Customer Relationship

Management
A Databased Approach

V. Kumar
Werner J. Reinartz

Instructor’s Presentation Slides

 Chapter Eight

Designing Loyalty Programs

 Topics Discussed

• Satisfaction-loyalty-profit chain

• Loyalty programs

• Key objectives of Loyalty Programs

• Examples of Loyalty Programs

• Design Characteristics of Loyalty Programs

• Reward Structure
 Satisfaction-Loyalty-Profit Chain

Product
Performance
Customer Retention / Revenue /
Service
Performance Satisfaction Loyalty Profit
Employee
Performance

Source: Strengthening the satisfaction-profit chain”, Eugene W Anderson, Vikas Mittal.

Journal of Service Research, Nov 2000. Vol 3, Iss.2, p 107
 Results of Customer Satisfaction-Profit
Link Studies
• Direct link suggests, that as customers experience greater
satisfaction with a firm’s offering, profits rise

• Improving customer satisfaction comes at a cost and once the cost

of enhancing satisfaction is factored in, offering “excessive
satisfaction” doesn’t pay

• Marginal gains in satisfaction decrease, while the marginal

expenses to achieve the growth in satisfaction increase

• There is an optimum satisfaction level for any firm, beyond which

increasing satisfaction does not pay
The link between Satisfaction and Retention

Source: “Strengthening the satisfaction-profit chain”, Eugene W Anderson, Vikas Mittal. Journal of
Service Research, Nov 2000. Vol 3, Iss.2, p 114
 The link between Satisfaction
and Retention (contd.)

• Link between satisfaction and retention is asymmetric:

– Dissatisfaction has a greater impact on retention than satisfaction

• Even if the level of satisfaction is high, retention is not guaranteed

• If customers are dissatisfied, other products become more enticing

• The link is nonlinear in that the impact of satisfaction on retention is greater

at the extremes

• The flat part of the curve in the middle has also been called the “zone of
indifference”

• Factors like the aggressiveness of competition, degree of switching cost,

and the level of perceived risk influence the shape of the curve and the
position of the elbows
The link between Satisfaction and Retention

Source: “Why satisfied customers defect”, Jones, Thomas O, Sasser, W Earl Jr. Harvard
Business Review. Boston: Nov/Dec 1995. Vol. 73, Iss. 6

The figure shows the variability in the relationship between satisfaction and retention
across industries. Loyalty was measured as the customer’s stated intent to repurchase
 How Competitive Environment affects
Satisfaction-Loyalty Relationship: Example

• In the very competitive automotive industry,

– Very high levels of satisfaction are necessary for a customer to

repurchase the same brand again

• When utilising an airline:

– Consumers may incur considerable switching costs

– This cost might increase due to bonus point build-up in frequent flyer
programs and due to limited airline choice at any given airport

– Thus, consumers tend to re-patronize an airline even though their

satisfaction might only be moderate
 The link between Loyalty and Profits
• Reichheld’s hypotheses

– Long term customers spend more per period over time

– Cost less to serve per period over time

– Have greater propensity to generate word-of-mouth

– Pay a premium price when compared to that paid by short-term

customers

• Does not hold true in a non-contractual relationship

– Revenue stream must be balanced by the cost of constantly sustaining

the relationship and by fending off competitive attacks

– Efforts at increasing customer satisfaction and retention not only

consume a firm’s resources but are subject to diminishing returns
 Lifetime Duration-Profitability Association

• Reinartz and Kumar: Across the different firms,

– there is a segment of customers that is loyal but not very profitable

(due to excessive resource allocation)

– there is a segment that generates very high profits although it has only a
short tenure

– Since these short-term customers can be very profitable, it is clear that

loyalty is not the only path to profitability
Lifetime Duration-Profitability Association

High
Lifetim
e Profit

Low

Low High
Loyalty

• Overall trend shows a direct correlation between loyalty and

profitability

• Outliers on the graph who generate high profits while not

having high loyalty will outperform those customers who have a
high level of loyalty but who are not very profitable
 Association of Profitability and Longevity
of Customers

Source: “The mismanagement of customer loyalty”, Werner Reinartz, V Kumar.

Harvard Business Review
Choosing a Loyalty Strategy
 Customer Loyalty

• Loyalty to a product or service by repeat purchases can be due to

customer’s natural satisfaction and preference for the products’
features and benefits

• Loyalty can also be induced through marketing plans and programs

from the firm

• Behavioral loyalty: the observed action that customers have

demonstrated towards a particular product or service

• Attitudinal loyalty: the perceptions and attitudes that a customer has

towards a particular product or service
 Loyalty Programs

• A marketing process that generates rewards to

customers based on their repeat purchasing

• Consumers who enter a loyalty program are expected to transact

more with the focal company, giving up the free choice they have
otherwise

• In exchange for concentrating their purchases with the focal firm,

they accumulate assets (for example, ‘points’)

• Points are exchanged for products and services, typically but not
necessarily associated with the focal firm

• CRM tool used by marketers to identify, award, and retain profitable

customers
 Key Objectives of Loyalty Programs

• Building true (attitudinal & behavioral) loyalty

• Efficiency profits

• Effectiveness profits

• Value alignment
 Building True Loyalty

• Encompasses both attitudinal and behavioral components of loyalty

• Greater commitment to the product or organization through the building of

true loyalty

• Function of true value provided to the customers

• Involves degree of involvement in the product category, visibility of the

product when using it, or value expressive nature of the product

• Goal of many customer clubs

• Difficult in the case of a low involvement category– e.g.: grocery shopping

CRM at Work: Supermarkets - Difficulty in
Building True Loyalty
• Despite spending hundreds of millions of pounds on price-cutting
campaigns and loyalty card schemes, supermarkets
have only persuaded a small minority of shoppers to stay loyal

• According to a report from Mintel Research:

– Only 15% of all grocery shoppers are completely loyal to the store where
they do their main grocery shopping

– 29% use one other store

– 22% use two others

– Men are more likely than women to be loyal to a single store

– 46% of men shop in just one or two main stores

 Efficiency Profits
• Profits that result from a change in customer’s buying
behavior due to the loyalty program

• Change in buying behavior can be measured, in:

• Basket size
• Purchase frequency acceleration
• Price sensitivity
• Share of category requirements (SCR) or share-of-wallet
• Retention
• Lifetime duration

• Measured in terms of the immediate profit consequences as

compared to profit consequences without loyalty programs – net of
the LP cost
 Effectiveness Profits

• Measured in terms of the long-term profit consequences realized

through better learning about customer preferences over time

• Allows sustainable value creation for customers through

customization of products or communication

• Most likely to generate sustainable competitive advantage since it

produces the highest profits in the long run

• The strategy of using a LP to learn about customer preferences may

result in impressive gains for both customers and organizations

• Customers get more of what they truly want, and firms are safe in
terms of not having to engage in a costly mass marketing exercise
 Value Alignment

• Goal of aligning the cost to serve a particular

customer with the value he/she brings to the firm

• Allows firms to serve their most valuable customers in the best

manner

• The goal of value alignment is particularly critical when there is great

heterogeneity in the customer’s value and in the cost to serve the
customer
Example: the airline business, the hospitality industry and the
financial services industry
 Revenue and Profitability of Customers

1000
860

800

600
435
(in $'s)

Revenue
400
per year
161 159
200 Annual
17
profit
0
-67
-200 Tier A Tier B Tier C

Example of a firm with a highly heterogeneous customer base:

-Tier A represents 31% of the customer base, Tier B 42% and Tier C the remaining 27%.
- More than a quarter of the customers are unprofitable and need to be subsidized by the

highly profitable ones

 Examples of LPs
• Frequent-Buyer programs

– City Bagels, a sandwich retail chain offers every 10th sandwich free for
customers who have nine stamps from previous purchases

• Volkswagen Club and Card

– Customers collect points from Volkswagen (VW) for servicing their car or
buying accessories and from partners of car rental companies and tour
operators

– The points can be redeemed for dealer services, price reductions on car
purchases, and catalog merchandise

• Star Alliance Frequent Flyer Program

– Any flight on any Star Alliance airline counts towards a members

 Examples of LPs (contd.)
• Webmiles.de

– Webmiles allows its members to collect and redeem assets in a network of

retail partners. Thus, the retailers become members in Webmiles’ partner
network

– Webmiles manages the program and the communication with more than 1
million customers

• Neimann Marcus

– Offers its LP ‘InCircles’ to all customers. Using a shopping card,

customers accumulate points that can be redeemed for exclusive rewards

• Buitoni Pasta Club

– Buitoni offers a platform for exchange among pasta enthusiasts: sharing

recipes, cooking experiences, and testing innovative product concepts.
Loyalty Programs Membership Growth
 CRM at Work: Frequent Flyer Programs

• American Airlines, United, Continental, and USAir multiply miles flown by a

customer by a coefficient derived from the type of seat class that customer
has paid for
• Passengers who are willing to pay to upgrade to business or 1st class will, in
turn, earn more miles and thus be rewarded sooner and more often

• Southwest’s reward program is based on the number of flights that an

individual takes. Every eight round trip flights are worth one free round trip
flight
• Southwest rewards customers who fly 50 round trip flights in a year with a
free companion pass for the next year
• Southwest captures the business of high value customers who fly at least
once a week, on an average

• By reducing the role of the middleman, Southwest is able to capture revenue

• Result: Southwest has been the only major airline that has had a positive net
income since the year 2000
Design Characteristics of Loyalty Programs
• Reward structure

– Hard vs. soft rewards

– Product proposition support (Choice of rewards)
– Aspirational value of reward
– Rate of rewards
– Tiering of rewards
– Timing of rewards

• Sponsorship (existence of partner network, network externalities)

– Single vs. multiform LP

– Within sector vs. across sector LP
– Ownership (focal firm vs. other firm)
 Reward Structure

• Hard vs. soft rewards

– Financial or tangible rewards (hard rewards) and those based on

psychological or emotional benefits (soft rewards)

– Hard rewards: price reductions, promotions, free products and preferred

treatment

– Soft rewards: psychological benefit of having special status in addition to

receiving preferred customer service
 Reward Structure (contd.)
• Product proposition support

– Reward directly supports the firm’s product proposition

• Example: The US Bagel franchise Finagle-A-Bagel has a LP that allows

participants to redeem their accumulated bonus points for the firm’s own
products – sandwiches and drinks

– Allows LP member to redeem points for products that are completely

unrelated to the focal firm’s offering

• Example: British Petroleum’s LP users may redeem points from their

gasoline-related purchases for merchandise such as first-aid kits,
photographic films, coffee mugs, and Barbie dolls
 Reward Structure (contd.)

• Aspirational value of reward

– Consumers prefer hedonic goods as opposed to utilitarian goods when

receiving a gift or a LP reward

• Mercedes Benz’s LP makes it possible to transform points against a flight in a

MIG 29 combat aircraft

• Neimann Marcus, the US luxury retail chain, gives out each year a new list of
“wow and cool” rewards. These unique rewards include a world famous
photographer to come to a customer’s home for taking pictures
 Reward Structure (contd.)
• Rate of rewards

– Ratio of reward value (in monetary terms) over transaction volume (in
monetary terms)

– How much a consumer is getting in return for concentrating his or her

purchases

• Tiering of rewards

– Rewards based on asset accumulation response function - how assets

or rewards are accumulated as a function of spending behavior
 Change in Cumulative Spending with Two
Different Response Functions

Asset accumulation per $

Asset accumulation per $

spent
spent

Cum ulative $ spendings Cum ulative $ spendings

In case 1, the buyer receives the same amount of rewards per $ spent, regardless of
the spending level
In case 2, the buyer receives a larger amount of rewards per $ spent, with increasing
spending level. Here, the program is relatively more attractive for buyers who are
high spenders. Many airline programs follow this pattern
 Reward Programs in the Gaming Industry

• Harrah’s Entertainment: Three-tiered loyalty program - ‘Total Rewards’.

-The tiered structure offers different levels of reward services and privileges to
customers of differing tiers
-Reward ranging from cash back at slots/tables to complimentary offers for
shows, meals, and hotel stays at any Harrah’s location.
-Members also can draw benefits from Harrah’s alliance with partner firms
such as Sony, Royal Caribbean, and Warner Brothers
CRM at Work: Bloomingdales Rewards Plus
Program

• Increasing levels of rewards to customers based upon their annual

spending level

• First tier: Premier Insider- all members that sign up for a

Bloomingdales credit card

• Second tier: Premier Plus Insider- members who spend more than
$1000 annually

• Third tier: Ultimate Premier Insider – customers who spend over

$2500 each year at Bloomingdales
 Reward Structure (contd.)
• Timing of Rewards

– Determined by minimum redemption rules, type of reward given out, and

reward rate

– Longer the timing to build up to a certain reward level, the greater the
“breakage” (the amount of rewards that are never redeemed)

– “Lock-in” effect - firm creates redemption rules that favor long

accumulation periods, thereby impacting customer retention

– Customers build up assets that function as switching cost

 LPs Based on Sponsorship
• Single vs. multi-firm LP
– Single: LPs that reflect only the transactions with its own customers

– Multi-firm: LP member may also accumulate assets at organizations associated

with the focal firm’s LP

• Within sector/across sector

– Supply side dimension of multi-firm LP design-degree of cross sector partners

• Example for within sector: The STAR Alliance of SAS, Lufthansa, United
Airlines, Varig

• Example for across sector: The LP of AOL and American Airlines, with its
2000 or so partners, spans many different industries
• Ownership

– For multiform LPs, the ownership dimension characterizes who owns the LP within
the network; whether it is the focal firm, a partner firm or a firm whose sole purpose
is to manage a LP
Loyalty Ladder
Customer Life cycle model
 Summary

• Satisfaction-profit-chain (SPC) needs to be implemented at a disaggregate

level or individual level than aggregate, firm-level

• Link between satisfaction and retention is asymmetric, i.e., dissatisfaction

has a greater impact on retention than satisfaction, and nonlinear

• Reinartz and Kumar demonstrated that loyalty is not the only path to
profitability

• The success or failure of a loyalty program (LP), whether contractual or

motivated through incentives, is determined by profitability from the customer

• Most companies need to revisit their business model

– to reflect on the impact of Loyalty Programs on their bottom line
– to determine how customer service initiatives add value to future revenue streams
 Achieving Competitive Advantage

• Reason a firm develops a LP program is to achieve competitive advantage

• Competitive advantage of a firm results in the ability to operate more

profitably over a sustained period of time

• A highly frequented category like Grocery Stores is more likely to attract

members in to its LP

• LPs with the goal of creating Efficiency Profits provide the smallest basis for
achieving competitive advantage

• The value provided to the customers participating in a LP must be greater

than for customers not participating

• Industries such as financial services or telecom can expect to reap

competitive advantage when pursuing a goal of value alignment
 LP to Achieve Competitive Advantage:
CRM at Work: Tesco
• Launched the first LP in British supermarket industry in 1995 called Club
Card ; relied on incentive aspect of the loyalty scheme

• Successful in capturing both market share and share-of category

requirements in subsequent years

• Later established segmentation scheme of its customer base

– Sends 80 different versions of its mailing to members and publishes four versions
of its clubcard magazine
– Offers tailored cards to students, families, top customers, seniors, etc

• Aligned its LP offering closely with the specific members’ needs as opposed
to giving out general incentives e.g. Tesco’s Baby club

• Tesco merges information on customer transactions within Tesco’s website

and with point of sale data to customize its product offerings and
 Mini case: Starwood Hotels

• Operates a customer loyalty program called Starwood Preferred Guest

(SPG) - allows customers to accumulate points for staying and spending with
Starwood

• Unique - points never expire and Starwood does not have “black-out dates”
(dates when customers cannot use their points )

• Challenges

– Collection of too much information on individual customer behavior without

knowing how to use it, exacerbated by customer’s concern about privacy invasion

– Very little knowledge over a large portion of its customer base; while roughly 7
million Starwood customers are members of the loyalty program, 6 million are not

– Knowing the extent to which customers will tolerate frequent offerings; while
maximizing its cross-selling and up-selling opportunities