Loyalty programs seem to be everywhere these days. From major airlines to local dry cleaners, it seems like wherever we go a company is offering us the option of joining their rewards program or loyalty club.

So what are these loyalty programs and, more importantly, how effective are they?

What Is a Loyalty Program?

To my surprise, a good definition of loyalty program (LP) is hard to find. Considering the amount of focus and resources directed towards loyalty programs in modern business, one would think better definitions would be available. Below are the three best definitions I found, and ironically, none of them were from a “customer service” site:

• “Loyalty programs are structured marketing efforts that reward, and therefore encourage, loyal buying behavior — behavior which is potentially beneficial to the firm.” Source: Wikipedia
• “A rewards program offered by a company to customers who frequently make purchases.” Source: Investopedia
• “A customer loyalty program is a structured and long-term marketing effort which provides incentives to repeat customers who demonstrate loyal buying behavior.” Source: About.com 

Since the existing definitions are so weak and since I cannot very well have a post entitled “What Is a Loyalty Program” without defining the term, I decided to take a stab at creating a more comprehensive definition myself.

A new definition of loyalty program:

A loyalty program is a system of structured rewards given to customers, usually in exchange for desired behaviors, with the goals of increasing customer loyalty and collecting customer data. Loyalty programs use the psychological principles of reciprocity, commitment and loss aversion to increase the likelihood of customer loyalty.

As I offered in The Definition of Customer Loyalty, if anyone finds a better definition than the one above, please feel free to share it below in the comments.

Loyalty Programs Today

Many readers might remember S&H Green Stamps as the primary rewards program of the pre-Internet era. I vividly remember getting those ever-familiar green stamps from the grocery store as a child and filling up those ridiculous books to get, well… stuff. However, though a rewards program, the S&H program was not truly an LP, since it stretched across retailers and was not exclusive to any one store or brand.

Modern loyalty programs are generally tied to specific brands, such as Starbucks Rewards, or groups of related brands such as Hilton Honors. As can be seen in the chart below, the prevalence of loyalty programs also varies greatly by industry.

Some of the most common rewards in modern loyalty programs are:

• Points that can be redeemed for products and services from the company
• Points that can be redeemed for products and services from third parties
• Cash back rewards that are accumulated and paid at regular intervals, often annually
• Other rewards for being a member, e.g. member-only sales, first notice of new products, extra discounts
• Tiered benefits at different levels of the program

Despite some major commonalities, the list of reward types and program structures seems almost limitless in its variety. Accordingly, the efficacy of loyalty programs is inconsistent and leads to some interesting data.

Loyalty Program Statistics

Customer loyalty programs do not just seem ubiquitous, they are. According to the The Billion Member March: The 2011 COLLOQUY Loyalty Census (pdf), the average household is signed up for 18 loyalty programs, yet are active in only 8 of them.

The COLLOQUY study also notes the incredible value of loyalty programs and estimates the amount of rewards given or sold in 2011 to be $48 billion in the U.S. alone.

Some other statistics show how prevalent, how powerful, and how empty loyalty programs can be.

• 3 out of 4 Americans have at least one retail loyalty card
• 85% say they have not heard from the program since signing up
• 81% say they do not know the benefits of the program or how/when they will receive the rewards

Source: CustomerThink

• 84 percent of loyalty program members are likely to choose the program retailer over its competitor
• 71 percent feel their loyalty programs deliver benefits that are important to them
• 49% of loyalty program members said that they never or rarely take advantage of loyalty program perks when shopping online

Source: Loyalty360

• Only 36% of consumers received a reward or promotion that made them come back to the store
• 44% of consumers have had a negative experience with a loyalty program

Source: NeoLane

Can a Loyalty Program Work For Your Business?

If the above statistics prove anything, it is that an LP is not a guaranteed win for a company. Loyalty programs require time and capital to create and implement.

It is safe to assume that a successful loyalty program is created around rewards that consumers actually want and learning which rewards those are requires market research.

Setup and management of an LP can require increased staff and professional fees, items that might make the threshold for return on investment difficult to overcome.

Even with these numerous capital challenges, for the first time in history, small and medium-sized businesses have a chance to compete with the big boys. Technology has put loyalty programs within reach of smaller organizations, and big businesses have made loyalty programs so ubiquitous that small businesses can easily draft off of the inroads already made by the majors. If the average household is a member of 18 programs, the neighborhood yogurt shop should not have too much trouble convincing a family to make them #19.

Technology has kicked the hassle factor of loyalty programs in the teeth. Whereas previously large companies with their networked systems had a tremendous advantage over small business with their paper punch cards, technology has now leveled the playing field some. Services such as LoyalBlocks allow customers to put a digital “punch card” on their mobile phone, and small business credit card acceptance service Square just added a loyalty program to their service.

So, can a loyalty program benefit your business? While the devil truly is in the details on this question — dependent on industry, business model, and competitive landscape — here are three big picture concepts that you should consider before pursuing a program.

• Differentiation — Will a program set you apart from your competition? What competitive advantage will you gain from a loyalty program?
• Value — Will it provide your customers value and will that value increase loyalty? Value is highly dependent on context. Will rewards add value where your business model does not? Wal Mart does not have a rewards card because its prices brings its customers back. Mattress companies do not tend to have rewards programs because their customers only purchase every eight years or so.
• Cost Effectiveness / ROI — What effect will loyalty and increased retention have on revenue? Will that amount be greater than the cost of the program? Make sure to calculate not only the hard costs of the rewards but also the softer costs of administration and setup such as legal fees, accounting fees, extra support staff, and computer upgrades to name a few.

The reality is that, even when contracted through a third party, customer loyalty programs require an investment in labor and capital that is significant for almost any organization. And while these programs can be very effective, they are but one path to increasing customer loyalty.

Any business considering a loyalty program should not only consider the costs and benefits of the program but also the opportunity costs of company focus — focus that might be able to increase customer loyalty just as much if applied to Voice of Customer programs, Customer Experience Optimization, or just good, old-fashioned, kick-butt customer service.

Do you have a favorite loyalty program? Why do you like it and would you be as loyal to the company without it? Do you have programs you have signed up for that you have never used?