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  1. 1. Are You Giving Away Margin for No Good Reason? How Retailers Blow It with Conventional Loyalty Cards, Coupons and Promotions A Guide to Earning and Growing Customer Loyalty by David P. Williams President, LoyalTec, LLC 1725 Mendon Road Suite 106 Cumberland, RI 02864 LoyalTec Partner: (866) 598-3343
  2. 2. Are You Giving Away Margin for No Good Reason? How Retailers Blow It with Conventional Loyalty Cards, Coupons and Promotions The Problem More and more retail shops and restaurants are using loyalty cards, coupons, and promotions to encourage patronage and track customer spending. In general, it’s a very good idea. The merchant can obtain valuable information about customer behavior, highlight specific products, motivate desirable customer behavior, and build relationships immune to competition. Unfortunately, very few such promotions achieve even a fraction of their intended results, and instead lead to business-damaging negative consequences. Yet, because most of these problems are errors of omission, business owners do not recognize them when they occur and therefore cannot act to repair the damage. Why Should You Listen to Me? I’m David Williams, the founder and President of LoyalTec, LLC. We help retailers increase their profits by mining their own data. Our methodology allows retailers to analyze and leverage the information they collect (or should be collecting) about their customers and their customers’ behavior. Our clients increase profits by dramatically growing the value of their customers, keeping good customers longer, and getting them to refer other customers. Previously, as founder and Chief Technology Officer of Retail Solutions, Inc., I pioneered real-time visibility and analysis of retail point-of-sale (POS) data throughout the entire supply-chain. My clients and strategic partners have included Revlon, Unilever, Pfizer, Bayer, Bristol-Myers, Wyeth Healthcare, American Greetings, CVS/Pharmacy, Eckerd, Walgreens, Duane Reade, L.L. Bean, and Toys ‘R Us. Before starting Retail Solutions, I designed continuous replenishment programs that automatically placed replenishment reorders on behalf of individual retail stores based on actual consumer take-away – an industry first for national drug retailers. My twin passions are analytics and loyalty marketing. In my career, I've seen companies that collect amazing data about their customers and fail to capitalize on it. I've also seen companies committed to creating raving fans of their customers who couldn't pull it off because they didn't have the means to treat each customer as an individual. My mission is to place the cutting edge of information technology in the service of enlightened permission- based, one-to-one marketing. What You’ll Get From This Paper This White Paper deals with one of the major unintended consequences of promotions: Subsidization of purchases that were going to happen anyway. First, I’ll define subsidization and give three examples. Next, I’ll describe the four main problems with subsidization. Finally, I’ll explain a few simple ways to prevent subsidization and ensure that your promotion achieves completely positive and profitable results. © 2005 LoyalTec, LLC – All Rights Reserved Page 1
  3. 3. Are You Giving Away Margin for No Good Reason? How Retailers Blow It with Conventional Loyalty Cards, Coupons and Promotions Am I Subsidizing My Customers? Subsidization in Action You are subsidizing customers when you pay them to take actions they would have taken anyway, or when you attract customers on whom you lose money over their lifetime as your customer. Example 1: “Buy One Nail Clipper, Get One Free” This is a ridiculous example – I only bring it up because it was actually used and because it makes the point clearly. The company printed a coupon that offered a free nail clipper with each one purchased. The problem was, nobody needed to buy two nail clippers. They’re generally not considered great gifts (“Oh, a nail clipper, just what I always wanted!”), and even the most talented individual can just use one of them at a time. So what was the result of the promotion? Shoppers hanging out in the nail clipper aisle started strategizing with one another: “I’ll buy two with the coupon and you can pay me half.” The company sold nail clippers for half price and didn’t even collect information on the second, “hidden” purchaser. Example 2: “$1.00 off Pampers” I have young children, one of whom is still in diapers. So, most Sunday newspapers contain coupons for Pampers and Huggies. My wife is an avid Pampers buyer; it’s the only brand she’ll use. She takes that coupon, and she uses it to buy Pampers. She would’ve bought Pampers anyway, but since the coupon is here, we’re going to pay less for them. Now, I have neighbors down the street, and they only use Huggies. So, an interesting thing happens, because that neighbor cuts out the Pampers coupon, and gives it to my wife. My wife cuts out the Huggies coupon, and gives it to her. So what’s happening? The Pampers buyers, us, are being subsidized for buying what we would have bought anyway. My neighbor is also getting subsidized, because she’s getting her Huggies coupon. More interestingly, down the street, I have another neighbor. Both her children are well out of diapers. She takes those coupons, she cuts out the Huggies and gives them to my neighbor, and takes the Pampers and gives it to my wife. Now, she’s got three coupons for Pampers and can buy all her diapers at a discounted price. The same diapers she was going to buy all along! Example 3: “Buy 12 Cups of Coffee, Get Your 13 th Cup Free” Many establishments use punch cards to reward frequent purchases. There are a lot of things wrong with this strategy aside from subsidization, but that’s beside the point I’m making here. © 2005 LoyalTec, LLC – All Rights Reserved Page 2
  4. 4. Are You Giving Away Margin for No Good Reason? How Retailers Blow It with Conventional Loyalty Cards, Coupons and Promotions The customer coming in with a full punch card to receive their free cup of coffee is clearly already a coffee buyer. Do you have any doubt that they were going to buy that 13th cup anyway? The Five Hidden Costs of Subsidization Hidden Cost #1: Giving Away What Your Customers Were Going to Buy Anyway This is the most obvious problem with coupons and punch cards and sales. You’re losing money because you don’t have the ability to offer the promotion to just those customers who aren’t going to try your product without an added incentive. Hidden Cost #2: Attracting and Training “Cherry Pickers” “Cherry Pickers” are those customers who exhibit no loyalty behavior at all. They treat all establishments as commodities, and are forever in search of the cheapest vendor. For example, the long distance phone companies have trained many consumers to become long distance cherry pickers, depositing the check that authorizes AT&T to switch us to their service until the next check comes from Sprint. Some of us are even savvy enough to ignore the $30 and $50 checks until we get the $100 “final offer.” The problem with cherry pickers is that they cost merchants more than they’re worth. They are actually a negative profit center within a business. Establishments who lack the ability to track profits by customer would be shocked to learn what percentage of their customers are not worth keeping. The diaper example shows not only how the coupon attracts cherry pickers, it also creates them. If I know that diapers or premium orange juice or a magazine subscription is frequently on sale, I’d have to be a fool to pay regular price. Unless my need is urgent, I’ll wait for the next promotion. I’ve been trained to view the regular price as unreasonably high. Hidden Cost #3: Missing the Opportunity to Change Behavior The purpose of a promotion is to change consumer behavior, to increase their lifetime value to the merchant. A coffee drinker receiving the 13th cup for free is continuing the same behavior as if they had paid for it. The Pampers buyer is continuing to do what they would have done anyway. When a promotion is targeted at an individual with a known buying profile, it can powerfully alter behavior and enhance customer value. (I’ll explain how shortly.) Subsidization misses this opportunity completely. © 2005 LoyalTec, LLC – All Rights Reserved Page 3
  5. 5. Are You Giving Away Margin for No Good Reason? How Retailers Blow It with Conventional Loyalty Cards, Coupons and Promotions Hidden Cost #4: Missing the Opportunity to Reward Desirable Behavior At this point, you may be silently protesting, “But surely it’s good business to make my customers happy. What’s wrong with giving them gifts of discounts to earn their goodwill and continued loyalty?” There’s nothing wrong with that at all. The strategy is great. It’s the execution that’s typically the problem. If you want to reward your best customers, do just that. Identify a group of customers who have behaved in ways you want to nurture and amplify, and give them something special that reinforces their feelings of belonging and gratitude. Does a punch card for an extra coffee do that? How does a customer who’s bought a double cappucino latte grande every morning for the past eight years feel after handing in the full punch card and receiving a free coffee and an empty punch card? The same as a new customer who just walked in off the street for their first cup. Once the punch card is full, they have to start over and forfeit all tangible evidence of their “special status.” The other problem with coupon promotions is that they reward people with the least leveraged thing there is: money. If you give someone a coupon for $1.00, you’ll give up exactly $1.00 when they redeem the coupon. If, on the other hand, you give them extra product, you may only have to pay $0.20 or $0.30 for every $1.00 of value as perceived by your customer. Hidden Cost #5: Reinforcing the “Commodity” Image of Your Business and Your Customers This is the most subtle cost, and I would argue, the most significant in the long run. Think back to the old days, when you had one butcher, one hardware store, one retailer in your area. The proprietor, typically the owner, knew their customers, and because they knew their customers, those customers enjoyed shopping there. Because, when they came in, they got an experience that was unique to them. For example, Mrs. Jones walks into the butcher shop and the butcher immediately says to her, “Welcome back, Mrs. Jones, I have the lean flank steak you like, and here’s a bag of soup bones for Ripper.” The reason that you only had one butcher in town is, if another butcher came in, he’d never get any business, because of the already developed relationships. Now, you’ve got 100 different retailers in a square, 10-mile block. When you start to pick which retailer you’re going to go to, you’ve got to find a reason other than they’re the only one in town. Without a relationship, the only thing the consumer has to go on is price. That’s why they’re treating businesses like commodities. But the important point here is that the process began because retailers started treating customers like commodities. From “one size fits all” promotions to clerks who don’t have a clue who the best customers are to frankly lousy service. Promotions that discount indiscriminately reinforce the commodity image by heightening price-consciousness at the expense of every other differentiator. And promotions that treat all customers the same – the one who’s bought 12 lattes over the past year and the one © 2005 LoyalTec, LLC – All Rights Reserved Page 4
  6. 6. Are You Giving Away Margin for No Good Reason? How Retailers Blow It with Conventional Loyalty Cards, Coupons and Promotions who’s bought 200 – reinforce the perception that customers are commodities as well, rather than individuals who honor us with their continued business and referrals. How to Get the Most from Your Promotions and Avoid Subsidization 1. Create Promotions That Reward New Behavior. As we’ve seen from the diaper example, a person can just look through the Sunday paper and cut out coupons for things they already buy. Try a different strategy: design a coupon as incentive for them to try something different. Create a coupon that gets people to buy a larger size of a given product. For example, to move from the 2 ounce tube of Crest to the 4 ounce tube. Or to choose a new product within the same general category: to buy Crest with Whitening rather than Crest Regular. Obviously, in order to use coupons in this way you must have data on your customers. Don’t spend money to print coupons for a mass audience, most of whom will either throw the coupon away or subsidize their own or someone else’s behavior. Instead, spend the money sending targeted coupons to a sensible segment of your market. 2. Make sure the coupon can be redeemed only by the customer to whom it’s sent. Tie coupons to users. If you send out a “Buy one, get one free” coupon, tie it to that consumer, so the coupon is good only when redeemed by that consumer along with their frequent buyer card. So the coupon alone has zero value, but if you bring that coupon in, and bring in your frequent buyer card, now that coupon has value. Because we’re only going to give those coupons to people who are not exhibiting the behavior that we want them to exhibit, we can actually use the coupons to change behavior, and that’s money well spent. 3. Tailor “loss leaders” to stop giving away margin to cherry pickers There are times when it makes sense to give away a product. Drugstores often put soda or paper goods on sale, when they’re making almost no money on those products. The theory is that, if you come in to buy paper towels at your local drugstore because they’re on sale, while you’re in there, you’ll buy something else. That’s called the “market basket”; everything that you bought on that visit. There are studies that say when someone comes in to buy paper towels, they have a tendency to spend more than if they weren’t enticed by the paper towel sale. Carbonated beverages is another typical example. If you come in and buy a soda, odds are you’re going to buy a candy bar. The candy bar is at high margin, and the soda was at a near-zero margin. It all balances out, and everyone’s happy. But there are people who aren’t following those rules. They’re only coming in and buying paper, or they’re only coming in and buying soda. When you gain the ability to track those customers, and learn what they’re buying, you now can say, “This person bought only what’s on sale.” You can flag them as a cherry picker, and stop giving them those kinds of offers. Or tie the offer to something with a higher margin: “Half off on a can of soda if you buy © 2005 LoyalTec, LLC – All Rights Reserved Page 5
  7. 7. Are You Giving Away Margin for No Good Reason? How Retailers Blow It with Conventional Loyalty Cards, Coupons and Promotions four bags of Frito-Lay chips.” Those chips are at a high margin, so it’s worth giving away the soda. 4. Use promotions to address “opportunity gaps.” An opportunity gap exists when you have a customer who limits their value in a way inconsistent with other customers like them. For example, most of the coffee shop patrons buy a Danish or a muffin with their morning cup. If you identify a customer who buys coffee but never buys anything else with it, you can send them a coupon that offers “Free muffin with your next cup.” If they take you up on the offer, you have the potential to turn them into a muffin buyer on a regular basis. Another example from a drugstore: customers who buy toothpaste but never buy toothbrushes. The drugstore has not capitalized on the opportunity to sell those customers toothbrushes. Maybe they don’t realize that the drugstore carries toothbrushes. Maybe they’ve always picked up a toothbrush at the supermarket. Maybe they wait six months for the dentist to give them a new one. A promotion for a reduced price or free toothbrush for regular “toothpaste only” buyers is a powerful way to introduce new habits that can significantly increase the lifetime value of those customers. 5. Use promotions to nurture loyalty among your best customers. The punch card is a great example of how not to reward loyal customers. As we’ve seen, once the last circle is punched, they’re demoted to the level of the first-time, off-the-street shopper. Instead of promotions that plummet in value on a regular basis, design loyalty programs that step your best customers into higher and higher levels of recognition and reward. Airlines do this well, with frequent flyer lounges and first class upgrades and many other perks for their best customers. Just because someone redeems 200,000 frequent flier miles for a family vacation doesn’t mean they get treated like cattle on their next trip. Yet punch card programs do precisely that. 6. Use loyalty programs to provide incentive to your customers to share their purchase information with you. Data on your individual customers’ buying habits is worth a fortune to the retailer who knows what to do with that information. This information allows you to increase the value of your best customers, save customers at risk of defecting, bring back lost customers, and vastly increase return on all your marketing expenditures. But unless you give your customers a good reason to present their shoppers card every time they buy, you will end up with incomplete or no information. © 2005 LoyalTec, LLC – All Rights Reserved Page 6
  8. 8. Are You Giving Away Margin for No Good Reason? How Retailers Blow It with Conventional Loyalty Cards, Coupons and Promotions 7. Track and analyze the results of your promotions. With proper data collection and analysis, you can continuously improve your promotions to increase customer value, loyalty, and profits. How to do this is beyond the scope off this White Paper, but one example will suffice here. You can (and should) track when coupons are redeemed. If you send an offer on January 1st , and your customer has redeemed it by January 3 rd, you’ve learned two very useful things. Not only do you know that the coupon works, you also know that this customer is very easily motivated by coupons. They are a good candidate to send additional coupons. If, on the other hand, the customer redeems the coupon six months later, you learn that you probably didn’t change their behavior. You just subsidized them. So you will alter the type of promotion you offer to this customer in the future, to avoid further subsidization. Next Steps When I present these concepts, most retailers intuitively understand that running strategic loyalty programs, rather than haphazard promotions, is a good idea. They see that they’re leaving money on the table by subsidizing customers for purchases they were going to make anyway. They sense that they’re treating themselves and their customers as commodities. But they are daunted by the seeming difficulty of putting together a loyalty program, specifically collecting, warehousing, analyzing, and acting on the data. They see how large national chains such as Staples and CVS can dedicate the resources to running the program effectively, but don’t think they can do it themselves. I don’t blame them. Setting up the computer infrastructure for data warehousing is a complex and expensive job. Setting up the loyalty cards themselves, whether barcode or magnetic strip, also requires a lot of expertise. The equipment to scan cards is typically cumbersome, and requires a lot of training of staff due to high turnover rates. To solve these problems, LoyalTec has developed a turnkey solution for businesses who don’t want any of the headaches or startup costs or risks of setting up their own programs. We set up your database on our state-of-the-art, data-redundant servers and make it as easy and secure for you to upload your data as transmitting a credit card transaction. The solution can either stand-alone or tie in to your existing checkout system. We’ll consult with you to set up a loyalty program that makes sense, analyze the data, make recommendations, and implement all the steps of the program, from sending out mailings to running coupons to sponsoring members’ only events and in-store promotions. © 2005 LoyalTec, LLC – All Rights Reserved Page 7
  9. 9. Are You Giving Away Margin for No Good Reason? How Retailers Blow It with Conventional Loyalty Cards, Coupons and Promotions To find out whether LoyalTec can increase your profits, nurture your best customers, and explode your referral business, contact us by email, phone, or post: LoyalTec, LLC 1725 Mendon Road Suite 106 Cumberland, RI 02864 (401) 333-7900 Author’s notes: Do you know someone who should read this document? Have them send a blank email to They will instantly receive instructions for obtaining their own copy. If this copy was emailed, faxed or photocopied for you, you will not automatically receive future cutting-edge documents on building and profiting from customer loyalty. Some of the titles in the works include: * How to Alienate and Scare Your Customers with Ill-Timed Communication * How to Find and Fire Your Cherry-Pickers * How to Identify and Reward the 20% Responsible for 80% of Your Profits * The Secret to Not Losing Customers: Steps to Take Before It’s Too Late To be sure that you get these special reports, just send a blank email to I need your feedback. Whether you agree or disagree with me, I’d love to discuss it with you. Please drop me a line at or call me at (401) 333-7900. © 2005 LoyalTec, LLC – All Rights Reserved Page 8