Loyalty programs are a win/win. It costs a lot less to keep a customer than to proselytize one from a competitor. And loyal customers market for you. But a new study out of Ryerson University in Toronto suggests that loyalty programs may not be so profitable for some brands and that some companies may be better off not offering this type of customer incentive.
The study by Saeed Zolfaghari, professor and director of the university's industrial engineering program, and PhD candidate Amir Gandomi also shows that marketers who do loyalty programs don't have much research to support its virtues. Also, they developed a mathematical model that measures the programs' effectiveness, and what they found was that, really, if you have loyal customers already, you don't need to spend the money to keep them that way.
"Loyalty programs entice people to become, and remain, customers," says Zolfaghari. "Our model demonstrates that if average customer satisfaction increases over time, there is less incentive for a company to offer a loyalty program. Essentially, your customers are already happy with you."
The two scientists say they have developed a model meant to maximize revenue. The study combines the price of a product sold in two separate periods, and the amount of the loyalty reward offered. Customers who made a purchase got a reward in the form of a discount for their purchase in the second period. The study says an example might be a coupon offering 15% off the next purchase made within the following two months.
Thus, to maintain revenue, the "company" was forced, at some point, to raise the initial price because of the size of the discounts it was offering in the second period, said Zolfaghari in the study. "In our model, we also found that as the number of customers who intended to make a purchase in the second period increased, a company had to increase their price in the first period to offset the discount offered on subsequent purchases. To make up for increased reward costs in the future, you need to increase your prices in the present."
The study, "A Stochastic Model on the Profitability of Loyalty Programs" was published online in April in the journal Computers & Industrial Engineering and will also be published in its print edition later this year.