Loyalty Programs | Peter Fader

Why Loyalty Programs Should Provide Lifetime Value

Dan Loney: For some time, the food industry, the hotel industry, and the credit card industry have used loyalty rewards as a key ingredient to keep customers coming back to their stores, as well as using their products. But how important are these programs as businesses in those sectors look to strengthen the connection with the consumer? Pleasure to be joined here in studio by Peter Fader, who is a professor of marketing here at the Wharton School.

Let’s start with the path that loyalty programs have taken over the last couple of decades and how important you think they are to these companies not only now, but moving into the future?

Peter Fader: You forgot to mention the sector where it’s probably the biggest of all: airlines. In fact, it’s airlines that brought us the loyalty programs as we know them today. It was American Airlines in particular. It was Bob Crandall, a Wharton alum, who kicked it all off in 1981. What’s happened with the airlines is it becomes such a monster that that’s kind of where all their profitability is, actually through the loyalty programs and the arrangements they have with various different banks.

It’s a little different than it is with some of the other sectors you mentioned. It’s both in terms of how they use the loyalty programs as well as the economics behind it. But it’s become a big deal everywhere, to the point where a lot of companies are jumping in and doing it because they have to, even if they don’t quite know why or how to manage or how to measure the effectiveness of it.

Loney: You talk a lot in your research about lifetime value with the customer. It seems like there’s an element of loyalty rewards that connects back into lifetime value, because these companies are looking to get those customers and keep them for as long as they can.

Fader: Absolutely. It’s such a hand-in-glove relationship, really, for three different reasons. No. 1, the loyalty program lets you tag and track customers in a way that you might not get just through their transactions alone. So, that’s better data that could justify the cost, the overhead of the loyalty program right there. No. 2, being able to deepen relationships with the customers, get them to buy a little bit more, engage a little bit more, do stuff that they wouldn’t do otherwise. And No. 3, it gives companies some tactics, some leverage to be able to treat different customers differently, which is certainly a big deal in all my work on customer centricity. Not to say the loyalty programs are essential, but they have to be seriously considered by any company that wants to be customer centric.

Loney: How much value do companies put into what a loyalty program can mean to their bottom line?

Fader: That’s the big problem. They don’t measure it particularly well. Very often, they’ll just say, “How much stuff did we sell through the loyalty program?” But it’s hard for them to measure [if] the customer is actually going to stay with us a little bit longer, they’re going to do more with us, not only when they’re getting or redeeming points. But truly, if we can measure the way we deepen relationships, and if the loyalty programs are letting us do that, they can be enormously profitable.

A lot of companies sometimes try the loyalty program because it’s a competitive imperative. Everyone else is doing it; we have to as well. But then, because they don’t know how to manage it or measure it really well, they’ll sometimes either give up on it or they’ll make major changes to it. They never quite get their arms around it, which is too bad, because they have all the data analytics technology to be able to really do it well.

Balancing Customer Rewards and Return on Investment

Loney: The company has to be very aware of what those metrics are in terms of giving out those rewards. They have to make sure that they’re not going too far and asking too much of a customer to get a reward, but hit that sweet spot so that the customer feels like, “I’ll keep coming back and I’m going to be able to get something down the line.”

Fader: That is right. It’s not only going too far that way, but it’s going too far the other way as well, which sometimes they’ve given too much away. These loyalty programs can be a very, very addictive drug. There’s an amazing case study playing out right now before our eyes in the coffee market. We all understand Starbucks has been changing a lot with its loyalty program. But there’s the new kid in town, Luckin Coffee. They’re the Chinese behemoth.

Starbucks entered China very successfully. They’ve been blown out of the water by Luckin. Luckin has opened two stores in the U.S. now, and they give away very generous discounts. Again, sometimes it’s hard to say how much of it is due to the loyalty program or discounts that they just throw out there, but they’re much more dependent on those discounts. There’s a chance they can give Starbucks a good run for their money, but are they going to do so from a lifetime value standpoint, or are they just kind of, in some sense, buying loyalty that’s not real loyalty? Who knows?

Loney: Let me ask you about Starbucks, because I’m somebody that’s in that realm. My kids like to drink Starbucks, and I do as well. It’s interesting with the changes of CEOs that they’ve had in the last couple of years, the change of mindset has occurred about, how much do we want to potentially give to the consumer? How much do we not want to? Some of those offers where, if you buy five drinks over the course of a week, you get 70 extra bonus points. Those went away for a while, and now they’re just starting to come back a little bit.

Fader: Yeah, they keep blowing like the wind. Sometimes that’s good — the loyalty program shouldn’t be static. You should be adaptive with it. But sometimes they’re doing things that are either trendy or some executive saying, “Just do that,” without a lot of accountability for it. They recently took away a discount they gave people if they brought in their own cup. It used to be, “We’ll give you all just whole bunch of points.” Where’d they come up with that number? Who knows? They just made it up. They said, “Instead, we’re not going to give you that automatic 25 bonus stars or something. Now, we will double the number of stars we give you based on the overall size of your transaction.” I love that.

Loney: Is there a formula that companies have in terms of trying to figure out how much they want to get from the customer before they’re giving something back?

Fader: It should be tied to lifetime value. If these companies were smart and they could calculate lifetime value and they would trust it, then they would use that to decide what kinds of discounts, benefits, perks they’re offering, as well as evaluating the return on investment of offering some of those things. Again, Starbucks has been fairly clever with it, trying to come up with a wider range of things. It’s not just “buy nine, get one free.” In fact, they’re into all their partner perks as well, trying to incentivize their employees. They’ve been a little bit more creative, innovative with it, but they don’t necessarily evaluate these things in a financial basis.

Loney: For a company like Luckin, as they are starting to build out their presence, you say they’re very generous. How generous do they want to be? Because they’re trying to connect with the consumer against an established behemoth like Starbucks.

Fader: That’s right. At this point, they’re just trying to buy a customer base. Let’s just give everything away. They have very, very, very deep pockets. They’re hoping that they can just attract a bunch of people to try it and then maybe get them to make that second purchase, and then just hoping and praying that they’ll be locked in at that point and maybe they could tamp down the discounts. But it’s not clear whether that’s a profitable way to go, and I just don’t think they’re looking at it from this longer run lifetime value standpoint.

Loney: Are we seeing companies take a longer look at whether or not a rewards program is right for them?

Fader: Obviously, it varies a lot from one company to another. And you often see it through the things they’re doing in the loyalty program or adjacent to the loyalty program. One of the things I’m a huge fan of is, in addition to the loyalty program, at the tippy top level, instead of just saying, “You’re the best, you’re gold, whatever. We’re going to throw stuff at you.” To have a paid membership program on top of the loyalty programs.

Best Buy does this. You have your best buy total rewards. You know, “buy nine, get one free,” whatever it is, typical kind of thing with your points and so on. But on top of that, they have their — I forget what they call it — but their total tech program where you pay $200 a year and you get all kinds of benefits. You get the Geek Squad to come to your house and fix anything. Most people wouldn’t want that; therefore, most companies wouldn’t want to institute something like that because only a few people want it. But those few people are incredibly valuable. So, if we recognize that those people are different and should be not only part of the loyalty program, but part of something special, that’s a company that’s really thinking through very, very carefully, and recognizing it shouldn’t just be a one-size-fits-all loyalty program.

AI and Loyalty Programs

Loney: Where does artificial intelligence play a role in making these determinations down the road?

Fader: I’m not sure how well AI is going to help us on the financial aspects of it, at least not yet, but it will help us a great deal in figuring out what kinds of features and functions and benefits and capabilities. What is it about our best customers that makes them different? And let’s build some of that stuff in as perks in the loyalty program. AI can be really, really helpful to broaden the nature of the program, to make it more than just discount oriented, to make it more experiential, to make it more emotional.

It can be really helpful there. And that’s going to be important for companies to do, not only to break away from the pack, but to try to find out what are the features and functions and benefits and capabilities that uniquely identify those top customers who are interested in visiting the back of the store and seeing how the employees do the thing, not just getting the discounts. It’s going to help us better filter out customers, to know who are the really good ones, and to start building more programs around them.

Loney: Seemingly, the main reason why companies do this is to get more foot traffic, to get more people in the door.

Fader: Well, I kind of disagree. It’s to build deeper relationships. As a great example, let’s talk about McDonald’s. McDonald’s launched their loyalty program and their mobile app a couple years ago. Talking to Jami Guthrie, the senior executive there who basically runs it all, he says, “We want to turn McDonald’s from a transaction company to a relationship company.” Foot traffic isn’t enough. If you get a bunch of one-and-done people or people just coming in to chase the discounts, that’s not nearly as good as getting the right people’s feet coming into the store.

Loney: How much of a challenge is that for using McDonald’s or another fast food company as that example when, realistically, I think the perception by the consumer is get into the drive-thru, get your food, and keep going?

Fader: That’s a super good point, that you don’t want the deepened relationship to get in the way of convenience. You have to know when to turn it on, you have to know when to turn it off. It takes much more sophistication. Again, the AI can help with that quite a bit. That’s part of the Luckin story, is that you order, the coffee is ready for you, you pick it up. There’s no chit chat with people there. Again, very different than Starbucks. It’s putting in all this extra effort to write your name and some happy slogan on the cup, or something like that.

Now, the thing is, even for Starbucks, sometimes it really should be quick in and out, I’m late for work. Other times, it’s, you know, I want to loiter. I want it to be the third place. It can’t be one, it can’t be the other. In fact, you can’t even say it’s going to be one or the other for a given customer. Even for a given customer, it’s going to change from time to time. And that’s where the data, the AI, and the willing to invest in these kinds of insights [comes in]. Instead of saying, “Listen, if it’s not getting us foot traffic, we’re not going to do it.” Sometimes you need to go a level deeper than that.