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Do Customer Loyalty Points Actually Work?

Jun 24, 2015

Written by: Tim Houlihan
(View Author Bio)

An investigation into how customer loyalty points can shape customer behavior with behavioral economics, rewards and incentives .

The average US household is signed up for 14 consumer loyalty programs even though they may only be active in 6. Most of these loyalty schemes are structured so participants can earn “points” in exchange for loyal behavior toward the sponsoring brand. Companies continue to offer these programs and we wondered: is the power of points an illusion or is it undeniably effective in cultivating customer loyalty?

To find the answer, we applied three aspects of behavioral economics to a shining example of a long-running, highly successful point-based loyalty program: frequent flyer miles.  Originally created by American Airlines in the 1980s, frequent flyer programs are still wildly successful in their third decade of use. A closer look reveals why…

 1. Mental Accounting

Frequent flyer miles are essentially customer loyalty points under a different name. They are relatively low value and would mean little to an individual (like me) if doled out in discounts or rebates. Researchers are clear that discounts on goods and services need to be large as measured by percentage to make a difference. A 1% discount on $1,000 is $10, just as a 10% discount on $100 is also $10. Same amount of money ($10), but we like the 10% discount a lot more than the 1% discount.

Let’s say that if you flew from Minneapolis to NYC (about 1,200 miles), you would earn about $24 worth of miles (at 2 cents per mile). Today, the average fare on a major airline from Minneapolis to NYC is about $400. As a percentage of the cost of the flight, the $24 in miles/points is about 6%.

If the value of the miles were put into the form of a rebate, $24 off the price of the flight would have little impact. Because consumers are riddled with 25% and 50% discounts at retail, a 6% rebate is not considered enough to sway the purchase decision.

Furthermore, if the $24 were positioned as a straight discount, every airline would manage their prices to a competitive level and it’s uncertain that the major carriers would even reduce their $400 flight to $376. They may not need to, given flight availability and quality of service.

In behavioral economics terms, these issues play into the principles of mental accounting.

The first way mental accounting makes frequent flyer miles so effective is that miles are separate from money. Researchers discovered that we have mental accounts for a whole variety of things just as we have actual bank accounts for money. We have mental accounts for vacation time and gifts (received and given) just as we have mental accounts for points accumulated in frequent flyer programs.  

Mentally, we don’t consider frequent flyer miles as money. This is because they are accumulated toward a trip – a free flight – and we track these miles in a specific, separate mental account.

Additionally, adding 1,200 miles (Minneapolis to NYC) to your frequent flyer account will increase your balance significantly toward my 25,000-mile objective. In relative terms, the 1,200-mile deposit into my account could be doubling my balance or adding as little as 5% to get me closer to a free ticket.

By emphasizing the accumulation of points as something different from money, their relative value has a higher perceived value

Adding $24 to your frequent flyer account is very different than adding $24 to your total income. When we consider the impact on income (which let’s say is $50,000), the $24 increase in my total wealth is only a 5/100th of 1% increase. We can quickly calculate that $24 doesn’t even cover the fee for good drop-in yoga class. However, with a frequent flyer account, that $24 addition may be anywhere from a 5% to a 100% gain over the current balance. That amount of gain in a frequent flyer account is definitely worth it.

 2. The Social Value of Rewards

Frequent flyer miles don’t have an explicit value – because 25,000 miles can be used to fly from Minneapolis to Fargo ($650 today) just as easily as Minneapolis to NYC ($400 today). Either way, you only use 25,000 miles  – in one case they are worth 2.6 cents/mile and in the other they’re worth 1.6 cents per mile.

When considering using our frequent flyer miles, we don’t choose a destination because it’s a better deal. Not at all. We only choose a destination if that’s where we want to go.

That’s the magic of non-monetary points. In Behavioral Economics terms, this is called the social exchange.

The social exchange is alive and well in our world. It can be observed when we take a $20 bottle of wine to the hostess of a party we’re attending but we take the price tag off before we give it to her. 

By using points, the airlines aren’t bribing us with money; they’re offering us an opportunity to take a free flight. They’re exchanging our time and money for their goods and services with an offer to let you fly wherever you want to go (as long as you have enough miles).  If the airlines sent you a statement after earning 25,000 points that said, “Your 25,000 are being redeemed for a $400 flight to NYC. They are worth 1.6 cents each today,” most people would quickly calculate other options and start viewing the miles (points) in monetary terms – and that would be bad for the airlines.

 3. The Gamification of Behavior

Frequent flyer miles require you to accumulate 25,000 miles before you can redeem. At 20,000 miles, you are just a few flights away from being able to redeem your points – and the research is clear: the closer we are to reaching the 25,000-mile mark, the more we accelerate our earning. No one consciously stops accumulating miles on Airline X at the 20,000-mile marker – they keep earning.  

The 25,000-mile minimum is a great way to get people to keep coming back to Airline X because it keeps us focused on “just another 500 miles here and another 1,000 miles there and we’ll be going to Disneyland!”

In behavioral economics, this is a goal-setting strategy and is common in gamification, where players can only take advantage of their efforts as they successfully achieve their goals.

Part of our motivation to keep earning miles is to get to the free flight and we eventually frame our progress as “X more miles to go.” The same is true with points: when we have our heart set on a new bicycle, an espresso maker, concert tickets or a limo to pick up the family at the airport in Orlando rather than taking the shuttle to the hotel. We begin to express our relationship to the limo ride as “only 56 more points to go!”

The Alternatives

Forgoing rewards points leaves us with either money in the paycheck, cash on the spot or pulling stuff out of the gift closet. It’s not that those approaches don’t work; it’s just that they’re not as effective as points.

Points combine three great elements – mental accounting, the social value of rewards, and gamification – into a very powerful tool to help change behavior, including the entire culture of an organization and sales results.

Tim Houlihan at BI WORLDWIDE

Tim Houlihan

Vice President
Reward Systems Group

For more than 25 years, Tim Houlihan has indulged his curiosities of human behavior in the workplace. He passionately pursues answers to questions such as “Why do some people work harder than others?” and “Why do some people set and achieve goals?” and acknowledges that behavioral economics holds excellent explanations for some of these mysteries. As the Vice President of Reward Systems at BIW, Tim is responsible for leading the development of innovative reward systems. He partners with academic colleagues from leading universities around the world and he is actively engaged with leaders in Fortune 1000 companies to develop solutions for the human side of business problems.