The importance of retaining a profitable and loyal customer-base is unchallenged. Research on loyalty drivers shows that the most effective determinants of customer loyalty are product quality and pricing. But can customer loyalty be bought?

Many companies use simple discounts hoping to ‘buy’ their customers’ loyalty. This practice might boost short-term sales but does not create long-term loyalty. Bargain hunters, attracted by discounts, are the first to leave when a better deal is available elsewhere.

Natural born profit killers

Simple discounts are profit killers and defy the fact that customers cannot be bought. A couple of years ago the Universal Music Group decided to cut CD prices in the US by 30% to increase sales volume after experiencing declining sales and competition from legal and illegal music downloading. However, a simple calculation (see figure 1) shows that UMG would have had to sell 60% more CDs to keep contribution stable. The decision was quickly reversed.

Figure 1: Dangers of flat discounting

Financial incentives, such as discounts, should be used to reward customers and direct their purchasing behaviour (e.g. switching to more profitable products).

Sophisticated loyalty pricing

Thus, smart loyalty marketers use sophisticated pricing methodologies that are specifically designed to encourage loyalty. The most effective are introduced below:

1. Multi-dimensional pricing is a mixture of an up-front payment and subsequent discounts spread out over a fixed period of time.

A classic example of this is the UK’s Railcard for students, disabled people etc. and the BahnCard 50 from the German National Railroad Company Deutsche Bahn. The BahnCard 50 is one of the company’s most successful products. The customer pays an annual fee of € 200 and receives a 50% discount on all trips for one year. Since the cost per mile decreases the more you travel it provides an incentive to maximise the use of rail. More importantly, however, while the communicated/perceived discount is 50%, the actual average discount realised by the customers is only about half of that due to the annual fee.

2. With multi-product pricing the strongly discounted sale of the main product is linked to a long term agreement to purchase complimentary products or services exclusively from the supplier.

In some cases the main product is even sold as a loss leader. This method insures a regular stream of income to offset the discounted product and is an effective tool to ward off potential low price competition. A typical example of this is a “free mobile phone handset with any 18 month contract”. Another form of multi-product pricing is price/product bundling, which packages products and services that are generally sold separately together at one discounted price.

Bundling offers change customers’ purchasing decisions leading to additional revenues through higher customer loyalty/share of wallet. A bundling strategy is particularly attractive when the marginal costs of the additional goods in the bundle are very low, and when value-to-customer and demand for different parts of the bundle varies. For example, utility companies such as Npower who previously only offered electricity or gas use bundling offers to allure customers into purchasing gas, electricity and insurance as a package.

3. Loyalty pricing can also use the time dimension to its advantage in a number of ways.

Mobile operators such as T-Mobile or Orange, gyms, pay TV (Sky, Premiere) and insurance companies often offer a lower price in return for a longer contract. Bell South in America lets its customers accumulate points as part of its Presidents Club and rewards increasing points for every six months the client relationship lasts, thus continuously increasing the barrier to switch. Phantasialand, a German theme park, offers its visitors a heavily discounted ticket for a further visit during the same season. The ticket, however, has to be bought on the first day of their initial visit, thus tying the customer in very smoothly.  

4. More relevant in B2B, a discount matrix based on revenue and revenue growth rewards both the current and the future importance of a customer and sets strong incentives for a continuous strong relationship.

Revenue (growth) is better suited than volume (growth) since it also reflects the quality of the product mix. Similar contracts can be found in many industrial and service industries.

Reaching its plateau

Loyalty marketing, while still hugely popular, has reached a plateau and must now move to the next level. Smart pricing strategies can create a win-win situation; the customer benefits from better pricing while the supplier benefits from increased loyalty, sales and profits.

By Stephan A. Butscher and Jonathan Baillie

Email: Stephan.Butscher@simon-kucher.com
Web: http://www.simon-kucher.com
Tel: +44 (0)20 7841 5750

Stephan A. Butscher is a partner and Jonathan Baillie a senior consultant with Simon, Kucher & Partners Strategy & Marketing Consultants in London. They can be reached at www.simon-kucher.com.