A Prisoner’s Dilemma? The Real Value in a Loyalty Program

October 5, 2017 Nicole Bump

vale of customer loyalty program

From airlines and hotels to gas stations and drug stores, customer loyalty programs abound. Scott Neslin, Professor of Marketing at the Tuck School of Business at Dartmouth College, argues that, while many brands initiate loyalty programs to generate incremental sales, the real value in a loyalty program is the data it generates.

He discussed this topic at the August 2017 meeting of the Harte Hanks Marketing Advisory Board.

Loyalty Program Basics

According to Scott, there are two approaches to loyalty programs: those that provide frequency rewards and those that advance customers in customer tiers. Both can generate incremental volume. 

The loyalty program creates points pressure: the customer wants the reward or tier status, so he or she buys more to get there. Research has shown that as members get closer to achieving a loyalty goal, they work harder (or purchase more) to achieve the reward or status. 

points pressure from customer loyalty program

A familiar example is airline runs—people that are close to achieving rewards and/or tier status for the year often figure out the minimum cost to get mileage they need and buy the flights to achieve it.

Program design is important: If you make it too difficult to get the reward, the customer gives up from the beginning. If you make it too easy, there is no points pressure to work harder to get the reward.

After achieving a reward or a tier upgrade, brands often see more incremental value outside of the points pressure, as Scott explains.

And loyalty programs work. For example, Scott’s research in the hotel industry shows that about 25% of loyalty members’ spend is incremental.

incremental sales from customer loyalty program

But Are Loyalty Programs a Prisoner’s Dilemma?

If one competitor in an industry offers a loyalty program and another does not, the one with the loyalty program statistically performs better. But what happens if both competitors offer a program? Now, each brand has the expense of the loyalty program, which results in a lower profit margin, and they still have an equal likelihood of attracting customers.

strategic implications of customer loyalty program

The prisoner's dilemma is a standard example of a game analyzed in game theory that shows why two completely "rational" individuals might not cooperate, even if it appears that it is in their best interests to do so. In the case of loyalty programs, it would make logical sense for competitors to agree not to have loyalty programs—this obviously doesn’t happen.

At the end of the day, each company has $8 in their pocket, whereas it would have been $10/$10 without the loyalty program. Each brand is getting better share of wallet with some customers but less with others—so each company makes less money with the loyalty program than without.

The Opportunity Is in the Data

The question therefore is: how do we make this NOT an $8/$8? Rather than focusing on share of wallet, we should focus on growing the wallet. For example, a department store loyalty program could focus on getting the customer to buy more clothing than they would have otherwise purchased. A hotel could try to get the customer to spend more nights than they would have otherwise spent. 

The way to make this increase in wallet size happen is with the data collected through the loyalty program. As customers make purchases tied to their loyalty memberships, brands can collect their data and use it for further personalizing offers to these customers—which leads to additional sales. For example, research shows that a grocery store saw a 14% increase in customer revenue per week after sending a targeted coupon.

use the data from your loyalty program to personalize marketing efforts

Personalized marketing enabled by this new data is the third way in which loyalty programs can generate incremental value for the brand.

Is this too much work and/or expense just to collect the data? Kim Whitler, Assistant Professor, University of Virginia, Darden School of Business, doesn’t think so. She explains the immense value of customer data generated through a loyalty program she ran at PetSmart.

Carla Moradi, Executive Vice President, Operations & Technology, HUB International, agreed with Kim that the value of the data and using it to gain a more holistic view of the customer is worth the effort and expense of a loyalty program.

Loyalty program or not, all marketers should be figuring out how to best use customer data to provide a more personal, human experience. Learn how with our 5 Pillars of Best-in-Class Marketing.

About the Author

Nicole Bump

Nicole Bump, Senior Content Manager, is responsible for developing the Harte Hanks content strategy, bringing this strategy to life through the editorial board, generating much of the company's content and managing the Harte Hanks social presence. A writer at heart, Nicole also enjoys evaluating ways in which new technologies can enable better content production, distribution and measurement.

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