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The Price of Loyalty?

The average US household belongs to an amazing 23 loyalty programs - and the numbers are increasing. So, can we assume there is a well-established ROI for these programs? You would be shocked to learn that loyalty programs are probably destroying value for many companies. McKinsey research showed that those companies that spend more on loyalty than their peers, or have more visible loyalty programs, grow at about the same rate – or slightly slower – than those that do not. In addition, companies surveyed that had higher loyalty spend also had EBITDA margins that were about 10 percent lower than companies in the same sectors that spent less on loyalty.

Conversely, big loyalty spenders reaped larger market cap gains, and fared better where they had built alliances with companies in non-competitive business activities. Hotels had also done better than other sectors like airlines, car rental and retail.

Read the full original article from McKinsey (Nadeau and Singer, Feb 2014) for more detail and analysis. My take on it is as follows:

  • The effectiveness of a loyalty program will hinge on how much identifiable, additional revenue / profit was created by the program. Did the under-performing companies end up giving additional discounts and incurring program management costs for sales they would have had anyway?

  • Are the rewards being directed to the most profitable customers? While most airlines attach rewards to miles flown, Southwest now offers rewards proportional to ticket price, a metric more directly tied to revenue generation. Their loyalty spend targets more profitable customers, rather than customers who fly longer trips at discounted prices.

  • Did the company initiate the program as a defensive or offensive measure? Loyalty spend to hold on to customers will probably just add cost. The effectiveness of spend targeted at new customer acquisition can be more closely monitored and isolated.

Bottom line - Loyalty is more complex than most traditional loyalty schemes recognize. From a profitability perspective, companies need differentiated approaches to the folks who sign up for a one-off use of a loyalty card to get “points” or discounts for purchases they intend to make anyway, versus creating a real “fan” who will purchase liberally, as well as enlist others to create real new sales and margin.

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