Comprehensive guide to building loyalty programs

The modern world is rapidly changing every day, bringing new levels of complexity and new challenges. This means both customers and retailers are continually making adjustments to their behaviors to meet changing desires, expectations, and environments.

At the same time, the market has never been so competitive due to the vast number of convenient and seamless online shopping experiences on offer. That’s why customer loyalty programs have now been elevated beyond being somewhat of a novelty to being absolutely vital. Task number 1 today is to retain your existing customers while trying to establish relationships with new customers.

In this article, we’ll explore the most popular types of loyalty programs in detail, showing you what they are, how they work, and how to build one.

Let’s take a look at a straightforward real life situation as an example. Say you are the owner of a burger place. Once a customer has finished their lunch and walks out the door, they’ll likely  forget about your place. After they’ve walked out, they might see another burger place and think, “wow that looks like a nice place, I should try that out next time.”

Now let’s say you’re the owner of a burger place and you have a great loyalty program up and running. Now when your customer walks out and sees another place they still may think, “that seems like a nice place, maybe I should check it out next time…..but I’m only two orders away from my free combo meal at my regular burger place.”

So at a basic level, that’s what loyalty programs do. But what exactly is a loyalty program?

Here’s a definition:

“A customer loyalty program is a structured and long-term marketing effort which provides incentives to repeat customers who demonstrate loyal buying behavior.” (The Balance Everyday)

So a loyalty program is a strategy that encourages customers to increase their interactions with a retailer over time. It uses the psychological principles of reciprocity, commitment, and loss aversion to increase the likelihood of customer loyalty. It allows retailers to increase revenue at relatively low additional marketing expense, and make customers more excited about engaging with the business. The main idea behind an effective program is that loyal customers will be rewarded by receiving additional benefits.

As many studies have shown, increasing the customer retention rate by even a small margin can boost retailer profitability significantly. This is where loyalty programs can help by retaining existing customers as well as expanding the customer base. A dedicated and personalized loyalty program that offers customers benefits and privileges is one of the best ways to thank them for shopping with you and helps keep your business at the forefront of their mind rather than simply being a purchase they make once then forget about.

There are many potential positives, both financial and non-financial, that loyalty programs can provide. Many surveys have proven that customers are more loyal to a retailer with a better loyalty program or one that consistently provides better offers and rewards.  

Let’s review the key loyalty benefits and how they can help you retain your most important customers. Keep in mind that for smaller businesses, budgets are always limited. This creates a constant trade-off between investing funds into acquiring new customers versus trying to retain existing customers to return time and again. Loyalty programs play a major role in this balancing act.

The main benefits of loyalty program are:

— Retain existing customers with less effort
Existing loyal customers spend more on average than new ones and acquiring new customers costs at least 5 times more than keeping existing ones. Even during difficult times such as during the COVID pandemic, loyal customers were shown to spend more than new customers. Retention impacts a businesses long term growth significantly.

— Increase Customer Lifetime Value
This attribute helps you to estimate how valuable a customer is in terms of how much they could potentially bring to your business in the future. If you have access to the necessary data, then you can accurately understand and forecast customer habits and needs as part of the development of your loyalty program.

— Strengthen relationship with customers
Creating an emotional relationship with a customer and promoting customer loyalty demonstrates to the customer that the retailer values them. That’s why every customer should be encouraged via personalized offers. For this reason, customer data such as order history, activities, or store visits becomes very important. The more a retailer knows about their customer, the easier it is to build an effective loyalty program. The main point here is to make each customer feel like a VIP customer.

— Encourage social media and word of mouth marketing
Every retailer should not only think about the customer spending money in the store, but also about customers who can help generate greater revenues by attracting more customers to the business. This group of customers are known as retailer advocates. People trust word of mouth recommendations and having a loyalty program in place allows you to build a network of retailers’ advocates to take advantage of this. In this scenario, a two-way reward system should be used – to encourage existing customers to refer friends as well as offering a discount to the newly engaged customer.

— Connect to a customer through all channels
A customer should remember your business. For this reason, retailers should track the channels through which customers have engaged with the brand. For example, if a customer stops following you on Instagram, then look to reach out to them via email or another channel.

— Highlight the business among competitors
To think only about the products you sell is the wrong way to go about developing your business. The current market is too competitive to be successful by taking such a narrow approach, so it’s vital that you’re also continually working on your brand and stores. This means retailers need to ensure they’re not just competing with others on price, but are also actively working to establish an emotional connection with their customers. This provides the opportunity to offer a more personal experience and for new ways to surprise and reward customers. And every time a customer is rewarded is another chance to strengthen the relationship with them and use them as an advocate for your business as they share their positive experience with friends, family, and colleagues.

— Reduce marketing and advertising costs
Creating a loyalty program generally requires a lower level of investment because they are primarily targeted at existing customers, which is cheaper than acquiring new customers.

Loyalty programs have a very long history. At least as far back as the late 18th century when “premium marketing” was first used. At that time, American retailers began to give customers copper tokens with purchases that could be later redeemed for products on future purchases. Since then, loyalty programs have continued to evolve and today we now have an enormous array of them. Let’s take a closer look at the most common types.

Point-based program
The oldest and simplest type of loyalty program. Remember those copper tokens from the 18th century? That’s a points based program! But over time, physical tokens evolved into virtual points. You make a purchase and receive points. You can then redeem your points to get free stuff, discounts, or even cash. Sometimes businesses reward other activities too such as inviting friends, sharing posts on social networks, or downloading apps.

Paid loyalty program
Many retailers started offering customers the ability to enroll in a new type of loyalty program where the customer actually had to pay for it. So while it may sound strange, many customers were happy to pay to feel like a VIP member and to gain early access to new products, free or faster shipping, or personalized targeted promotions. This type of loyalty program works well for popular retailers with a large existing customer base.

Tier-based program
Tier-based programs place greater focus on the level of loyalty. The more a customer is loyal to the retailer, the greater benefits or rewards they receive. At the same time, tiers help to encourage customers to join a loyalty program and spend more. It also adds an extra gamification element to the program itself. Loyalty programs of this type usually motivate customers to spend more by continuously reminding them about the benefits of higher tiers and showing them their progress to reach a new milestone.

Mission-driven program
As we’ve noted several times above, the most crucial aim is to establish an emotional relationship with your customers. Retailers should work to understand exactly what the main values of its customers are, such as what makes them feel accepted, or that they’re doing something good for their family or society. An example of this would be to structure a loyalty program around supporting a charity or helping to fund medical research. This helps take the customer relationship to the next level and helps build a community of advocates for the business.

Community program
Another way to build support for your business is to build a community of customers with the same interest as a mission-driven program. This involves building a community where the customers can share their experiences, thoughts, photos, videos, invite friends, and send referrals. Meanwhile, the customer also gains access to exclusive perks. Don’t underestimate the power of your customers being fans – they can create powerful marketing content like unboxing videos or affiliate links that help grow your brand through word-of-mouth or content creation.

Cashback program
This type of loyalty program offers real rewards (in the form of cash or credits) from every purchase or activity. This is a straightforward type of program that is easy to understand and maintain.

Punch card program
A punch card program is similar to a points-based or cashback program. Upon their first purchase, customers receive a business card that gets a hole punched in it after each new purchase they make. After they’ve punched a set number of holes in their card, they receive a free benefit or reward. So for example, after buying 10 coffees from their local coffee shop, they receive the 11th coffee free. The benefit of this system is that the business can guarantee that the customer will visit them a certain number of times before issuing a reward. These punch cards can be paper or digital depending on the provider.

Coalition program
By understanding what is attractive to your customers, you can provide more meaningful opportunities for them. This is where a strategic partnership can come into play. By forming a coalition with a relevant partner as part of your loyalty program, it demonstrates that you care about your customers’ interests and needs.

A good example of this is Nike, which is partnered with Classpass, iTunes, and many other giant brands. It broadens the scope of benefits and perks that can be offered to your customers by giving them rewards from coalition partners that offer products and services outside your normal market. Another common example is the partnerships between hotel chains, airlines, and rental car services. In the case of a coalition loyalty program, customer data is collected in a shared customer database, which is also worth keeping in mind.

Hybrid program
Some programs incorporate features from a variety of different loyalty program approaches. For example, tiered programs with points combined with transactional and experiential benefits. These kinds of hybrid loyalty programs are becoming increasingly popular these days as every retailer is looking for innovative ways to attract and retain customers. Don’t limit your imagination and be open to mixing elements from all possible loyalty strategies and ideas.

So you’ve decided you need a loyalty program because you want to improve your retention rate, bring more attention to the business as well as to help achieve other goals. Fantastic! It will be an exciting new challenge. But what’s the first step? Build it in-house or outsource a vendor?

Essentially there are two options available; build in-house, or use a 3rd party platform.

A 3rd party solution can be a safer option for a retailer because it’s already been previously implemented. There’s no time needed to pull together any requirements or implementation tools as all the basic functionality has already been developed. Many 3rd party solutions also incorporate more complex features including translation, omnichannel, and social media activities. As a bonus, a 3rd party usually assigns an expert team to customize a product and help to build a successful loyalty program. In this case, this reduces the need to do research on which loyalty program to choose, what your competitors are doing, or what the best strategy for your industry is.

At the same time, 3rd party solutions aren’t free, and retailers can usually expect to pay an ongoing subscription fee. Payment models can vary, as either a monthly subscription fee or payment that depends on the number of accounts that are supported. Access to customer data is usually closed to retailers unless officially asking for specific requests.

The most painful aspect of integrating a 3rd party solution is usually the data migration. It takes a lot of time to source and standardize the right data to fit the 3rd party schema. It should also be taken into account that if there are problems with the 3rd party platform or that provider goes out of business, your loyalty program will be lost as well.

If a retailer wants to be more flexible so they can easily add new features, promotions, or other personalization perks quickly, then it’s better to build an in-house solution. An in-house solution will help to reduce issues with the migration and data schema. In the case of in-house solutions, there is no subscription fee, only ongoing maintenance costs. For this type of solution it’s important to use a transparent points and reward calculation system so that it’s always easy to understand how it works or when it has been adjusted.

One final important point to note is the importance of analytical reports. Every marketing team and/or financial team wants to be able to generate their own reports. Therefore the logic and data that feeds into these reports should be very clear and transparent.

There are multiple loyalty program types, and each program type has its own rules and flow. Let’s take a look at the basic loyalty flow:

A customer

1. Signs up to a loyalty program
2. Meets the requirements to earn points or rewards
3. Earns points or rewards
4. Redeems rewards

The process appears straightforward and transparent at first glance. But every step can involve its own set of difficulties. A customer can join the program in store or online, download the app or join via social media, from an email, sms, friend invite, or game. The key here is to work out which channels will work best for you, and which will attract the most newcomers without creating an onboarding system that is overly complex.

The next task to solve is to set up the business rules. These are the actions or activities from which a customer will earn points and receive different kinds of benefits.

Basic examples here are:

• Place an order. Every $1 spent converts to 10 points or a customer can earn real money from the very beginning like Kohl’s cash as an example
• Download an app – receive 50 points
• Invite a friend
• Write a review
• Provide feedback
• Sign up to a retailer credit card
• Install a game

Business rules include the activities required to earn points as well as any actions that can lead to a reduction in points. Loyalty programs can also complicate product return business logic due to potential abuse of the program. For this reason, order histories need to be maintained accurately to prevent loyalty fraud. Simulating cash behavior in points and rewards may simplify the implementation of the loyalty program (for example, Kohl’s cash).

While a customer is progressing towards their next goal, whether it’s a free drink, other benefit, or achieving the next tier, it’s a good idea to clearly demonstrate this via a progress bar. It can also be a good idea to show how many other customers are at the same level or on the next tier up, to encourage customers to progress to the next tier more quickly.

Once a customer has earned enough points, they should be encouraged to convert them into rewards. This can be in the form of a regular coupon, a free item, or free membership. By redeeming the reward, the customer sees a tangible benefit from being a loyal customer and this promotes further loyalty to your business.

One final point about loyalty programs is that you should encourage your customers to be aware of the program all the time. This can be via a smartphone app, email, or sms campaign so that the customer is regularly updated about their progress via a daily, weekly, or monthly snapshot that shows them their progress towards the next reward level.

Almost all retailers eventually encounter some problems with 3rd party loyalty software, which can push them towards building in-house loyalty engine solutions. In this case, time and effort should be put into planning and implementing a loyalty engine so that the program is properly thought out and organized to deliver a quality outcome for you and your customers. Special attention should be paid to data migration and quality to ensure the transition from a 3rd party to an in-house solution is smooth and seamless.

Every retailer should understand that loyalty programs are effective. They help increase growth, build customer trust and engagement, and enhance brand reputation. They also keep your business in the minds of your customers so they don’t forget about you and move on to another business. So once you have determined your main goals for the loyalty program and selected the type of program that best suits those goals then you should be ready to go!

The topic of designing a high quality loyalty engine is vast and can be complex. In the following articles in the series, we will continue our discussion about how to migrate from a 3rd party solution to an in-house solution and how to design the architecture of the in-house loyalty engine to deliver the best long term results.

Meanwhile, if you would like to learn how Grid Dynamics can help you create a best-in-class Customer Loyalty Program, don’t hesitate to reach out.