The 1% Discount Plan

How do you encourage loyalty among even the most price-sensitive customers? Loyalty programs are a big component of both consumer and business-to-business pricing strategies. (In B2B, they’re usually called rebates, promotional allowances, co-op advertising, or the like, but they’re essentially loyalty programs.) This article from the WSJ highlights a computer reseller who uses a loyalty program quite effectively. This is essentially a 1% rebate. Like credit card reward points (that typically also give a 1% rebate), this is a good mechanism to encourage buyers to at least look before buying elsewhere, and you can often make up more than 1% on the float, depending on how long it takes to “spend” the rebate, and how expensive the program is to administer.

To have an effective loyalty program you must:

  1. Give the customer something they want.
  2. Let them track their progress.
  3. Drive the behavior that you want.
  4. Keep it simple.

Naturally, if you want an example of pricing gone awry, turn to the beleaguered airlines, whose frequent flier programs are a popular example of this type of loyalty program. Unfortunately, by rewarding mileage rather than profitability or even revenue, they do not drive the behavior airlines really want. Airlines have also introduced “bonus” mileage, which may or may not count towards elite status, and if you have elite status, you may get a mileage multiplier. This adds complexity, but does not address the fundamental misalignment of incentives. (In addition, the huge overhang of “unspent” miles has led to another set of complex and opaque rules about redeeming miles. This means that they’re starting to fail #1, so all they have left is #2.)

For an example of a good loyalty program, see American Express Membership Rewards. This amounts effectively to a 1% rebate, but Amex has made up the 1% easily on the float (they may also get preferential pricing by aligning sellers with the right buyers).

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