.

The low cost, and lack of a dominant party controlling the coalition, means much more value will flow to customers, and much better data can be shared among partners to create rich customer profiles.

Incentives for new loyalty touchpoints

While partners can greatly assist with data gathering, there are also opportunities to do this in your own ecosystem.

Too few brands reward customers for non-purchase activities that help generate more value for the brand – such as completing product reviews, referring new customers, participating in research, or simply answering questions about their own preferences.

There is a direct cost to this, but if it creates value, why not share a portion of that net present value (NPV) with customers who are co-creating with you.

For example, the car someone drives will tell you a lot about the customer. Ask the customer what type of car they drive, music they listen to, or places they like to visit for leisure in exchange for a few points and this will greatly enhance your ability to understand what motivates them.

Ask a customer what is their ideal trip or evening out, or Sunday activity or fondest family memory. Then use those insights to surprise 1-2% of customers, and let those stories go viral. The stories will impact much of your customer base.

If a valuable and influential customer had disclosed their favourite Sunday activity is a BBQ and you knew a best friend lived in a city 1000km away – and you had forecasted vacancy on Friday and Sunday flights, you could offer a flight for $25 to let the friend to visit during the weekend. Even at $25, such an incremental traveler (not to mention the PR benefits) would actually be profitable.

Beware that greater points liquidity (customer freedom), in the form of paying with points anywhere Visa or MasterCard are accepted, is coming worldwide. Customers will be able to spend your points in small increments for things they will forget ten minutes later.

This will, of course, require your permission, but market forces will require you to provide this degree of freedom or face losing many members.

In such a world, you will want to encourage customers to save for experiences that tie your brand to fantastic memories. This is done by making the points spent on insignificant items to have a lower value, so customers are incentivized to save.

Relationships with complementary brands, where you do each other favors, can enable this kind of thing to take place at scale.

This is the key to evolving from a rewards program, to a real loyalty program, which leads to greater attachment between your customers and your brand.

Steps to a smarter reward pricing strategy

Changing the way you price your loyalty rewards may seem like a daunting task, but actually, there are relatively simple, actionable steps you can take.

Start by freeing up the funding for loyalty rewards in your ecosystem.

Loyalty is severely held back by the presence of middlemen in the ecosystem, and a lack of collaboration which could drive greater perceived value.

Research has shown that many programs’ total cost represents an additional 150% of the value of points given customers. If 1% on average is given to customers, the direct third-party costs might be 0.5%.

With additional indirect overheads of another 1%, a loyalty program can be costing a brand 2.5% of those sales to loyalty program members – while the customer is only getting 40% of the program cost. Of course, if you collaborate with other brands and therefore attract twice as many customers to participate, the cost of points doubles, but the overheads are better amortized across a much broader base – raising the value that goes to the customer to perhaps 60%-65% of total program costs – which will dramatically increase your overall program ROI.

Then, introduce the technology to enhance the most profitable engagement techniques to maximize Customer Lifetime Value (LTV).

That means capturing customer data from as many touchpoints and partners as possible and getting it into a single CRM so you have a single, but comprehensive view of customers based on coordinated efforts from your loyalty technology stack.

If your current loyalty program management system cannot do this, you don’t have to throw it out. You just need to put a thin layer of cloud tech in front.

Many travel brands are already profiting from the theory introduced in this article, but OTAs are also a good reference point for optimizing every channel of customer acquisition and retention. These technology companies proactively and dynamically adjust their investments across affiliate marketing, Real Time Bidding (RTB), and other channels until the ROI from each acquisition channel is equal.

Brands cannot let intermediaries outsmart them across sales channels. They need to be competitive and use their loyalty currency as a competitive weapon.

For an example, I just booked the Intercontinental Magnificent Mile hotel in Chicago for December 29^th to January 1^st through Hotels.com for $115 per night, whereas the cost on intercontinental.com (their direct channel) is $133 per night. Granted, I may not get IHG points if booking through an intermediary, but I get $11.50 per night in the Hotels.com loyalty program – so the net difference in cost per night is about $25. IHG should keep the price at $133 per night, but give me $25 per night in loyalty points (rather than about 4%).

Most importantly of all, be bold in making continual, experimental, tactical improvements to every element of your loyalty program.

As brands continue to delay implementing new techniques to engage their customers, I often hear ‘We need more time to get our strategy right’.

That sounds like a naive comment from the 1990s.

In a PSD2 (the Payment Services Directive in Europe) and open-banking world, your customers will soon have the power to share everything they buy from you with your competitors – and the competitors will be able to see the gross transaction amount and the date of purchase.

Imagine if Waitrose can know that your customer spends £250 every other Saturday at Sainsbury’s. Do you anticipate they’ll just think that’s nice, or do you think they’ll present your customer with a £15 coupon the Friday before?

In such a climate, an underdeveloped reward pricing strategy will swiftly become uncovered, and most likely weaponized. Competitors, which swiftly learn where they can afford to offer precision-targeted sums of value, will become able to steal ‘loyal’ customers out from under your nose.

So, try stuff. Find out what works (and equally important what doesn’t work).

Break things – and especially break free from legacy models showing diminishing returns.

Strategy in the modern age is formed from testing and learning based on data. Too many organizations are slow to evolve because they claim they don’t yet have their strategy right, so they don’t know what to execute.

Baloney.

It is no longer the 1990s.

Your organization needs to go through various iterations every single year to keep customers engaged.

Changing things up every four to five years is boring for modern customers, and they will move to where the excitement is.

Feeling tied down by your loyalty platform?

Currency Alliance can help.

Our core business is in loyalty partnerships: allowing brands to issue the loyalty currencies most desired by customers. Many partners have integrated into our platform in 3-5 days; and with a single integration, can access a rapidly growing network of partners with whom they can collaborate to meet customer desires, while capturing richer customer data to really understand lifestyle preferences.

Currency Alliance is not opposed to legacy technology.

In fact, we can enable those platforms to be much more flexible – simply by adding a layer of cloud-based, flexible technology in front of them to enable greater collaboration in broader ecosystems.

Currency Alliance continues to be the only provider of a microservices Points Bank platform that can stand alongside, or work in unison with your existing Points Bank. The platform also includes an enterprise-scale loyalty Rules Engine for your partners that do not have their own loyalty system.

This can set you free to choose the CRM, Campaign Management, and Redemption Catalog options that best serve your business.

Our platform is basically a tool kit for building a highly differentiated loyalty ecosystem that will appeal both to your frequent and less frequent customers.

Try Currency Alliance for free today.

References:

[i] https://www.financialexpress.com/industry/loyalty-revolution-its-time-for-companies-to-rethink-how-they-reward-customers/1613939/

[ii] https://www.brierley.com/emotional-loyalty

[iii] https://www.washingtonpost.com/lifestyle/travel/unhappy-with-your-travel-loyalty-program-join-the-crowd/2019/09/05/41845258-c9c1-11e9-a1fe-ca46e8d573c0_story.html