Review of Article by Nunes and Dréze (2006)

Nunes and Dréze (2006)

“Your Loyalty Program Is Betraying You” 

(Harvard Business Review; April 2006, Vol. 84 Issue 4, pp.124-131.)

This is a very valuable article and can be purchased from the Harvard Business Review (and no, we aren’t paid to say this).

In this excellent article (one of our favorites), Nunes and Dréze (2006) identify five main objectives, five critical components and five common mistakes of loyalty programs.  The authors present, in their opinion, what an effective loyalty program should look like and they give a broad overview of loyalty programs.

Nunes and Dréze (2006) point out that many high profile companies have started customer reward programs, but then later abandoned them with little to show for their efforts.  They subsequently ask why so many potentially successful programs have failed before presenting their answers and theories developed through their research.  In their article, the authors are advocates of loyalty programs and present what they consider a “tool kit” for designing an effective system.

According to Nunes and Dréze, loyalty programs can address five main objectives:

  1. “Keep customers from defecting.”  This can be achieved by creating exit barriers.  In some cases, consumers may be reluctant to abandon their suppliers, despite occasional problems in service, due to their perceived “investment” in accumulated points.  (Illustrating this point, in a 2006 study by Peter Roundhill an interviewed business complained that a nearby competitor offered a buy 10-get-1 free program, but charged roughly 20% more for its products. After seeing this business’s lower prices, but already having 4 stamps on the competitor’s card, customers would promise to shop at the new place in the future but only after completing the card and getting their “free” product.  By switching right immediately and throwing away the stamp card a customer could save about $20, but having already “invested” in the competitor’s program many customers would illogically prefer to wait, much to the less expensive business’s frustration).
  1. “Win greater share of wallet.”  By providing extra incentives, loyalty programs encourage consumers to direct more of their purchases toward a business and less at competitors.  All other things being equal, for a consumer who is split 50-50 as to where to shop, a reward program can be the deciding factor.
  1. “Prompt customers to make additional purchases.”  Especially when close to achieving greater rewards, consumers can be enticed to buy more than they would have without an incentive program.
  1. “Yield insight into customer behavior and preferences.”  Careful tracking of customer purchases can help identify profitable customers and assist in the evaluation of specific promotions.  The authors point out, however, that effective use and collection of data can be extremely expensive.
  1. “Turn a profit.”  Reward programs and their points in their own right can be valuable commodities.  To do this, a reward program needs to be successful and have a broad base and excess capacity, which is why it works so well for the airline industry, as it also does with hotels.

After identifying potential core objectives, Nunes and Dréze list five characteristics or components they believe all customer loyalty programs should have.

  1. “Divisibility of rewards.”  The authors point out that if the point total needed to redeem a reward is too high, customers might fail to see value in participation.  At the same time, however, the lower the threshold of redemption, the less securely a participant will be locked into the program.
  1. “Sense of momentum.”  According to Nunes and Dréze, “research has proven that the further along members are in a loyalty program, the more they use it.” (p.128).  This is why, the authors point out, that reward programs have generous signing bonuses.
  1. “Nature of rewards.”  Here the authors note that research shows people respond more to promises of luxury or incentives that offer pleasure than to more utilitarian rewards.
  1. “Expansion of relationship.”  Instead of offering a free item that the customer buys anyway, effective programs offer rewards that introduce new products to entice the individual to expand their purchase categories or upgrade their product preferences in the future.
  1. “Combined-currency flexibility.”  At the very minimum, rewards need to be perceived as valuable and attainable.   Flexibility can enhance both.  In their research, Nunes and Dréze “found that if companies allow program members to redeem their points in combination with hard currency,” such as Air Miles’ offer of 2-for-1 movie tickets or vacation packages for different combinations of cash and points, “it lowers the psychological cost to consumers.”

Also in their paper, Nunes and Dréze suggest that programs typically fail because of a few very basic mistakes.  They offer five main pieces of advice.

  1. Don’t create a new commodity.”  This is important because to be successful a loyalty program needs a sustainable, competitive advantage.  The authors argue that if a loyalty program does become a commodity, indistinguishable from the competition, then the company will likely end up in a price war.  When stores compete directly with one another, offering double and then triple reward incentives, consumers inevitably shop at whoever has the best deal and businesses lose out.  Managers of loyalty programs must never forget that using points to merely buy customers, in the long term, is simply not sustainable.
  1. “Don’t reward the disloyal.”  Reward customers for being loyal, not simply because they possess a card.  If a customer is not loyal, or at least potentially valuable, do not offer them discounts to buy their business.
  1. “Don’t reward volume over profitability.”  Too many programs base rewards on the dollar volume of purchases or factors such as the number of miles flown.  Instead, purchases generating higher profits should be distinguished and rewarded more than less profitable sales.
  1. “Don’t give away the store.” In other words, a business should not be overly generous with the rewards and, as a result, weaken profit margins.  The authors point out that rewards and privileges can be free or low cost, yet still highly effective.
  1. “Don’t promise what you can’t deliver.”  Whether the special treatment is in the form of faster service, free upgrades or tangible rewards, a major (yet not uncommon) mistake of loyalty programs is to fail to deliver on the incentives offered.

The authors also provide examples of discoveries that illustrate the capabilities and characteristics of reward programs with respect to consumer behavior and preferences.

All in all, throughout their article, referring to their various studies and general knowledge, the authors present a variety of well researched observations and interesting points illustrating the effectiveness of customer loyalty programs.

Source:  Nunes, Joseph C. and Xavier Dréze.  “Your Loyalty Program Is Betraying You,” Harvard Business Review; April 2006, Vol. 84 Issue 4, pp.124-131.

This is a very valuable article and can be purchased from the Harvard Business Review (and no, we aren’t paid to say this).  We recommend this article.

(Review Source: Customer Loyalty Programs: What Makes an Effective (Community-based) Program, MBA Thesis, 2007).

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