Keep clients coming back · Every business
Loyalty Programs for Small Service Businesses: What Works and What Wastes Money
A loyalty program pays for itself only when it changes what customers do, and the research on reward cards shows the change comes mostly from occasional customers, while the rewards go mostly to the regulars who would have come back anyway.
At a glance
- A loyalty program is a standing promise of a reward for repeat visits, such as a free tenth haircut, points toward a service or a perk for members, and its real cost is every reward handed to someone whose behavior it did not change.
- In a study of a convenience store program published in the Journal of Marketing, heavy buyers were the most likely to claim rewards but did not change how they bought, while customers who started as light or moderate buyers gradually bought more.
- For an illustrative salon giving a free tenth visit to 80 monthly regulars, the rewards cost $4,800 a year, so the program has to create 160 extra visits from everyone else just to break even.
- A cheaper reward, a head start on the card and a reward aimed at the next visit rather than the tenth change the math more than a bigger prize does.
- Retention is worth the effort, since a summary of Bain & Company research in Harvard Business Review reports that raising retention by 5% raised profits by 25% to 95%.
Part 1 | Most rewards go to customers who were coming anyway
The first instinct when the book feels thin is usually a card at the register: Let's do a punch card so people come back. The trouble is that a card cannot tell the difference between a customer it brought back and a customer who was already on the calendar every four weeks, and the second kind fills cards fastest. A regular who visits monthly earns a free service every ten months without the program ever changing a thing about her habits, and each of those free visits is a full-price appointment the business gave away.
The best long-run evidence comes from a study of a convenience store chain's loyalty program, published in the Journal of Marketing, which followed members' purchases over time. Customers who were already heavy buyers when the program started were the most likely to claim their rewards, but the program did not prompt them to change their purchase behavior; customers whose starting patronage was low or moderate gradually bought more, and for light buyers the program widened the relationship into other parts of the business.
| Customer at the start | Claims rewards | Changes behavior |
|---|---|---|
| Heavy buyer | Most likely | No |
| Moderate buyer | Sometimes | Gradually buys more |
| Light buyer | Least likely | Buys more, and in more parts of the business |
That pattern points a service business toward a different question than what should the reward be? The useful question is which customers have room to come more often, and what would bring them in one more time this year.
Part 2 | Progress pulls harder than prizes
Two field experiments on reward cards show that the design of the card matters more than the size of the prize. In a study published in the Journal of Marketing Research, customers of a university café given a 12-stamp card with two bonus stamps already filled in completed the ten required purchases faster than customers given a plain 10-stamp card, and they bought coffee more often the closer they came to the free one, a pattern the researchers called the goal gradient.
A car wash experiment published in the Journal of Consumer Research tested the same idea with 300 loyalty cards. Half the customers received an eight-stamp card and half received a ten-stamp card with two stamps already given, so both groups needed eight washes; over the following months, 34% of the head-start cards were redeemed against 19% of the plain cards, and the head-start customers came back sooner between washes.
The lesson for a salon, a detailer or a studio is practical. A card that starts with progress already on it, a reward close enough to feel reachable and a stamp or note that shows how far the customer has come will do more work than a larger reward at the end of a long card.
Part 3 | Pricing the program before printing the card
Every reward has a cost, and the honest way to price a program is to count the rewards that go to customers who would have visited anyway, then ask how many extra visits the program must create to cover them. The formula is rewards to regulars per year × cost of each reward ÷ margin per visit = extra visits needed to break even.
| Average visit (Assumption) | $50 |
|---|---|
| Variable cost per visit (product, commission) (Assumption) | $20 |
| Margin per visit (Calculated ($50 − $20)) | $30 |
| Regulars who visit monthly (Assumption) | 80 |
| Their visits a year (Calculated (80 × 12)) | 960 |
| Free tenth visits earned (Calculated (960 ÷ 10)) | 96 |
| Cost of rewards, valued at the full visit (Calculated (96 × $50)) | $4,800 |
| Extra visits needed to break even (Calculated ($4,800 ÷ $30)) | 160 |
| Per occasional customer, among 220 (Calculated (160 ÷ 220)) | 0.73 a year |
Illustrative example; replace every assumption with your own numbers.
The same program with a different reward looks very different. If the tenth-visit reward were a treatment or add-on that costs the business $8 in product, the 96 rewards would cost $768, and the program would need about 26 extra visits a year, roughly one extra visit for every eight or nine occasional customers, to pay for itself.
A discount works the same way, only faster, because it reaches every visit rather than every tenth one. A Rice University survey of 324 businesses that ran daily deals found that only 19.9% of deal customers came back to buy at full price, which is why a standing percentage off is the most expensive kind of loyalty program a service business can run.
How you compare
- Who holds your cards: sort card holders by visits last year. If most completed cards belong to customers who already visit on a steady cycle, the program is mostly a discount for regulars.
- Card completion: in the car wash study, 19% of plain cards and 34% of head-start cards were completed. A program where almost nobody finishes a card is not changing behavior either.
- What retention is worth: a summary of Bain & Company research in Harvard Business Review puts the cost of winning a new customer at five to 25 times the cost of keeping one, so a program that keeps occasional customers coming is worth a fair amount of margin.
- Your own baseline: the number to watch is visits per customer per year among occasional customers, measured before the program starts and again six months in.
Questions to ask this week
Who would earn the first ten rewards? Pull the customers with the most visits last year; if they are the people the program would reward first, price that cost before launch.
What does the reward cost us, not the customer? A product sample, an add-on or a priority booking slot can feel generous while costing a fraction of a free service.
Does the card start with progress on it? Two stamps on day one, or credit for today's visit, gives the card the head start that lifted completion in the car wash study.
What one extra visit are we after? A program aimed at one more visit a year from occasional customers is easier to design and measure than a program aimed at everyone.
Before printing a card, list last year's top 20 customers, count the rewards they would earn under the plan and divide that cost by your margin per visit to see how many extra visits the program has to win.
About this research: This article draws on a study of a convenience store loyalty program in the Journal of Marketing, field experiments on reward cards at a café (Journal of Marketing Research) and a car wash (Journal of Consumer Research), a Rice University survey of 324 businesses that ran daily deals and a Harvard Business Review summary of Bain & Company retention research. The car wash completion rates come from the published paper as quoted in several consistent secondary summaries. The worked example is illustrative.
Sources
- Liu, Y. The Long-Term Impact of Loyalty Programs on Consumer Purchase Behavior and Loyalty. Journal of Marketing 71(4), 2007.
- Kivetz, R., Urminsky, O. and Zheng, Y. The Goal-Gradient Hypothesis Resurrected: Purchase Acceleration, Illusionary Goal Progress, and Customer Retention. Journal of Marketing Research 43(1), 2006.
- Nunes, J. C. and Drèze, X. The Endowed Progress Effect: How Artificial Advancement Increases Effort. Journal of Consumer Research 32(4), 2006. 300 car wash loyalty cards.
- Dholakia, U. M. How Businesses Fare with Daily Deals: A Multi-Site Analysis of Groupon, LivingSocial, OpenTable, Travelzoo, and BuyWithMe Promotions. Rice University, SSRN, 2011. 324 businesses.
- Gallo, A. The Value of Keeping the Right Customers. Harvard Business Review, 2014.
Related reading: What a Discount Really Costs You, Shown in Margin Math · How Service Businesses Turn One-Time Visits Into Monthly Memberships · Why Customers Don't Come Back (and How to Find Out Which Ones Left) · Punch Cards, Points or Perks: Picking a Simple Reward
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