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For free or a fee? Why more retailers are launching premium customer loyalty programs

The success of Amazon Prime and other programs has many retailers rethinking their approach to customer loyalty.

Gary Friedman has a pronounced distaste for discounts. The outspoken Restoration Hardware chairman and CEO blames the retail sector’s reliance on sales and pricing promotions for many of the problems facing the upscale home furnishings chain.

“Much of how we behave promotionally is left over from the Great Recession,” Friedman wrote in a February letter to shareholders published ahead of Restoration Hardware’s disappointing Q4 2015 earnings report. “The multiple sale events and email communications do not reflect the brand we are building, nor are these promotions aligned with how our customers shop with us.”

Restoration Hardware is eliminating traditional promotions altogether in favor of introducing a premium customer rewards program. Priced at $100 per year, its new RH Grey Card offers shoppers a flat 25% savings on all regularly priced merchandise across all of Restoration Hardware’s brands, along with 10% savings on clearance merchandise, complimentary interior design services and reduced interest rates on its RH credit card.

“Our lives are filled with complexity—and we long to break through the clutter to find simplicity,” Friedman said in a press release announcing the RH Grey Card program. “We want to shop for what we want, when we want and receive the greatest value. So rather than navigating countless promotions, we’re changing things… because time is the ultimate luxury.”

Restoration Hardware is just the latest retailer to roll out a premium customer loyalty program. Investment firm Piper Jaffray estimates that nearly half of all U.S. households subscribe to Amazon Prime, which offers free two-day shipping and a growing arsenal of additional perks for $99 per year or $10.99 per month. Bookseller Barnes & Noble has long charged members of its rewards program a $25 annual fee in exchange for exclusive in-store discounts, free express shipping online and other benefits. And analysts anticipate that warehouse retailer Costco likely will raise the price of its signature annual membership program in 2017, hiking the basic Gold Star Membership to $60 from $55 and the Executive Membership fee to $120 from $110.

Experts anticipate that even more retailers of all shapes and sizes will hop on the premium loyalty bandwagon in the months ahead.

“These programs are designed to get loyal customers into these stores more often, and they often work,” Matt Schulz, senior industry analyst at credit card comparison and information site CreditCards.com, told Retail Dive. “Plus, if people are loyal customers of a store, they’ll be willing to pay for these types of programs—as long as they feel like they’re getting value. That’s the whole key: Offering them something of value, something that is unique to your store and that targets the customers’ wants or needs.”

A history of loyalty

While retail loyalty programs date back hundreds of years—merchants began giving out tokens redeemable for in-store purchases during the late 18th century—they’ve gained increasing momentum in recent years, buoyed by the introduction of mobile loyalty efforts and other digital innovations.

According to the most recent installment of loyalty marketing research firm Colloquy’s biennial Loyalty Census, published in early 2015, Americans maintain 3.3 billion memberships in customer loyalty programs, up 26% from the previous study, conducted in 2013. Memberships in loyalty programs offered by specialty retailers—defined by Colloquy as merchants dedicated to selling one line of goods to a particular clientele, offering laser-focused but deep selections within their niches—totaled 434 million in 2015, eclipsing airline frequent flyer memberships (356 million) for the first time and trailing only credit card reward programs (578 million).

Affluent shoppers are among the biggest users of rewards programs. More than 70% of American households with annual incomes exceeding $112,000 have an Amazon Prime membership, Business Insider reports, while the 150,000 members of Neiman Marcus’ free InCircle program generate 40% of the luxury retailer’s annual sales.

Retailers have historically favored building out free customer loyalty programs, which attract three times the number of members that fee-based programs do, according to reward program solutions provider Paytronix. Free programs are low-risk propositions for both customers and retailers alike: Consumers spend nothing to join, and merchants can evolve the program as needed while sidestepping the special financial accounting requirements associated with premium programs.

But premium retailer loyalty programs have grown increasingly popular over time. Charging a fee guarantees that merchants generate revenue upfront, Paytronix notes, adding that consumers who pay for benefits are more likely to shop with that particular retailer to guarantee a return on their investment. Merchants also gain quality data about their best customers—information and insight that can be leveraged for more personalized interactions.

“With increased competitiveness not just within brands here in the U.S. but increased global competition, profit margins and the ability to make significant profits continue to be more and more difficult. Premium loyalty programs are a way for organizations to enhance the profit margin,” Andrew Graft, vice president of corporate marketing at loyalty and reward programs supplier Access Development, told Retail Dive.

“There’s also a lot of ‘Monkey see, monkey do,’” Graft added. “You’re seeing the Amazons of the world come out with [premium loyalty] offers that have been so successful that smart businesses want to copy what they do. Imitation is the sincerest form of flattery.”

Millennial motivations

A survey conducted in mid-2015 by loyalty marketing and programs provider LoyaltyOne found that 62% of all U.S. consumers would consider joining a fee-based rewards program if their favorite retailer offered one, and 47% believe rewards in premium programs are better than those in free programs.

Interest in premium loyalty programs is strongest among millennial consumers. Three quarters of respondents between the ages of 18 and 24 and 77% between the ages of 25 and 34 told LoyaltyOne they’d consider joining a fee-based rewards program, while 61% of 18-to-24 year-olds and 54% of 25-to-34 year-olds contend that fee-based rewards are better than free ones.

Customer loyalty programs like RH Grey Card, with their stated emphasis on simplicity and accessibility, are engineered to hold particular appeal for millennial shoppers.

“Millennials are such a different generation,” LoyaltyOne Partner Melissa Freund told Retail Dive. “They’re used to getting what they want when they want it, and they’ll pay for it if they have to. They don’t want to be inundated with sale emails every day. They want to know that if they pay a fee, they can go in anytime and get a product for ‘x’ percentage off. They value that more.”

Value, ease and relevance are the fundamentals of a successful premium loyalty program regardless of the customer demographic in question, according to Access Development's Graft.

“Consumers want to know what exactly are the benefits, and whether they offset the cost of participating in this program,” he said. “Also, how easy are these benefits for me to get? Do I have to send in a rebate check to receive my benefits, or will it happen at the point of purchase? How much work do I have to do? And lastly, are these benefits truly relevant to me? Will I personally benefit?”

The perception of value changes from customer to customer, of course, but some perks enjoy wide appeal. Among consumers surveyed a year ago by LoyaltyOne, 69% who already participate in fee-based loyalty programs said they were enticed by free shipping, just ahead of special discounts at 67% of respondents.

“Free shipping is table stakes,” Freund said. “[Differentiating a program] is more about experiences and special treatment. Everyone’s busier today, everyone’s got more things to do, and if I can pay a fee and only a select group is allowed to access this benefit, there’s a trophy value that is really good for the brand. People will remember how you treated them, not necessarily that you gave something free or a $10 discount.”

That’s what makes a program like Restoration Hardware’s RH Grey Card so intriguing. On the one hand, the retailer’s upmarket furniture, lighting, décor and textiles target a fairly narrow demographic: Consumers with annual incomes above $200,000, or roughly 5% of the U.S. population. Given that shoppers who sign up for loyalty programs make up only about 10% of a retailer’s traffic, per FTI Consulting data, RH Grey Card seems unlikely to attract a sizable membership base.

On the other hand, widespread adoption ultimately may not matter. According to FTI, loyalty program members may account for just 10% of customer traffic, but they drive up to 50% of merchant sales. If even a relatively small percentage of Restoration Hardware enthusiasts believe RH Grey Card’s complementary interior design input and other specialized perks are worth $100 a year, the retailer will have a hit on its hands.

“Let’s face it: This is a fairly limited-sized audience that Restoration Hardware speaks to. As well it should be—they shouldn’t be trying to go out to speak to those who aren’t already somewhat engaged in their product," Graft said. "Instead, they know their lowest-hanging fruit comes from people who like what they have to offer. Interior design is perfectly set up for them. I think it’s incredibly smart to tie in those additional benefits to the product offering.”

Restoration Hardware did not respond to requests for an interview from Retail Dive.

Lessons in loyalty

It’s still far too early to judge the RH Grey Card as a success or a failure, but it’s clear that many companies are lousy at loyalty. Colloquy found in mid-2015 that U.S. households maintain memberships in an average of 29 loyalty programs across a range of business verticals and program types, but they’re active members who earn or redeem at least once per year in just 12 of them, suggesting that a majority of programs fail to deliver on their initial promise or do not properly identify and accommodate customer demands.

“Even free programs have a hard time getting consumer attention,” Graft said. “For brands to play in this space, overcoming that burden can be a heavy one. The best chance for these brands to succeed is for them to target those who already enjoy a certain affinity for the brand.”

LoyaltyOne’s Freund believes that some retailers are biting off more than they can chew.

“It can be very difficult for retailers to implement [loyalty program] experiences through their stores because a lot of employees might be part-time, and it’s hard to train everyone,” she said. “If someone pays for a loyalty membership, they expect exemplary service, so there has to be a commitment from executives on down in order to deliver. It’s really difficult. You’re counting on people to deliver that, and when they already have a hundred other things they’re supposed to be doing, it takes serious effort to make sure you’re recognizing the top customers and that you’re delivering the experiences you promised.”

Freund says retailers must remain focused, and ignore impulses to please everyone all of the time. “You should say ‘Let’s look at our top 10% to 20%’ of customers. You can’t think that just because they’re a customer that [all shoppers are] going to be willing to pay for something like this.”

Retailers can further boost their chances of building effective, sustainable premium loyalty efforts by paying close attention to customer feedback culled from surveys, one-on-one interactions and even social media activity, according to Freund.

Whatever retailers do, they should proceed with caution. “I’m always surprised at the clients that will roll out a loyalty program rather than test it in pilot,” Freund said. “I know it’s very tempting to say ‘I’m just going to go ahead with this,’ but that’s a stumbling block. You’re not only testing an offer—you’re also testing operations. You only get one chance to make a first impression. If you go out there and offer all these experiences in the store, it’s going to take a while for your employees to ramp up and deliver those. You could really shoot yourself in the foot by just rolling it out rather than testing and planning and taking that extra time.”

None of this is easy, and it isn’t going to get any easier. As additional retailers introduce premium loyalty programs, the competition will only grow fiercer. “There’s always the risk of an arms race when it comes to retail rewards,” CreditCards.com’s Schulz said. “As the perks increase, consumer expectations and demands increase along with them. Retailers have to be careful to understand their own limits, and at what point rewards programs cost more than they’re worth.” 

Experts say there’s little data on the number of premium loyalty programs that consumers will support, and information on membership churn is equally scant. But the path to guaranteeing that your best customers sign up and continue paying their membership fees year after year is clear.  

“It’s all about how you treat [customers], and it’s about digging in and knowing them, working with them and delivering a better experience,” Freund said. “For example, if you’re a specialty retailer for young men, they really value someone working with them in the store and helping them pick out certain clothing. Don’t do loyalty to them; do it with them.”

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Filed Under: Marketing
Top image credit: RestorationHardware.com