LOYALTY PROGRAMS AND THEIR IMPACT ON REPEAT PURCHASE BEHAVIOUR : A REPLICATION AND AN EXTENSION ON THE SINGLE SOURCE PANEL

BEHAVIORSCAN

The purpose of this research is to contribute to a better theoretical knowledge about the sources of efficiency in loyalty programs, in the retail sector. It is based on the BehaviorScan single-source panel which has been crossed with the store data base of a French retailer. We implemented the multinomial Dirichlet model, in order to test the impact of loyalty programs on the general market structure. The double jeopardy phenomenon is present and loyalty programs do not substantially change market structures. When all companies have loyalty programs, the market is characterized by an absence of change of the competitive situation.

Introduction Loyalty programs, in particular those employed by distributors, are currently regarded as fundamental by many companies. They lie within the scope of rather defensive customer retention strategies, being based on the double conviction that retaining customers is less expensive than conquering new ones, and than the best customers are the most profitable (Bolton and Drew 1994, Reichheld 1996).

Despite the practioners strong interest in loyalty programs, there is only scarce empirical evidence about their potential impacts. While anecdotal evidence seems to be plentiful, certain academic authors worry about their effectiveness (Dowling and Uncles 1997, Sharp and Sharp 1997, Benavent et al. 2000). This report is all the more surprising as many companies developed them during previous years. Indeed, if one looks at the retail sector in Europe, the costs associated with the management of loyalty cards were estimated in 1999 at 2,5 billion dollars for 350
th

million emitted cards (Wall Street Journal June 19 2000). This is why, English retailers, such as Safeway as well as Asda, decided to give up their loyalty programs. Indeed, Safeway considers savings 75 million $ per annum. However, other retailers, such as E. Leclerc in France, still reinforce their marketing expenditures by devoting approximately 18 million of their marketing budget to the animation and management of their program. Consequently, there seems to be a need for more rigorous empirical evidence on the efficiency of loyalty programs. This is why we want to explore the impact of loyalty programs on repeat purchase behaviour. In his context, we shall follow the piece of advice of Sharp and Sharp (1997), that is to say, to make replications of their work and therefore to use the Dirichlet model, a nearly experimental methodology which has been well established in marketing research for 40 years (Ehrenberg 1988). We shall thus evaluate the efficiency of four retailing loyalty programs situated in the BehaviorScan test market in Angers (France). The main result is that this kind of defensive marketing tool only affects the markets competitive structure in a very shallow way. What is more, the double jeopardy effect is clearly present. Theoretical background Whatever the efficiency of loyalty programs may be, they henceforth absorb considerable resources and it should be noticed that in order to pay off those tremendous costs, most managers are probably going to consider a program as efficient if it increases sales, penetration and market shares. In this context, a major issue arises. In saturated and stationary markets most marketing mix tools including loyalty programs -do not make well established brands market shares

evolve. As Ehrenberg (1997) notices, they only maintain their positions in a defensive perspective, which is in opposition with the managers viewpoints. This stationarity and the lack of effectiveness is certainly due to the fact that in a competitive market, the initiator of such campaigns will certainly be imitated, so that the total result will be a return to the former situation and will consist in an increase in marketing costs. Considering these issues, Sharp and Sharp (1997) suggest to complete the judgement about the efficiency of loyalty programs by measuring loyalty indicators, in particular the repeat purchase rate (purchase loyalty), and/or the decrease in the sensibility for competitors offers (differentiation loyalty). In this paper, we shall rather focus on the impact of loyalty programs on repeat purchase behaviour (purchase loyalty , i.e. average purchase frequency, penetration, share of requirement) for several reasons First of all, these judgement criteria correspond to their expectations in terms of expected results. Secondly, in most markets, (particularly those more characterized by imitation than differentiation), it is slightly likely that a decrease in the sensibility for competitors offers may occur without being followed by a rise in repeat purchase behaviour. Loyalty programs impact on the normal Dirichlet market If a number of individual customers do change their behaviour in a similar way, one can imagine that changes in aggregated market structures, that is to say store levels, may occur. In concrete terms, we might suppose that certain stores with a loyalty program succeed in creating a niche position by possessing subgroups of customers, who are probably card holders and are more prone to loyalty which would be exemplified by higher repeat purchase rates (Kahn et al.1988). In order to test this idea, we shall use the Dirichlet model which became famous in marketing by Goodhardt et al. (1984) thanks to its simplicity and some empirical regularities providing theoretical benchmarks. Thus, through many markets and product categories, the double jeopardy phenomenon has been observed according to which smaller stores get hit twice, as they have a smaller penetration and as their customers have a lower average purchase frequency

(Keng and Ehrenberg 1984). Thus, if loyalty is an additional product of a high market share and penetration, loyalty strategies would then be more efficient for market leaders. In contrast to other marketing efforts, the nature of the effects provoked by loyalty programs due to their long term and cumulative rewards, should attract the heavy buyers of the store but also of the category who tend to maintain larger repertoires of brands (Ehrenberg 1988). That is why they should have more impact on the average purchase frequency of existing customers (as they bring more utilities to them) rather than on penetration. Beyond that, it is likely that loyalty programs more affect the purchase frequency of already store loyal and heavy purchasers as their features could signal that acquiring points is not easy without changing purchase behaviour (i.e. loyalty, purchase concentration at one single retailers with the loyalty program, decrease in variety seeking,in order to obtain a reward). Therefore, penetration is unlikely to rise. On the other hand, the lighter buyers of the category or store are unlikely to be attracted as rewards are probably not attractive enough for them. This is the reason why one does not expect that a loyalty program moves a store smoothly along the double jeopardy line, but rather in a vertical way, causing the latter to exhibit "excess loyalty" (Sharp and Sharp 1997). Thus, the retailer should have higher average purchase frequency than expected given its level of penetration and it would then be situated above the double jeopardy line. The outlet has thus become a niche store (Kahn et al.1988). In addition to these deviations from the Dirichlet purchase loyalty predictions, the loyalty program should, for the same above indicated reasons, create a degree of market partitioning. Thus, there should also be a higher purchase duplication than normal between the stores belonging to the same retailing chain and far less switching to competitors stores. Finally, in many competitive repertoire markets people are rarely 100 percent loyal and generally show divided loyalty (Ehrenberg 1988). We expect therefore that loyalty programs increase the share of requirements of the participating stores and the number of solely loyal buyers.

Methodology

In order to test our hypotheses, we shall resort to the single source BehaviorScan panel in Angers, France (five hypermarkets respectively named S1 to S5 and two supermarkets known as S6 and S7). These stores represent 95% of the consumer goods sales of the area. It is a closed test market, which allows to follow nearly all the purchases per customer in the 7 stores over our period of time. We also have at our disposal some information about the possession of one of the four loyalty cards of the seven stores present on the market. The only retailer that has not got one is S6. S1 and S2 belong to the same retailing chain and the loyalty card can be used in both stores. S3 and S4 are as well part of the same retailing chain with a loyalty program valid in both outlets. From this panel, we have extracted a total of 50, 000 purchase acts coming from 2,476 individuals who are holders or non-holders of the four loyalty cards over a 24 week period (week 28/2000 to week 52/2000). A 28 week duration has been chosen because it corresponds to the lapses of time that Ehrenberg (1988) uses for the implementation of the Dirichlet model. Results The estimation of the Dirichlet model brings out the nearly universal double jeopardy phenomenon. Stores with the highest penetration (S4, S1, S3) also have higher purchase frequencies than those with low penetration rates (S5, S6, S7). Figure 1: The Double jeopardy line (2,476 holders and non-holders of the 4 loyalty cards)

One can however notice significant deviations concerning three outlets (S2, S4 and S7) between the predicted theoretical values and those which can actually be observed. S2 and S4, both having a loyalty program, exhibit excess loyalty. Are the loyalty cards responsible for this comfortable situation by catching and isolating individuals from competitors actions ? The answer is not obvious because S1 has indeed the same program as S2 and S3 offers S4s card as well. This does not mean though that S1s and S3s clients develop a loyalty level proportionally superior to their penetration rates as they are in the Dirichlet norm. Nonetheless, S5 and S7 which as well possess loyalty programs, have got values under the norm as for visit frequency but above it as for penetration. This means that both stores proportionally have more clients than their sizes would theoretically allow, but these customers are not loyal and do not go shopping here in a regular way. Kahn et al. (1988) call this a change-of-pace situation. Finally, only S6 which does not have a loyalty program is perfectly in the norm. This can be explained by its location, very close to the town centre, and its small size. This outlet is probably perceived as a convenience store where to do ones every day shopping. In order to test if S2s and S4s excess loyalty is linked to their respective loyalty programs, we shall again estimate the Dirichlet model, first only on the panelists holding at least one of the four available loyalty cards (N=1,646) and then on those having none (N= 830).

The results can be seen in the following tables: Table 1: Results of the Dirichlet model (card holders all programs N=1,646, 24 weeks) Store Penetration Purchase Share of 100% Loyal

Frequency Requirement O S1 S4 S3 S2 S5 S6 S7 69% 66% 55% 37% 37% 26% 19% T 67% 72% 59% 39% 39% 21% 19% O 4,2 5,3 3,9 2,8 2,8 1,8 2,1 T 4,4 4,9* 3,7 2,7 2,7 2,2* 2,2 O 17% 25% 17% 10% 12% 6% 8% T 14%* 14%* 15% 10% 10% 7% 6% O T

1,7% 1,2% 1,5% 1,2% 1,5% 1,3% 0,7% 0,9% 0,9% 0,9% 0,1% 0,7% 0,6% 0,6%

O = Observed Value, T = Theoretical Value, * : significant deviation from Dirichlet Table 2: Results of the Dirichlet model (non-card holders N=830, 24 weeks) Store Penetration Purchase Share of 100% Loyal

Frequency Requirement O S1 S4 S3 S2 S5 S6 S7 61% 55% 46% 51% 25% 34% 7% T 59% 59% 42% 63% 16% 39% 1% O 3,7 4,1 2,7 5,1 1,5 3,3 0,3 T 3,9 3,6* 2,9 4,1* 2,3* 2,9* 1,8* O 18% 22% 13% 21% 7% 14% 5% T 14%* 14%* 10%* 15%* 7% 10%* 6% O T

1,2% 1,2% 3,4% 1,2% 2,6% 0,9% 3,0% 1,3% 0,3% 0,7% 1,4% 0,9% 0,1% 0,6%

O = Observed Value, T = Theoretical Value, * : significant deviation from Dirichlet

The category leader S4 possesses excess loyalty regarding both holders and non-holders of its loyalty card. S4 also has a greater number of 100%-loyal customers and a higher repeat purchase rate than the norm. We can notice that stores with loyalty programs and weaker penetration as well as market shares do not have stronger excess loyalty. S5 and S7 are still under theoretical values as for visit frequency. S1 and S3 are in the Dirichlet norm. Regarding cardholders, S6 is clearly disadvantaged. S2 has not got excess loyalty anymore but is in the norm. S1, S3, S5 as well as S7 are in the norm too. Moreover, regarding the share of requirements and in particular the rates of sole-buyers, we can say that nonholders possess superior values to holders which lets us suppose that loyalty is not generated by the loyalty program (because S6 has not got one) but by other factors, such as competitive position, proximity, comfort, choice, product variety (for S4, it is linked to its important sale surface, i.e. 10,000 m) or the relative isolation from other stores (i.e. S2). However, purchase duplication is superior in the outlets participating in the loyalty program. A customer who holds S1s card has more duplication in S2 and vice versa, because they both have the loyalty card in common, and less duplication in competitors stores (S3, S4, S5). Switching behaviour seems then to be decreased.

Conclusion Without substantially modifying the competitive structure of the market (market shares, penetration, double jeopardy) loyalty programs impact on visit frequency, purchase duplication and sole-loyalty is quite weak which is coherent with Sharps and Sharps (1997) investigation. Programs seem thus to play a defensive role, slightly reducing the scattering of purchases among several shops. This can be explained by the fact that thanks to the rewards cumulative characteristics over the long term, loyalty programs are mainly interesting for the heavy buyers of the retailing chain or the category (Meyer-Waarden 2002) who in general have a broader purchase repertory, including the store in question. Thus there is a significant probability for these customers to buy in the store before subscribing to the program. Indeed, if we look at our sample, we can notice that

the majority of cardholders have already been clients (88%) before subscribing to the card, which is comparable with the results found by Ehrenberg (1988). Loyalty cards therefore mainly attract existing customers and affect their visit frequency more than penetration (the recruiting of new clients). These observations strengthen an interesting strategic point of view: if loyalty is an additional product of market share and penetration, retention strategies seem to be consequently more efficient for market leaders and small firms are twice penalized (McGahan and Ghemawat 1994). On the other side, the hypothesis of Dowling and Uncles (1997) is confirmed: in the case of the simultaneous presence of several loyalty programs, the market is characterized by stationarity. Indeed, there seems more to be an effect of imitation than innovation and the result of marketing actions is a certain stability, even a return to the previous situation, before the existence of loyalty programs. This observation leads us to question the efficiency of S6s recent loyalty programs launching (S6 indeed had not got yet a loyalty program during our period of observation). However, some conditions (proximity, comfort, products offers) are more prone to attract individuals and to create excess loyalty with the help of a loyalty program. This phenomenon, underlines the defensive feature of loyalty programs and distinguishes them from the other marketing mix variables. These first conclusions should not though encourage to give up all loyalty programs because this could lead to a disadvantage in comparison with competitors. The keeping of loyalty systems is all the more necessary than that of other marketing tools, because, to quote Ehrenberg (1997): Marketers must work hard to stand still. This empirical investigation which is quite remarkable because of its detailed and exhaustive data presents a limit: the effect of loyalty cards has only been tested in a global way. The value of the points cumulated by the customers has not been integrated. Rewards dynamics has not been taken into account neither. We shall recommend therefore to develop this orientation in future research and to investigate on the individual level.

References

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