The reason for this is that most loyalty programs fall into one of three categories: discount-based, free stuff based, or gift based loyalty programs. Let’s review them one by one.
The discount-based loyalty programs
The discount based loyalty programs are based on giving loyal customers coupons with steeper discounts than regular customers can get.
The thing with discounts is that it triggers the pleasure side of the brain — that part of the brain that gets addicted to things. So in order to get the same satisfaction over time, our brain requires bigger stimuli — in this case, deeper discounts are the only thing that will keep us happy. If you bought an item at 50% off, you will never want to buy that item at full price anymore, or even with a 20% discount. Doing so would leave you with the feeling of being cheated. And after awhile the 50% off discounts become routine, and you only get excited if someone offers you 60% or 75% off. And if that someone is an alternative vendor, you might actually switch.
So all in all, and while discount-based loyalty programs may work for awhile, over the long run they suck the profitability out of an industry. They may actually not be a good basis for long term loyalty at all. And if you really think about it, they may actually reward your least profitable customers.
Free stuff based loyalty program
Many loyalty programs fall into this category, including airline programs and credit card programs. The more points you have, the more free stuff you can get and the higher up in status you go. It works really well because people will do anything in order to get something free. Dan Ariely, Behavioral Economist at Duke University has documented this phenomenon — people will do totally irrational things to get free stuff. Most of those programs also have gamification elements, such as leaderboards and levels that give you status — another powerful Human 1.0 motivator that is ingrained in all humans.
But since free is another form of discount, those programs too tend to suck the profitability out of the industry. Plus customers that acquire free stuff are acting irrationally, and in the end there are often hidden costs for the person who acquired free stuff that they did not really need — think of all those chotchkes that you may have brought from conferences in the past. And except for the leveling part and the status, I am not sure that they result in a lot more word of mouth from your “loyal” customers.
Gift-based loyalty programs
Giving a customer a gift, and in some cases unexpected gifts, in return for their loyalty is the most powerful of all loyalty triggers. Giving a gift to someone triggers one of the most ancient Human 1.0 characteristics — reciprocity. If you give me a gift, I am indebted to you and will be driven to give something back — reciprocity is a reflex, not something we learn from mom and dad or in grade school. A good example of a gift-based loyalty program is the Kimpton Hotel Inner Circle program. When you reach the inner circle, you not only have access to the CEO, but if they have the room they upgrade you free of charge and if they know that you like berries and wine (as I do), they may have a bottle of wine with those berries when you get to your room. They keep surprising you with gifts.
A program like this does not suck the profitability out of the industry. It truly instills loyalty. And it rewards your most profitable customers, not the discount-seekers or totally irrational free-stuff seekers. And because it triggers reciprocity, the word of mouth benefits can be considerable. Look at Kimpton again. According to Steve Pinetti, the SVP of Inspiration and Creativity at Kimpton, 60% of all their first time customers are there because of word-of-mouth — that compares to 20-25% being considered successful in the industry.