Switching Costs – Creating Love for Thy Captor

by Paul D'Alessandro on March 5, 2010


US Companies now spend over $2B annually on loyalty programs.  What are loyalty programs?  I would argue that they are simply a way to build up economic switching costs or a barrier to exit for consumers.  Loyalty?  I think not, lock-in is probably a better characterization.  Alternatively, some companies today are starting to think in terms of psychological switching costs.  This approach is often less expensive, generates higher profits and does not lead to many of the unintended outcomes of economic switching cost programs.  Some statistics on loyalty programs aka “switching cost” programs in today’s economy:

  • It is estimated that there are 1.8 billion members of loyalty programs within the U.S. (COLLOQUY 2009 Loyalty Census).
  • Marketers spend about $2 billion annually on operating these programs, reports PROMO Magazine.
  • The average U.S. household is enrolled in 14.1 loyalty and rewards programs, but is only active in 6.2 of them, notes COLLOQUY.
  • Top U.S. loyalty program memberships ranked by industry include Financial Services 422 million; Airline 277.4 million; Specialty Retail 191.3 million; Hotel 161.8 million; Grocery 153.3 million; Mass Merchants 124.8 million; Casino/Gaming 106 million; Department Stores 92.8 million; Drug Stores 73.9 million; Fuel/Convenience 51.2 million; Restaurant 13.7 million; Car Rental and Cruise Lines 10.7 million; and all other types are put at 127.9 million, reports COLLOQUY.

    Think about how they work.  You commit to a single source for your products or services.  In return for your “loyalty” you are provided an account that builds up points.  If you ever leave that program, that’s it, you lose the points.  Stay with the program and the you can occasionally reap the benefits of your account.  Given the economic nature of these programs an even better characterization is probably “economic switching cost programs”.  Doesn’t sound nearly as good as “loyalty programs”.

    However, economic switching cost programs are not without opportunity.  In return for their accounts, consumers provide in depth information about themselves (73 percent collect basic demographics and 68 percent track the location of members).  Unfortunately, even given this in-depth profiling of customers, the vast majority of marketers still miss the opportunity of gaining critical insights – such as advocacy rates (14 percent), brand loyalty and attachment (27 percent), personal preferences (31 percent), satisfaction levels (33 percent), and product preferences (38 percent).1  Startling statistics given the opportunity.

    There is an alternative though, a way to do it right.  Recently, after a long flight delay I checked into my hotel late at night.  The desk agent asked me if the airline had done anything for me in return for my flight delay.  I responded, “not a thing”.  She then proceeded to tell me about the time her Jet Blue flight was delayed for 2 hours and the flight attendants had brought pizza onboard to the delight of almost everyone.  She said she would never forget what they had done.  This moment of truth will live long in the minds of those who experienced it for a long time.

    Contrast her experience with that of a friend whose father was recently taken to the hospital for a major procedure.  After overcoming serious concerns the big day finally arrived.  Unfortunately upon arrival to the hospital my friend’s father was horrified to find the check-in nurse to be the same person with whom he had an absolutely awful experience the year before.  His anxiety rose, his blood pressure went through the roof and the procedure had to be delayed a day.

    Statistics show that negative experiences are at least 1.5x more memorable than positive ones2.  The clear implication being that for every two bad experiences with your company at least three are needed to at least neutralize them, four to overcome them.  Regardless of the challenge of building psychological switching costs think of the potential.  Rather than having to add to your balance sheet the liability of the ever growing obligations of economic switching costs you build reasons for people to want to stay with you because they have an emotional attachment.  This has the potential to be less expensive and the lasting memories can be far more lasting.

    Take the example of Patagonia and Yvon Chouinard their founder.  Yvon designed a culture that goes out of its way to delight its employees and customers.  Their employees live the brand.  If you have not read the story of one of the best experiential brands out there today it is highly recommended:

    Part memoir, part manifesto — legendary climber, businessman and environmentalist Yvon Chouinard, founder and owner of Patagonia®, Inc. describes his life and his start in business as an itinerant climber selling pitons from the back of his car. Let My People Go Surfing: The Education of a Reluctant Businessman offers a look at the guiding principles that Chouinard used to build Patagonia® into a global business — a business that has an environmental mission and is a fun place to work.3

    I would purport that Patagonia, whether knowingly or not has designed a set of psychological switching costs.  They think of every possible way they can build positives moments of truth for the customer to put in their account.  In concept this is not too distant from the idea of the other type of switching costs but instead the customer is locked-in on the positive rather than the negative.  All negative connotations aside, this concept has all the potential of creating the equivalent of the Stockholm Syndrome with your customers, let your customers love their captors.  Patagonia would tell you it is not such a bad thing.

    1.  CMO Council Annual Report on Loyalty Programs
    2.  Research of Elizabeth A. Kensinger, Ph.D.
    3.  http://bit.ly/bbE5n7

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    { 3 comments… read them below or add one }

    Amaresh March 26, 2010 at 8:26 am

    Excellent post Paul.

    The theme of your post reminds me of one of the sound bites I heard during the last presidential debate. ” We do not have a health care, we have disease care”.

    Similarly, we do not have “customer loyalty programs, we have customer hostage programs”

    Weave March 28, 2010 at 6:45 am

    After watching “Up in the Air” earlier this week, I’m curious how many “loyalty” patrons become obsessed with accumulating miles, points, etc. The “reward” is not the value the points create; it is the points themselves. E-horders, we could call them. (I’ll copy wright that term later today…)

    Loyalty club memberships often provide certain intangible benefits (personalized services, specialized offers). However, at what cost? How often do loyalty club members miss opportunities due to their decision to stay within the confines of their current program? It’s a bit of a microcosm, reflecting how people make decisions on a larger scale. Each day corporations have the opportunity to try a new service or vendor who could potentially lower cost, improve efficiencies, etc, but more often than not they stick with the known quantity, i.e. the incumbent. It’s the safe bet, and that safety generates loyalty.

    Great perspective, Paul. I look forward to your next article. PS: love the supercharger photo. There’s nothing quite like a huge blower sticking out of the hood, and the whine it generates at full tilt…

    Paul D'Alessandro March 29, 2010 at 2:29 am

    A friend last week introduced me to the trend of “punishing your customers” in the ultra-loyalty space. Black cards tend to do this with exorbitant fees or even the risk of “firing you from the program” if you do not behave. Isn’t it ironic that anyone would subject themselves to this type of punishment in the name of staying, with as you put it Weave, “the incumbent.” How many more programs out there are going to suck people in so deep that they too chose to inflict pain and punishment on their economically trapped betrothed? George Clooney was probably the quintessential example of this in “Up in the Air”. His whole live was a form of punishment in many people’s eyes, all done in the name of gaining the “points”!

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