The Loyalty Business

Who doesn’t love the thrill of savings? Drowning in buyer’s remorse, but gaining a jolt of confidence at the sight of 20% saved at the end of our receipt. I prefer to shop with a Loblaw’s company because I realize marginal value with every dollar that I spend. We’re biased towards offers that add to our Air Miles because we’ve attached value to the outcome of free flights, upgrades, and rewards. This feeling is not exclusive to saving money. We tend to get the same feeling when we skip the line, get first dibs on the newest offering, or have something that others don’t. We simply like feeling special. And naturally, companies have attempted to capitalize on that behaviour since the Golden Age of advertising. What have we learned from these scenarios? — Loyalty pays off. Companies have presented consumers with an opportunity to marginally increase the value of their dollars spent with them. However, when executed incorrectly, loyalty programs turn into a zero-sum game.

I like to think about this problem through what Alex Danco labels “positional scarcity”. Here, he breaks down the concept quite elegantly:

What these challenges all have in common is that they’re symptoms of abundance. In environments of real scarcity, these problems don’t exist. But in environments of abundance, when some new technology or paradigm has created a huge bounty and variety of new stuff that we enjoy, positional scarcity inevitably emerges, creating new bottlenecks and new opportunities.

Put simply, in a world of abundant choice, the most valuable thing you can have is a repeat customer who is loyal to you. Airlines make sure of this; we exchange our loyalty for positional scarcity to get faster lines, better seats and premium status. I love Starbucks as an example. It’s executed a seamless vertical integration of the loyalty business into its omnichannel retail strategy. The program creates incremental value to the consumer for each dollar spent on their product. This drives momentum for product sales and improves customer retention because they are now more likely to return on the promise of earning free stuff — something that we’ll never pass on. This isn’t the only thing that makes it valuable for Starbucks. Money that users deposit onto the Starbucks app is also used as “float” to invest in working capital. If a perfect substitute for Starbucks emerged, I’d predict that customers wouldn’t switch because of the compounded value they’d have already accumulated.

Loyalty programs can be extremely important for brands. Companies have masked their customer acquisition costs through discounts which they believed would incentivize a customer to spend more with them due to lower barriers to entry. Now, loyalty apps are the perfect middlemen for this strategy. Loyalty is an expensive vertical and outsourcing to platforms like Drop and Ampli have a massive potential to increase the customer lifetime value for brands. As the transformation of e-commerce and retail continues, there’s a great opportunity to build a loyalty business.

And of course, with this opportunity comes challenges. Often times, companies find that expanding into the loyalty business is a money loser instead of a value driver. Here are some reasons why:

A mental model

First, to understand how we can convert the loyalty business from a money loser to a value driver, we have to build a mental model for the customer’s decision-making process.

Let’s introduce the idea that the value of loyalty is compounding. Additionally, the perceived value of a user’s investment needs to exceed the consequence of switching to an alternative brand. The longer a user exchanges their resources and information for a product, the more marginal value they will realize as time goes on.

Since we love shortcuts and saving time, loyalty programs provide much more than a discount. The longer we stay with a brand, the more knowledgeable we are about its products, which benefits not only us but also the company. Data is a compounding instrument. Algorithms are great value creators and optimize for the efficient allocation of capital and resources across the value chain. The more we know the better we can do. The actual success of a loyalty program is determined by the amount of information exchanged between the business and the consumer. Everything else is an accessory to this. Without discounts, there will be no retention. Without retention, there will be no information exchange. Without information exchange, there will be no value created.

This helps us build a mental model for how users think. When I was reading through customer feedback for loyalty apps, the primary reason for churn was that the cost of privacy was greater than the value it brought to the user. Perceptions are everything; if it takes a long time to collect a reward, the perceived value of loyalty greatly depreciates:

What we need to do is help the user get over the hump. If a platform can get a user out of the “hesitation zone” as quickly as possible and convert that user, it will be a whole lot easier to help them realize the perceived value of loyalty. With enormous product choice and fickle customer loyalty, friction in touchpoints for these platforms cannot be afforded. Remember, when reality diverges from a customer’s expectations, perceived value decreases and the cost of privacy suddenly becomes greater than the value of loyalty.

The shopper’s dilemma

Now that we’ve built a framework on a micro level, let’s try to paint the bigger picture. I call this the “Shopper’s Dilemma”:

It isn’t perfect, but I think that this can be a simple way to illustrate the merits of loyalty in a two-sided marketplace. When all parties cooperate there is a big opportunity to create value. When parties only act in their best interests, the marketplace is suddenly zero-sum. But of course, this game comes with its assumptions. If we suddenly assume that the product is perfectly substitutable, then we can assume that the company cannot control retention and will lose customers in the long-run.

For the “Shopper’s Dilemma” to be relevant, the product needs to be somewhat differentiable. Starbucks is Starbucks. This game also holds up better for DTC brands which have products that need to be replaced. Think of products and services in food, beauty, healthcare, hygiene, and home maintenance. Businesses for consumable products that will inevitably need a replacement can almost guarantee a strong retention curve. Once product-market fit is established, it is unlikely that customers will deviate from their preferred consumables.

Even Apple is arguably beginning to participate in the loyalty business. Despite a strong economic moat and a high likelihood that Apple users will stay, they’ve dipped their feet into the waters of the loyalty business:

The message here is simple — if you can keep your customers satisfied and meet or exceed their expectations in the long-run, then you’ll greatly increase the economic value to your customers and to your firm.

The unbundling of loyalty

We’ve gone over the opportunity and framework — and now, we need a vehicle. We’ve seen examples where companies have built the loyalty business into their verticals. While there is a competitive advantage in carrying out this strategy, eventually SMB’s will greatly benefit from having access to standalone platforms. Drop and Ampli are effectively unbundling the loyalty business. In the future, these apps will serve as a platform for companies’ loyalty verticals. The strength of these platforms will come down to the volume of deals, the speed of execution and the quality of service. I went through both of these apps and took note of what I thought.

Drop

The good

Drop had by far the best onboarding experience. They keep their preliminary questions short-and-sweet and the use of Plaid’s API makes card integration super fast and easy to use. Overall, I think it took around 20 seconds to signup, answer some questions, and connect my card of choice. This step is crucial — the faster I can onboard, the faster I can realize the value that this app has to offer.

The first thing I really like about Drop is the vast amount of deals I can navigate through. I have access to popular deals, weekly offers based on my shopping habits and “stacked” and “boosted” deals which aim to speed up the trajectory towards my rewards goals. Not all platforms actually have an intuitive and viable category filter, so Drop’s UX is something I can appreciate. This is another factor that makes it easier to increase my perceived value of rewards. Not only can I navigate through what’s useful to me, but this will allow Drop to optimize my rewards for my shopping habits. This exchange of information may or may not be useful for the user. It all boils down to if the perceived value is greater than the cost of privacy.

The next thing that I really like about Drop’s app is that they make it easy to track how close I am to my goal. They really try to gamify the experience for users. A key example I like is that they give users a gift card to work towards, which gives users a tangible goal.

The bad

The bulk of complaints on the app came from a delay in receiving points. This is a huge negative because from what we know, an untimely response will decrease the perceived value of loyalty for the customer. There shouldn’t be friction in the “aha” moment. This point of the experience needs to be executed as flawlessly as possible.

The second bulk of complaints came from a change in the underlying business model. Previously, users didn’t have to order goods through the app to receive rewards. The model was passive and that was the main benefit of connecting your card to the app instead of browsing through deals and ordering separately. It seems that without the model of earning passive rewards, the perceived value of the app has greatly decreased. Many users don’t see the benefit of using Drop over any other loyalty app because it no longer offers any additional convenience. Suddenly, the value of rewards < the cost of privacy.

Another change that wasn’t invited was being able to cash out on rewards in increments of $5 starting at $5. This model is no longer in place and the starting point is now at $25 — a huge jump and roadblock in place that is preventing users from increasing their perceived value. Also, a previous feature for power offers, where users could earn rewards for frequented stores, was also taken away, further decreasing the compounding value of loyalty over time. When users connect cards but don’t receive rewards for months, this creates increased aversion to sharing data since there is no marginal utility for the user.

Drop had a strong value proposition for users. Connect your card in a matter of seconds. Receive automated rewards based on your regular spending. Get increased rewards from the brands that you are loyal to. When they abandoned the quick and easy business model, users churned since it became like any other app. There’s a key takeaway here; if you let users start small, their benefits will snowball and increase their perceived value. It’s crucial to get a user to their first rewards as fast as possible. The loyalty business wins when it can get a user over the hump and help them get the most value out of their favourite brands.

Ampli

The good

I think Ampli’s core message is really on the right track. “Earn cashback on your everyday spending”. Their model really picks up on Drop’s shortcomings. I can passively earn rewards on my purchases and the longer my investment lasts with brands through this app, the more information it can gather on my purchasing behaviour, allowing for the optimization of deals and offerings for customers. Whether that is negative or positive is completely up to interpretation. Again, if you can communicate that the value of loyalty > the value of privacy, then you’re in-the-money. Also, I can withdraw cash at any point in time and that really shortens the delay in time it takes to realize the value of loyalty.

Ampli has a great interface, although I believe it’s lacking some features. Overall, I highlighted the points that I like, but I think there’s some room for improvement. The filters on the home page are not that enjoyable to use. There’s no categorical or location-based filter to make my experience more meaningful and valuable to me. It feels slightly cluttered since there’s no pragmatic way to filter offers.

The bad

Ampli’s business model is certainly going in the right direction. However, there is friction in some crucial points in the process.

The first is that it took over a minute to sync my RBC account even though I have the app installed on my phone. After I connected my account, there was no redirect to the rewards home page. I was stuck in the settings portion of the app. This was a let down for me. Time is valuable and the faster I can see the value that this app offers, the better for the user and the platform. Some notes from customers:

These are all solvable problems. I do like Ampli’s value prop — it would be great if that value was shown to me sooner.

Recommendations

Altogether, there’s a really big opportunity here to help companies expand their verticals into the loyalty business at a smaller cost. The app that will be the winner will have the following characteristics:

In conclusion, as abundance increases and products are increasingly being commoditized, it will become more important to build a loyalty business that allows consumers to trade loyalty for positional scarcity.

· tech, strategy