Using Pricing To Increase
Customer Loyalty
By: Stephan A. Butscher
Stephan is a director with Simon, Kucher & Partners Strategy and Marketing Consultants (www.simon-kucher.
com) in Cambridge, MA and Bonn, Germany. He has published over 50 articles on pricing and customer loyalty
in journals in the US and Europe. His latest book “Customer Loyalty Programs and Customer Clubs” was
published by Gower Publishing in London in 1998. Stephan can be contacted at sbutscher@simon-kucher.
As more and more companies are realizing the
importance of retaining existing customers rather
than focusing entirely on the acquisition of new
accounts, customer loyalty marketing is playing an
ever stronger and more important role within the
corporate strategy. Today every industry offers a
variety of loyalty schemes aiming at differentiating
one
competitor
from
another. On
closer
examination, however, we see that these loyalty
programs have become commodities themselves.
The primary, and in most cases, the exclusive
benefit for the customer is a discount in some form
or another. In nearly all cases this discount is given
either in a straightforward manner (members
get10% off) or in soft currency (such as airline
miles). The lack of differentiation among benefits
has therefore made loyalty programs within an
industry interchangeable and consequently the
loyalty programs are losing their competitive edge.
Loyalty marketing has reached a plateau. It must
now move to the next level, which is value-oriented
customer loyalty programs. The new value-oriented
customer loyalty programs attempt to establish an
emotional relationship between company and
customer to create long-term loyalty. This strategy
is becoming increasingly popular in the US, Europe
and Asia.
The main difference between value-oriented
customer loyalty programs and the current loyalty
programs is that they do not focus solely on simple
discounts but rather offer a powerful package of
advantages consisting of hard and soft benefits
(financial and non-financial). It must be
understood that the success of any loyalty program
depends to a great extent on the quality of the
benefits it offers. The benefits must have a high
perceived value from the customer’s perspective.
While discounts have a high value for most
customers (everybody likes to save money) they
alone do not create loyalty. Long-term loyalty can
only be established on an emotional level.
Customer loyalty cannot be bought but must be
earned over time with good value for money,
superior products or services, and overall integrity
of the company. Discounts alone attract bargain
hunters. For instance, the customer who has
joined a loyalty program for the 10% discount will
be the first to leave if a 15% discount is offered
elsewhere.
It must also be noted that giving discounts is giving
away pure profit with no certainty that the increase
in sales volume will compensate for the discount
given. Therefore, smart loyalty marketers use more
sophisticated
pricing
methods
that
make
customers earn discounts rather than simply give
them away. Discounts are used to reward
customers and to direct their behavior into specific
directions such as using other products, increasing
purchasing volume, or switching to products with a
higher profitability. Over time this type of discount
builds a protection barrier which makes it more
difficult for competitors to lure away customers.
Consequently, while discounts or other financial
incentives will get customers to join a program, soft
benefits, the second half of the benefits package,
actually build the relationship. Thus, the
identification of the right mixture of hard and soft
benefits is crucial to the development of a
successful customer loyalty strategy.
Pricing Schemes For Loyalty
There are several pricing schemes that fulfill the
criteria of rewarding customers for specific
The Journal Of Professional Pricing 29
Hard Benefits
(discounts, rebates, coupons,
etc.)
Soft Benefits
(magazine, travel aids, special
services and events, VIP
treatment, etc.)
Exhibit 1: The Right Mixture of Benefits
SIMON KUCHER & PARTNERS
behavior and increasing their loyalty.
1. Multi-step quantity discounts offer increasing
discounts at higher purchase levels. For
instance, a manufacturer of industrial light
bulbs, which are normally sold at $10 per unit,
gives the following discount pricing schedule. If
more than 100 units per year are bought, all
further units are discounted at 5%, all units
over 200 per year at 10% and all units over 300
per year at 20%. As the purchased quantity
increases, the discount is also increased
progressively. The effect of such a multi-step
discount program is that is encourages
increased purchases, as the next discount level
is easily attainable. This may lead to a
consolidation
of the
customer’s overall
purchasing activity, normally divided among
several suppliers, to one supplier. Another
advantage is that the average discount given is
much lower than the current discount.
Consider, for example, the purchase of 250
units. The average discount is only 4%. At the
same time, in this particular case, a competitor
can only break into the market by offering
discounts greater than 10%. This discount
scheme is a win-win situation for both supplier
and customer. The customer gets high
discounts (up to 20%) and the supplier is
guaranteed a certain purchase level in return.
2. The two-part tariff is a mixture of an up-front
flat payment and subsequent discounts spread
out over a fixed period of time. The best-known
example of this is the BahnCard from the
German National Railroad Company Deutsche
Bahn AG, which has been a huge success for
many years. (In the following example US
currency is used for simplicity). Currently the
price per mile using the train is 24¢. The
BahnCard is sold for a flat fee of $220 which
earns the user the right for a 50% discount on
all train tickets for one year. Subsequently the
price per mile is reduced to 12¢. The breakeven point (total savings = $220 card fee) is at
1,833 miles. However the more the card is used
the lower the cost per mile becomes as the
$220 is distributed over more miles. Once spent
the $220 for the card are sunk cost and there is
a strong incentive to maximize its use as this
means saving more money. Over 3.1million
cards are sold per year, revenues are over
1.3billion USD and profits have risen
dramatically. Another success factor is that the
Deutsche Bahn dramatically broadened its
customer base. Today airlines and telecom
companies are using similar two-part tariff
pricing schemes to increase the loyalty of their
customers. Two part tariffs are commonly used
with cell phone packages combining different
monthly rates with different peak/off-peak
minute rates and free minutes.
From a competitive perspective the level of
competition is shifted from the individual
transaction (one trip) to a competition of
systems (rail, car or airline). Thus the
competition is altered radically creating an
advantage for the company which has an
overall superior system even though it may be
weaker in individual components.
3. Time and loyalty based pricing differentiates
discounts over time or length of a contract
signed. A good example is the price difference
The Journal Of Professional Pricing 30
Total price per year ($)
Price per mile ($)
0.7
1200
Total price with
uniform price
0.6
1000
Total price
with BahnCard
0.5
800
0.4
600
0.3
Uniform price per mile
400
0.2
BahnCard
price: $220 200
Price per mile
with BahnCard
0.1
0
0
0
SIMON KUCHER & PARTNERS
1000
2000
3000
4000
5000
Miles per year
Exhibit 2: The BahnCard
per edition a magazine subscriber gets for a one
year versus a three-year subscription. Bell
South’s President’s Club allows cellular
customers to collect points based upon the
telephone bill, the services they use (a mailbox,
etc.), as well as the length of their customer
relationship with Bell South. The points may
then be redeemed for a variety of goods and
services. Again instead of giving away discounts
these pricing schemes offer incentives for
increased and longer usage of existing services
or by adding new services to an account. The
more the services are used, the greater the
customer benefit. Similar systems are in place
in frequent flyer programs. The time and loyalty
based pricing is ideal for relationships between
a company and a customer that are based on
contracts as the length of relationship can be
measured and discounts be determined. Also
regular payments maintain cash flow to
amortize discounts.
4. With multi-product pricing the strongly
discounted sale of the main product is linked to
a
longer-term
agreement
to
purchase
complimentary products or services exclusively
from that supplier such as buying a copier at a
discount and agreeing to purchase toner
cartridges, paper and services in return (tie-in
sales). 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,
no-name
competition because the customer is tied to the
long-term agreement. The loyalty effect is very
strong although additional action will be
required at the end of the agreement. Another
form of multi-product pricing is price/product
bundling which combines products and
services that are generally sold separately. The
bundle is sold at a significant discount versus
the sum of the prices for the individual
products.
5. Multi-person discounts offer the discount not
to the main buyer but to an additional buyer if
their purchases are tied together. Good
The Journal Of Professional Pricing 31
examples are the ‘partner flies/rides free
programs’ from Southwest Airlines and
Greyhound and the Friends and Family
Program from MCI. Here the loyalty program is
aimed at the additional participants as well as
the main purchaser. They exploit different price
sensitivities between those purchasers and
create a price advantage for the entire group.
This scheme is generally used for revenue
maximization and is ideal for companies/
industries with low variable cost and high fixed
cost.
Many
conference
producers
take
advantage of this method, and offer ‘if three
attendees from one company pay full price, the
fourth is free’.
6. Price guarantees are another underused
pricing mechanism to build loyalty. Stores such
as Circuit City or LensCrafters use it as a
significant
part
of
their
marketing
communication. Here the company will pay the
customer the difference if a product bought in
their store is found at a lower price elsewhere.
7. Contracts and Exclusivity agreements are, of
course, another form of loyalty scheme. One
example are the exclusivity agreements between
airlines and Boeing/Airbus. Such contracts
could also include regular price reviews or
guarantee a price development that is linked to
the development of significant indices like the
inflation rate which assures a constant relative
price and a foreseeable price development.
The ultimate goal of a pricing strategy is to
maximize profits. In order to identify the right
pricing strategy and discount structure precise
analysis is necessary. A decision support model
must be developed which calculates price response
functions, the profit and revenue-maximizing price
and simulates alternative discount levels. But
rather than cutting into profits by simply
discounting this thorough preparation will be
rewarded with higher profit and competitiveness.
These are smart techniques to build fences against
competitors.
The ultimate loyalty enhancing pricing scheme is of
course pure individual price customization. The
Internet is the ideal technology that makes price
customization logistically possible at a reasonable
cost. Visiting customers are easily identifiable by IP
address and can be exposed to individualized
product and price offers or information. Combining
Internet with modern database technology will
provide unbelievable opportunities for savvy pricers
in the future.
Soft Benefits – The Only Limit Is Your
Imagination
Imagine you drove your luxury or sports car to the
airport and instead of leaving your car in an
unguarded parking space your are able to park it
at the Avis station. For free. And protected. Imagine
that when you got back your car had been cleaned
inside and out. A dream? Not for owner’s of the
Porsche loyalty card!
Imagine getting tickets for sold out shows like a
Barbara Streisand concert at a special price,
having access to vacation homes around the world,
a free babysitter, tickets to a movie opening or
premier nights, special rates for Harley Davidson
rentals, an opportunity to be an extra in movie
productions, have training sessions in a flight
simulator, fly a MIG, or dine with celebrities. These
are typical examples of soft benefits. This is the
part of the loyalty program that is responsible for
the long-term loyalty. There is no standard solution
for a company or industry in the selection of the
right soft benefits. It depends on the target group of
the loyalty program; a variety of benefits could have
great potential value to them. They could be related
to the core products or totally unrelated, be offered
all year or only periodically, or be available for free
versus for a fee.
The primary determinant of a soft benefit should be
the perceived value it has to the customer. The only
way to clearly determine what benefits to offer is to
involve the customers in the design of the program.
While internal brainstorming and external research
can help to create a long list of possibilities the
detailed value measurement and identification of
the key value drivers necessitates customer
interviews or focus groups. Only after the value has
been measured should cost and feasibility be
considered. High cost does not necessarily mean
elimination of a benefit. Rather it may be possible
to offer the benefit for a small fee. If the internal
competencies do not exist to offer a specific benefit,
external partnerships can be established.
Summary
Over the last decade customer loyalty marketing
has matured and many companies have jumped on
the loyalty bandwagon. This has led to a
commoditization of loyalty efforts. It is now time to
move to the level of value-oriented customer loyalty
programs. They combine sophisticated pricing with
valuable soft benefits to form a powerful benefits
package that creates a win-win situation.
The Journal Of Professional Pricing 32