Loyalty discounts are a biz cost that can pay off

Published 11:08 am Thursday, February 28, 2008

Editor’s note: This is the second of two columns on how businesses can survive an increasingly competitive environment by managing pricing policies to maintain their profitability.

A professional organization that I belong to produces a monthly journal and is also a bookseller and a publisher — specialty and technical books mostly, although one was made into a hit movie.

Currently on its Web site there is a banner-like notice that states that “Every item in our catalog is discounted, but members earn higher discounts of up to 30 percent on any item.”

There are two elements of current pricing models illustrated by the notice.

The first is that in today’s market for books it is very difficult to hold on to the list price. Discounting is so common, and expected, in book retailing that sales at list price, while not exactly rare, are certainly endangered. Even the so-called “big box” book retailers use visible and hidden discounts extensively to encourage sales.

The second element illustrated is that of the “loyalty discount.” In this example it applies to members of the organization, but more generally it is a discounting practice that applies to repeat customers.

The logic behind the loyalty discount is virtually identical to the quantity discount; the only thing that changes is the source of the cost reduction. Quantity discounts are a recognition of the reduction in the costs of processing and shipping an order. Loyalty discounts are a recognition of the marginal cost of bringing in a new customer.

Loyalty discounts come in many forms. In recent years, we have seen a substantial increase in the use of purchase record cards by dry-cleaning and other retail service stores, and especially in food and beverage establishments. The cards are punched or stamped to reflect purchases so that the customer, after buying, say, nine cups of coffee, gets the 10th one free — in effect, applying a discount to all purchases.

Similar loyalty discounting systems are in use in many supermarkets, though usually the customer’s purchases there are tracked by the computerized inventory and check-out system rather than by a punch card.

Loyalty discounts are aimed at keeping good customers, and they are positive actions for a firm. And while they show up as discounts like any other in our accounting data, they generally have a disproportionate positive psychological effect on customer loyalty because of the “free” coffee or “free” meal — which we tend to savor and remember.

Still, loyalty discounts are really only effective when combined with other, nonfinancial incentives for a customer to revisit a business establishment — whether a physical store or a Web site. And they are effective only when customers recognize that their loyalty is being appreciated.

Some businesses adopt loyalty discounts because everybody else seems to be doing it. A few adopt this type of discount in the hope that it will make up for their business’ shortcomings in other areas of marketing and customer service.

At bottom, though, loyalty discounts should be about reducing costs and maintaining profit margins by marketing to previous, satisfied customers. The math of business tells us that a real discount is the same as spending money — and loyalty discounts are just that.

The only exception to this rule is when the original price is a fake to start with, and the big discount is used simply to arrive at a realistic market price. While this is a practice common enough to be parodied — as in Leo Gallagher’s famous “Sledge-O-Matic” routines — it is a very specialized marketing area that most businesses enter at their peril.

From a management perspective, it is actually helpful to view discounts as spending money — because, as we all know, the way to business success is not to avoid spending money but to spend it wisely.

Many businesses spend money unwisely by cutting prices on the basis of poorly assessed information. Distributors and even your own salespeople, for example, will always tell you that they could sell more of your product if you cut the price. That may or may not be true — often it is not.

Getting good value for your money in discounting means staying focused on your customer base and your market yet having faith that your product or service is fairly priced. A price communicates more than simple dollars and cents. It communicates your belief in the value of your product or service.

As we move into a period of economic slowdown, that belief surely will be tested. Many firms will feel they have to make price adjustments. Each business is different, and each manager has to do what seems best. Generally, though, in a sluggish economy it is a lot safer, and a lot smarter, for a firm to discount prices for its good, loyal customers than it is to chase after new customers waving bigger and bigger discounts. Loyalty pays off — both ways.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by sending e-mail to otisrep@aol.com.