Companies start loyalty programs to encourage additional purchases, but a new book by the brains behind one of the world's most successful loyalty programs believe that that premise is the first step toward failure.

What companies really need to do, say Clive Humby and Terry Hunt, is establish loyalty programs that thank customers for previous purchases rather than encourage them to buy more. That approach is instantly understandable to anyone who has a wallet full of cards just needing a stamp or two to qualify for a “free” sandwich or cup of coffee.

Humby and Hunt, assisted by Tim Phillips, are the co-authors of Scoring Points: How Tesco Is Winning Customer Loyalty. The book details how Tesco used its Clubcard loyalty card to become the largest supermarket chain in the UK, and the largest grocery e-tailer in the world.

The card also laid the foundation for a profitable Tesco-branded bank, fueled substantial overseas expansion and, most important, improved profitability. All that, despite the fact that Tesco returned more than £1 billion to customers in awards since the program started in 1995.

Additionally, the book outlines an overview of loyalty alternatives and explains why competing loyalty programs at Safeway and Sainsbury's failed. Also interesting are the freely acknowledged mistakes along the way, such as the attempt to build loyalty among students or a pub-based scheme to offer “points for pints.”

The scope and capabilities of Clubcard are astounding. Tesco collects data on each head of lettuce, can of peas, bottle of wine or other item purchased by more than 10 million Club card members. It analyzes this tsunami of data to send a magazine with segment-specific content and six highly targeted coupons to each member four times a year.

Four coupons are for products the customer already buys, and two are for products that the customer has never bought before but is likely to buy. As of 1999, Tesco was sending out 145,000 combinations of magazines and coupons; undoubtedly, the number is higher today.

Many promotions just rob future sales, but the analysis enables Tesco to generate more than £100 million in incremental sales each year. Another benefit: “By monitoring short-term coupon redemption rates and then tracking the ongoing transactional activity of the members across all store departments, Tesco could calculate precisely the return on investment.”

Some insights result from “placing” customers inside a three-dimensional cube:

  1. The first axis, called “contribution,” examines current customer profitability. Interestingly, Clubcard focuses on improving loyalty from all customers, including the unprofitable.

  2. The second axis, “commitment,” measures future customer profitability. This contains two elements. The first is a measure of how likely the customer will remain a customer, and the second is “headroom.” Headroom is essentially share-of-wallet, or the potential to increase value in the future.

  3. The third axis is “championing,” or the potential to become a brand ambassador or, at a higher level, a “brand mentor,” like those mothers who sign pregnant daughters up for Tesco's Baby Club.

These are key principles of the Clubcard program:

  • Be self-funding: The program must pay for itself. Tesco limits its marketing budget to 1% of gross sales and drops any activity that does not produce a sustainable sales uplift.

  • Be creative: In the beginning, technology and budget constraints prevented Tesco from analyzing more than a small portion of the data flooding in. So it reframed questions, made astute extrapolations and did frequent tests. It also showed a refreshing ability to experiment for a large company, even throwing out a decades-old program to start Clubcard.

  • Establish a loyalty contract: “Open a Clubcard account with Tesco, and the more you shop with us, the more benefit you will accrue.” This benefit consists of money back based on purchases and precisely targeted coupons that are both useful and desired. That is the promise of many loyalty programs, but most companies just use these programs to sell what the companies have on hand, not what customers require as value. The contract also includes simplicity. No customer wants to jump through hoops for a benefit after having given a company his business.

Most fascinating was the topic of segmentation. Few companies do segmentation well. Technically, there were 1.2 million potential segments for Tesco customers based on the attitudes and beliefs driving behavior. How do you put each customer into the right segment?

The solution was the “Rolling Ball.” “Adventurous” customers bought products like extra virgin olive oil or Malaysian curries. The baskets of these shoppers were examined to see what products they bought. Products, like bananas, that everyone bought were discarded to find the products that indicated an “adventurous” customer.

A similar process, combined with sophisticated mathematics, could then identify customers who were more interested in “fresh” than “adventurous.”

Another great discussion was how loyalty program could guide intelligent pricing. In the marketplace, Asda, a competitive supermarket, was seen as the price leader because it did not have the expense of loyalty costs. To compete on price, most companies just look at competitor prices, make theirs lower and crown themselves the price leader. That is how destructive price wars start.

Tesco's first step was to use the data to look at price-sensitive customers.

“If Clubcard data could identify the products that were brought by the price-conscious customers, but not by the rest of us, then lowering those prices would have a huge benefit for them, at the lowest possible cost for Tesco…. By not knowing their customers, many retailers are effectively wasting their money on price cuts that could be targeted to people who want them because they need them.”

The targeted price cuts enabled Tesco to attract more shoppers from competitors and capture the volume that supported the lower prices—all without hurting overall corporate profitability.

This excellent book shows how hard it is to succeed at establishing and supporting loyalty schemes. And it shows how easy it is to fail with a loyalty scheme that is focused more on sales than on retention and profitability.

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Nick Wreden is the author of ProfitBrand: How to Increase the Profitability, Accountability and Sustainability of Brands (named "Best Business Book of 2005" by strategy+business) and FusionBranding: How to Forge Your Brand for the Future. Reach him at