The customer rewards cards that clutter wallets and clog key chains of many a shopper may soon be no more, as retailers move from physical to digital (read: mobile apps) forms of loyalty program member identification. It's a smart decision. Unfortunately, it's one of the only smart decisions retailers are making when it comes to customer loyalty schemes.
"Loyalty schemes are not being used to their best advantage"
"Most retailers are at a very basic level in how they use loyalty programs, and many customers see loyalty programs as punitive," says Harvard Business School senior lecturer José Alvarez. "Loyalty schemes are not being used to their best advantage."
Fortunately, there's hope. Retailers that do rewards programs right can see "incredible loyalty," says Alvarez.
In the case note Customer Loyalty Schemes in the Retail Sector, Alvarez and coauthor Aldo Sesia, a research associate at HBS, discuss how loyalty schemes evolved, what they look like today, why so many retailers aren't using them effectively, and how they can be improved to win customer business in an uncertain marketplace.
A brief history
Loyalty programs are a way for the retailer to encourage the continued patronage of customers. They allow retailers to gather data on customer behavior in order to decipher trends, appropriately reward loyalty, and influence shopping behavior. Loyalty schemes take many forms; some of the most common include rewards cards, such as CVS's ExtraCare, and pay-for-membership cards for stores including Costco.
In a very basic form loyalty schemes have been around for as long as people have been exchanging goods—consider the farmer who threw in an extra ear of corn for his best customers. The S&H Green Stamps program, launched in the late 19th century, took the idea a step further, rewarding customers with stamps that could be traded in for a variety of items. American Airlines introduced the next evolution of the customer loyalty program in 1981: the frequent-flier mile program.
The modern-day rewards program started in the 1990s, explain Alvarez and Sesia, in response to a few key issues: the rise of self-service in retail, which led to a weakening of face-to-face connections with customers; the increased commoditization of the retail experience; and "massive improvement" in all facets of data management.
Renewing loyalty in retail
Self-service retail, which started with customers selecting their own merchandise in the 1930s and evolved to modern conveniences including self-checkout lanes, has saved businesses labor costs and customers time. But Alvarez thinks the loss of face-to-face interactions between merchant and shopper has left a lot of customers wandering the desert. Well-run loyalty schemes are a way to bring them back into the fold.
Such programs can also help remedy the commoditization that has occurred in the retail sector on many levels. Both the Internet and what the researchers call a "massive availability of real estate" have made location differentiation a moot point. Retailers looking to differentiate on selection have fared no better, considering that the latest Coach bag can be found at Macy's, Nordstrom, TJ Maxx, the Coach outlet store, and, most importantly, on a panoply of Internet sites. It's just as hard to differentiate on price, for similar reasons: any consumer with an Internet connection can quickly determine if that flat-screen TV that Walmart claims is at a blowout price actually is. Loyalty schemes offer retailers a way to stand out from an ever-growing crowd.
Technology is also a helpful factor in rewards programs, representing a vast improvement over an old, markedly creepier, and now mostly illegal strategy: dispatching an employee to the parking lot to write down license plate numbers, which then could be cross-referenced with addresses at motor vehicles registries. In the digital era, retailers have myriad ways to collect, store, and slice-and-dice customer data. "The more information you can get and the better you can deal with it, the better you can become at providing services for the customer," says Alvarez.
Engaging the customer
The most important component by far is customer engagement. "Retailers should ask themselves, 'how do I create a partnership with the consumer?' instead of pulling one over on them," says Alvarez. Many customers see loyalty programs as a way of being ambushed by the retailer.
Successful retailers connect with customers via loyalty programs at three levels. The first is an introduction of sorts: the customer receives a generic reward for enrolling in the program. At the second level, the retailer contacts the customer directly, often via e-mail, to offer a reward more tailored to the customer's wants and needs. Two-way communication occurs at the third level with customer- or retailer-initiated feedback loops.
"I think Nordstrom is a great example of a retailer that's doing it well"
Alvarez has had hands-on experience with the third level of communication when he was president and CEO of grocery chain Stop & Shop. In 2007, certain brands of pet food manufactured in China and sold at several locations were found to be contaminated with melamine. Many pets became sick, and some even died. Through it rewards program data, Stop & Shop was able to identify and contact those rewards customers who had purchased the tainted pet food.
Loyalty program data can be enormously advantageous in other ways, such as helping a retailer perform market research, set pricing strategies, and decide whether and where to open new stores. "Retailers can get a better understanding about what brands matter to consumers," says Alvarez. "So if consumers are switching brands, or buying based on promotions, you can…drive the customer to your own label."
Brand-based data can also be used as leverage in retailer-manufacturer relationships. "If customers don't have brand loyalty, you can push back against manufacturers and tell them you won't carry their products anymore if they raise prices."
Customer care
An increasing number of retailers are implementing customer loyalty programs, but quantity doesn't equal quality. Most programs are failing, and the numbers bear this out. Less than half of loyalty memberships across all US sectors are in active use. This is due to multiple problems, including privacy concerns and poor ease of use, but Alvarez argues the main issue is the lack of concern retailers have for their customers.
"Most retailers are concerned only about what's best for them," says Alvarez. "But the customer doesn't care that you have to stock a shelf." Merchants need to move beyond thinking of a customer as a transaction and instead create a much more engaging experience.
"This is the one place where retailers will have an advantage—the experience with the customer," Alvarez continues. "It won't be price, selection, or convenience. The only thing that will matter is how a retailer can better understand and best serve the needs of the customer. This includes understanding the intentions of the customer."
Retailers that deploy effective loyalty schemes do just that. "I think Nordstrom is a great example of a retailer that's doing it well," says Alvarez. "Nordstrom looks at the rewards program from the perspective of how can we be a better agent for the consumer." The Personal Book software program is one tool that helps Nordstrom's sales staff do this. In it, they can record personal information about their customers, including size and color preferences, birthdays and anniversaries, and other information that can be accessed at a moment's notice.
Nordstrom's "Fashion Rewards" program is another tool. The program offers customers who make purchases on a store-branded card significant benefits: When the "rewards points" a customer accrues for each dollar spent in-store reaches 2,000, Nordstrom automatically mails the customer $20 in "Nordstrom Notes" that can be applied to future purchases. Depending on how much they spend annually, Fashion Rewards members also have access to perks such as concierge service and free alterations.
A well-run customer loyalty scheme can benefit all types of businesses. CVS and other retailers are experimenting with offering rewards program members discounts on gasoline, for instance. And Stop & Shop recently rolled out Scan It! Mobile, an app that turns a customer's iPhone into a mobile scanner and checkout.
"We're at a place where technologies allow for retailers to have two-way, back-and-forth interactions with customers," says Alvarez. "With smartphones, you have location-based information, so you can communicate with customers where they actually are."
Successful loyalty schemes require advanced technology—and age-old techniques. "It's about going back to the basic roots and origins of retailing," says Alvarez.
"Talk to the customer, listen, find out what they want, and get it for them."When you combine this with a keen understanding of trends in the marketplace you can pleasantly surprise customers with goods and services that they may not have known existed. A great retailer is the agent for the customer. Loyalty programs and the insight and communication capabilities they provide can help retailers achieve greatness in a crowded and commoditized space." 
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