Decoding Loyalty Programs: The Psychology Behind Customer Retention

From coffee shops to airlines, thousands of businesses offer loyalty programs. These programs reward customers for their repeat purchases to encourage continued loyalty thus increasing business revenues. Given their success in helping to retain customers, loyalty programs are growing in popularity and customers have come to expect their favorite retailers and service providers to offer reward programs.  Lets review some aspects of the Psychology of Customer Retention.

One recent study revealed that 79% of customers will use a loyalty program as a deciding factor in whether or not to give a company their business. Any business is only as strong as its customer base and ensuring that that customer base remains loyal is key to a successful business for many years to come. Implementing a rewards-based loyalty program makes it easier and faster to foster loyalty, with new customers feeling a sense of belonging very quickly.

It’s easy to understand why customers like loyalty programs – who doesn’t enjoy a freebie or gift? But the appeal of the loyalty program actually runs deeper than at first glance. Understanding the underlying psychological concepts that influence people’s choices, can give businesses an advantage when creating loyalty programs. 

In this blog, we’ll explore these concepts and show you how to use them to create a successful loyalty program for your business. 

Positive Reinforcement

Offering a reward to encourage a particular behavior is known as positive reinforcement, and is a tactic used by any parent who has ever tried to wrangle a stubborn toddler. By associating a positive result (i.e. the reward) with a certain action, it increases the likelihood that a person will repeat that action because they want to keep receiving the positive outcome. 

A loyalty program by definition is a prime example of positive reinforcement. The customer makes a purchase and receives a reward, such as in the form of points or even just a stamp on a card. The dopamine rush – however small – from that reward is enough to keep motivating the customer to repeat the behavior and keep returning to the business. 

Top Tip: Make sure you offer a reward immediately upon completion of an activity rather than at specific time intervals. It’s more effective to immediately show a customer the total number of points a purchase gave them, for example, rather than sending them a statement at the end of the month.

The Endowment Effect

The endowment effect states that it’s human nature to put a higher value on something one already owns and feels attached to as compared to its actual market value. This can be best illustrated by a study on the behavior of car wash customers. One group of customers was given an empty card with 8 spaces for stamps to be filled each time they got a car wash. Once all 8 were filled, they would receive a free car wash. A second group of customers got cards with 10 spaces for stamps, but 2 were already stamped. They too had to purchase 8 car washes in order to get a free one. 34% of customers with the head start completed all 8 purchases, while only 19% of those with the blank cards kept returning to the car wash. 

A loyalty program gains more value as it is used, and customers feel more attached as they watch their points or stamps accumulate. The more customers are given the opportunity to interact with a business in exchange for a reward, the more a true relationship will develop and customers will feel connected to the business and want to continue purchasing.

Top Tip: Always give customers a welcome bonus for joining your loyalty program and help them reach the next tier. The best loyalty program solutions will allow you to easily monitor activity, so if you see a customer getting close to the next tier but not reaching it it’s time to send them a special offer that can encourage them to get there. 

Goal Gradient Effect 

Along the same lines as the endowment effect, the goal gradient effect says that people tend to put effort into reaching a goal the closer they get to it. A University of Chicago study examined the behavior of coffee shop customers who were members of a loyalty program that offered the 10th cup of coffee for free. The study showed that the customers significantly accelerated their buying frequency as they got closer to the goal. The closer that free coffee was within reach, the higher the motivation to get it.

As visible progress is a powerful motivator to keep going, making it important for loyalty programs to constantly show progress that customers are making towards their next goal. The specific goal depends on the structure of the loyalty program, but could include accumulating a certain number of points, receiving a free item, or jumping to the next tier of the program. 

Top Tip: Remember that the goal gradient effect can also work in reverse. If it takes too long to achieve a goal or associated award, people will give up and find another business with a better loyalty program. Make sure that your program focuses on attainable rewards and always provides visual reminders and notifications of each customer’s status. 

Loss Aversion 

More commonly known as FOMO (fear of missing out), loss aversion is a powerful emotional tool. It speaks to people’s deep-seated fear of either losing something meaningful to them or missing out on something that other people are enjoying. Because people tend to change their behavior in order to avoid experiencing unpleasant emotions (such as FOMO), strategies like letting rewards points expire if not used by a certain date can be extremely beneficial to businesses. Rather than risk missing out, people will be motivated to use those points in time. 

FOMO is a strong motivator that keeps customers active. It can speak to both preventing loss of something one already has as well as not missing out on the chance to gain something valuable. Putting time limits or expiration dates on points will motivate people to protect what they’ve already earned, while offering double points for taking action by a certain date will encourage people to make those purchases on time. 

Top Tip: Loss aversion doesn’t have to mean actually taking away customers’ hard-earned rewards. It’s more about knowing what your customers are concerned about losing (or what they would want to gain) and then creating a situation that allows them to prevent that loss, such as taking action within a defined period of time. 

Continuous Investment & Personal Attachment 

The more someone invests or puts effort into something, the more value they assign to it. This builds on the endowment effect described above and adds an element of personal value-added effort to the item as opposed to just owning it. For example, when a group of college students were told to build origami frogs and then assign a monetary value to the finished product, they valued the frogs five times higher than a third-party who didn’t invest any time in the product creation. 

Using a loyalty program to reward customers for engaging with your website, social media, store or brand in addition to making purchases will make them feel personally invested. Having such a personal connection provides incentive to continue nurturing and growing the relationship. 

Top Tip: Reward your customers for activities that require personal investment of time and energy, such as filling out a profile, engaging with social media posts, sharing your content and making referrals, and rating products. 

Exclusivity & Social Status 

People love to think of themselves as VIP’s. Whether it’s the coveted platinum status on an airline that offers free upgrades and lounge access or simply being greeted by name and given early access to new products at their favorite retailer, customers love being appreciated and treated accordingly. 

By structuring your loyalty program in tiers, the program appears more exclusive and people will seek the thrill and (real or perceived) status that comes with reaching a higher tier. You can also provide them with social currency such as an image or badge they can share on social media. This can even engender friendly competition among friends as they try to out-pace each other – a win-win for a business as the customers keep buying in order to beat their friends!

Top Tip: To really tap into the feelings of exclusivity and combine them with FOMO, consider adding certain conditions to the tiered award structure of your loyalty program. For example, progress towards the next tier could reset at a certain time, which would require people to act fast to get there before time runs out. 

So What Does This Mean for Your Loyalty Program?

Psychology is certainly not the only thing to consider when you create and implement a loyalty program. But, having a basic understanding of the natural tendencies and cognitive biases held by most humans can certainly influence the way you design and market your program.

People’s perception of your loyalty program matters. Framing your reward proposition to be perceived as highly valuable, taking into account common human behaviors, will boost its popularity. And we already know that happy customers are loyal customers, and loyal customers are what keep a business growing and thriving. 

Contact us to learn more about setting up your loyalty program. 

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