Designing loyalty programmes using behavioural economics: a short essay for @danariely’s @Coursera course

Over the last 6 weeks, I’ve been taking Dan Ariely’s Coursera course ‘A Beginner’s Guide to Irrational Behavior’. It’s been a fair amount of work in addition to my day job: 7-10 hours of watching course lectures and reading academic papers per week, and as much as it’s been challenging to juggle my time, it’s also been rather eye-opening. For one, time management became a skill I was forced to master if I wanted to complete the course, and second, some of the research and experiments I learnt about really offered insight into what I do on a daily basis. A fair amount I was already familiar with thanks to Ariely’s books and the work of Rory Sutherland when he was President of the IPA, not to mention the fact that PHD’s Source pulls in a lot of behavioural economics theory, but I found it useful nevertheless. The course was structured very well and I was impressed with the amount of work they must have put in to organise it: apart from curating the video lectures and research papers, weekly Office Hours via Google+ Hangouts, discussion fora, and a look into the work at Ariely’s Center for Advanced Hindsight, for example.

We had one short writing assignment for the course. I thought I’d share mine below. We were asked to identify one problem with how people behave, relate it to behavioural economics, name the problem from what we’d studied till then, and come up with an original solution quoting relevant research where necessary.

We live in a world of excessive choice. An Economist article stated not too long ago that ‘the average American supermarket now carries 48,750 items, according to the Food Marketing Institute, more than five times the number in 1975’. There has been considerable research on the effects of choice on motivation to purchase (Iyengar & Lepper, 2000; Schwartz, ‘The Paradox of Choice’, 2004) – namely that too many choices can be detrimental to positive purchase decisions (with some caveats, such as, for the jam experiment referred to by Ariely, Iyengar and Leppar, ensuring participants were allowed sufficient time to make a decision and were not burdened with social pressure).

This diverse choice scenario, with hundreds if not thousands of brands fighting for the attention of people on a daily basis, naturally leads to an atmosphere of severe market competition. An oft-used tool to counter this and increase customer retention is the loyalty programme. The number of loyalty programmes in the US alone has doubled since 2000 from 973 million to 2.09 billion, with the number per household rising by over 50% from 12 to 18. But, as research indicates, ‘nearly one-third – a full $16 billion –  of those rewards earned in a given year will go unused’ (Hlavinka & Sullivan, ‘The Billion Member March: The 2011 Colloquy Loyalty Census’, 2011). So in theory loyalty programmes might sound like a good solution for brands to stand apart and increase profit, but they often turn out not to be because they are ‘misunderstood and misapplied’ (Yi & Jeon, ‘Effects of Loyalty Programs on Value Perception, Program Loyalty, and Brand Loyalty’, 2009).

The problem I’d like to discuss, following on from this, is that people have trouble redeeming reward points collected from multiple brands spread across a large shopping portfolio, and as a result a lot of their money goes to waste. This is because, as Ariely says, “the path of least resistance is especially likely when deviating from the default is more complex”.

If a brand automatically deducted what an existing customer has earned in the past from their next purchase using forced choice, this wouldn’t be a problem. But this rarely happens – it is typically not to a brand’s benefit to do this. Since people often don’t remember the extent of the benefits they accrue from multiple sources, brands typically use this to their advantage. There is therefore an opportunity to design purchase reward systems such that this default outcome is both to the consumer’s and the brand’s advantage. Somewhat along these lines, American Express in Argentina carried out a marketing campaign in 2010 that was based on raising awareness of opportunity cost: they alerted people who had over 5,000 points to be redeemed to this fact and more or less ‘forced’ them to act on this by focussing their attention very specifically on what they could buy in return. It was a very successful campaign, proving that reminding consumers of the existence of opportunity costs can in fact lead them to be considered (Spiller, 2011; Frederick et al, 2009).

Departing from these solutions which have been discussed and examined elsewhere, I suggest using loss aversion and the endowment effect as techniques in designing purchase reward systems instead.

I suggest that a supermarket credits all shoppers a certain amount, say $100, when they make their purchases at the beginning of the year (or first purchases, in the case of first-time shoppers). They are given a note or told by the check-out assistant that they can spend this money on any products they choose from the store by the end of the year, and that whatever is left over will be automatically taken back after that time. It is likely that once loss aversion and the endowment effect kick into action, people will find themselves not wanting to lose out on the $100 that they now ‘own’. Once this happens, I suggest that the self-herding model will take over: they will anchor continuing behaviour to their earlier behaviour of shopping at the store, having seen increased value, and which, luckily for the store, will reflect loyalty.

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