Tuesday, 13 January 2015

Loyalty - Building a better mousetrap

Gray mouse cheese 13952547

Ask someone how many loyalty programs they are a member of and they can probably name 3 or 4 big programs they use regularly. However, in the US, loyalty program membership is now over 23 per household and between 2008 and 2012 it grew by 10 percent per year. These are great numbers until you realise that only around 1/3 of these memberships are being actively used.

More worryingly, a study by McKinsey back in 2013 suggested that for many companies, those with loyalty programs actually underperformed vs the market with “loyalty-focused companies surveyed [growing] revenues at a weighted-average rate of 4.4 percent per year – compared to 5.5 percent for companies with lower loyalty focus.”

This doesn’t mean loyalty doesn’t work – it does and McKinsey acknowledge that. What it does mean though is that like anything, there is no quick fix; no silver bullet. A “me too” loyalty program is likely to add little long term value if it isn’t designed well and there are all too many of these in the market.

However, what is interesting is that when talking about what a good loyalty program looks like, the discussion frequently looks at program features like partnerships or reward value without really considering what actually makes a loyalty program work – and why they also fail.

If we can understand what makes someone use and continue to use a loyalty program - what’s going on in their brain - then we can truly design a program that works harder and is more rewarding.  As the famous quote says “Build a better mousetrap and the world will beat a path to your door"

A good place to start with this mousetrap is back in the month of May, 1938, in a cold Minnesota that had just experienced one of its heaviest snowfalls ever for that month with over 12 inches of snow falling in just one day. That same month, psychologist B F Skinner published his now famous book called The Behaviour of Organisms – and it’s that book, published almost 80 years ago which provides some answers as to both why loyalty programs work, and why they don’t.

Before discussing that though, it’s worth also considering something happening in the here and now.

Consider for a moment how often you check your phone for new email or to check your Facebook account. Whatever number you come up with, you’ll probably be way off the mark because half the time, we do it almost on auto-pilot. One article suggests we check our phones over 1500 times per week - thats more than once every 5 minutes during waking hours.

It’s not just the checking however, we are also at the beck and call of these devices.  

A research study by Loughborough University in the UK found that people, on average, take just 1 minute and 44 seconds to respond to a new email notification - with 70% of these alerts getting a reaction within 6 seconds and 85% within 2 minutes.

We talk about the mobile phone being the remote control of life… it could equally be said that the mobile phone is actually the remote control of us.

What this all means however is that we are essentially re-wiring our brains.  Our brains are wired to protect us from danger or to help us survive; when we see something in the corner of our eye we respond. This is known as our orientating responses and these are now constantly being triggered by the ping of a mobile or the flash of a notification meaning we’re becoming ever quicker at responding and anticipating a response.

There is more to this phenomenon however and this is where that cold May in Minnesota comes in.  

The book published by B F Skinner introduced the world to the concept of operant conditioning.  Simply put, operant conditioning describes any voluntary behaviour that is shaped by its consequences and it implies a creature (including you and I) will repeat an activity that produces positive rewards.  Underpinning this operant conditioning are a number of reinforcements which, when repeated, serve to further in-grain the behaviour.

Skinner based his research on observing animals such as rats and pigeons, which when placed into a specific environment (known as the Skinner Box), would carry out a repeated behaviour based on the rewards offered (i.e. press a lever to get food).  Using this environment, Skinner was able to vary how and when the reward was delivered in order to measure the ability to influence and maintain ongoing behaviour - called a positive reinforcer.

From this research, Skinner came up with three schedules of reinforcement, defined as continuous, interval and ratio based.

  • Continuous - Defined as a constant delivery of reinforcement for an action; every time a specific action is performed, the subject instantly and always recieves a reinforcement.  With this type, the reinforced behaviour is prone to extinction and the behavior can become inconsequential (i.e., producing neither favorable nor unfavorable consequences) and so starts to occur less frequently
  • Interval - Based on the time intervals between reinforcements.  These can be fixed time periods (FI) or variable (VI), with the variable being based on an average time that has passed since the last reinforcement.  Both of these are not directly linked to the persons actual behaviour and so typically produce slow, methodical responses.
  • Ratio - Can be based on the behaviour of the person and be fixed or variable too.  The fixed ratio (FR) is based on a specific number of responses (e.g. Coffee Stamp Card), whereas the variable ratio (VR) is based on a particular average number of responses (e.g Slot machines - pays out 10% of the time on average, but there is no guarantee when).  

Schedule of reinforcement

It’s these reinforcement schedules that are key to understanding why we’re so quick to react and respond to that email notification - and why some loyalty programs work and others do not.

Simplistically, where the reinforcement schedule is predictable, whether by being continuous or at set intervals, then the behaviour becomes in Skinners words “extinct” - so its passive and inconsequential and decreases or stops altogether over time.  On the other hand, where the reinforcement is on a variable ratio - where both the timing and the value can’t be predicted - then we get the highest rates of response and the the higher the ratio, the higher the response rate tends to be.

In the book The End of Absence: Reclaiming What We've Lost in a World of Constant Connection, author Michael Harris highlights this saying "Animals, including humans become obsessed with reward systems that only occasionally and randomly give up the goods.  We continue the conditioned behaviour for longer when the reward is taken away because surely the sugar lump is coming up next time."  This “variable interval reinforcement schedule” is really the critical factor in repeatable, ongoing behaviour.

This outcome can be seen in how we interact with email as discussed previously.  One behavioural psychology training course describes this effect with email saying:-

"Receiving a message serves as a reinforcer, or reward for, checking. You might check your email at 9:00 a.m. and have 5 new messages, at 11:00 a.m. and have none, and then at 3:00 p.m. and have 7. As long as you periodically continue to receive messages, your checking behavior will continue; however, this behavior can be influenced by the number of messages received. If you don't receive any messages for 5 days, you may check less often. On the contrary, if you receive several messages each time you check your email, you will probably check more often. In this case, your behavior is an effect of variable-interval schedules of reinforcement. You receive a reward (new messages) for a behavior (checking your email), and the reward is presented on a variable schedule (you can't predict when it is coming)."

This is also something that the gambling industry relies on to keep punters coming. Co-Author of the book Mind Hacks and lecturer at the University of Sheffield, Dr Tom Stafford discusses this saying:-

"Both slot machines and email follow something called a 'variable interval reinforcement schedule which has been established as the way to train in the strongest habits. This means that rather than reward an action every time it is performed, you reward it sometimes, but not in a predictable way. So with email, usually when I check it there is nothing interesting, but every so often there's something wonderful - an invite out, or maybe some juicy gossip - and I get a reward."

Another industry that uses Variable Ratio (VR) reinforcement schedules is video gaming.  In the research paper “Video game structural characterisitics - A new psychological taxonomy” it describes how powerful operant conditioning techniques can be for players saying:-

“Players respond rapidly and persistently to the reward features in video games, such as XP and points, rare items, and meta-game rewards. These features are core components of the variable reinforcement schedule, which is known to create a persistent pattern of responding to a stimulus over time that is resistant to behavioural extinction."

Video games build on this however using a number of different schedules - continuous, interval and ratio - in a combined way to create what is called a compound schedule which may superimpose two or more different and overlapping schedules to gain maximum effect. Just as a gamer is accomplishing one mission they have already started on another; in this way, using overlapping and compound schedules, game designers keep the players involved which leads to sticky and sometimes "addiction" like behaviours.

In the research study "Understanding and Assisting Excessive Players of Video Games”, authors King and Delfabbro (2009a) found that overlapping quests and objectives (i.e., concurrent schedules of reinforcement) in video games kept players playing for longer periods than games without these features.  The report also detailed how the use of VR schedules could also cause game players to carry out behaviours that are repetitive or boring, simply to chase the reward saying:- 

 “The variable-ratio reinforcement schedules in video games and participants’ need to complete goals often produced what was termed ‘grinding’ behaviour. Grinding refers to the repetition of an action or series of actions in a video game in order to obtain a reward."

Speaking about this behaviour, one player stated how he "played the same level 10 times to get the full set of armour. [It] gets frustrating but you have to do it if you want the items"

This is really interesting because it suggests that the power of the right mix of reinforcement schedules can actually mask the more mundane actions required to achieve it.

Whilst people obviously consider themselves unique and with their own individual decision making processes, the reality is that people tend to respond consistently to the same kinds of environment.  Keeping with the video game theme, it’s interesting that research has shown that it's more about the design of the game mechanics than the individual gamers characteristics that drives usage.  The research paper entitled “The role of Structural Characteristics in Problem Video Game Playing” pointed this out saying:-

"In particular, ‘structural characteristics’, defined as those features that facilitate the acquisition, development, and maintenance of playing behaviour irrespective of the individual’s psychological, physiological or socioeconomic status, have been shown to play an important role in explaining the appeal of gambling activities."

Further examining what makes video games “sticky”, the psychology book Mind at Play by Loftus and Loftus (1983) showed that the appeal of video games was a blend of variable-ratio and fixed-interval schedules which were intended by designers to be “addictive”.  They noted that key aspects of this are that players are:-

  1. Often reinforced almost immediately for correct play
  2. These rewards for good game play are of large [perceived] magnitude (i.e., the provision of 150 points appearing more significant than 15 points)
  3. Rewarded on numerous concurrent reinforcement schedules

So, back to the question at hand - If we can understand what makes someone use and continue to use a loyalty program - like they do a video game - then we can truly design a program that works harder and is more rewarding.

Loyalty programs, in part, already rely on the principle of positive reinforcement whereby when an event or stimulus is presented (e.g. points) as a consequence of a behaviour then the behaviour goes on to increase.  It’s this behavioural psychology that underpins much of the change we see within customer loyalty.

However for the majority of loyalty programs, whether explicitly designed in or not, there is only one reinforcement schedule which is the continuous issuance of points in response to a purchase.  From the customer perspective, every time I buy I get points which is much the same as the animal in the Skinner box which gets food every time the lever is pressed.  

The problem for these loyalty programs is that we already know that this continuous reinforcement schedule is the least likely to result in long term ongoing behaviour - we’re essentially designing in program extinction from the get go.

The second issue is that as previously discussed, our brains are increasingly becoming used to managing constant distraction - honing our orientating responses.  In a world where there is always another notification to respond to, another Facebook post to view, another email to read, any loyalty program has got to be able to cut through to compete with this.  With so many things fighting for our attention, the larger the gap between the behaviour and the stimulus, the more likely our brain will not link these two activities and the more likely we won’t get the full benefit of this positive reinforcement.  

This starts to manifest itself within loyalty program behaviour - customers will typically continue to swipe their card at point of sale because this is a learned (or prompted) behaviour - but it’s done passively.  There is no stimulus driving this current behaviour and so its less likely we’re able to influence it at this point in time.  Trying to get customers to then change or uplift their actual behaviour doesn’t work because there is no linkage between the behaviour and the reward/stimulus - the behavior has become inconsequential.

To create a loyalty program that works for consumers and works for brands, we have to ensure that the ’structural characteristics’ of the program provide a number of different engagement mechanics  - reinforcement schedules - so that we create a persistent pattern of responding to a stimulus over time that is resistant to behavioural extinction

As the research shows, this behavioural design works in gambling and it works in video games - some would argue it works too well.  However there is already evidence that it works within loyalty programs.  Some programs that do work well have many of these characteristics with a good blend of compound schedules.

For example, in a classic frequent flyer program there can be a continuous reinforcement schedule around miles earned for flights, but these are overlapped with fixed ratio schedules such as collecting towards tiering and benefits like companion tickets.  Whilst these are not necessarily using the most powerful variable ratio (VR) reinforcement schedule, they still manage to engage members through compound reinforcement schedules.

This also brings into focus gamification - that new entrant into loyalty program design - and starts to explain why, when implemented well it can truly accelerate program engagement.  Whether expressed as access to time limited deals, unlocking of recognition or achievement of challenges, gamification allows the loyalty marketer to superimpose additional, overlapping reinforcement schedules including variable ratio to gain maximum impact and benefit.  This isn’t just theory either - we’ve seen examples of this whereby simply switching a recognition mechanic from a fixed ratio to a variable ratio has resulted in a 33% increase in ongoing usage.

Yet loyalty programs continue to be launched and continue to under perform.

As loyalty marketers its imperative that we understand why loyalty programs work, why consumers respond to them and how to make them work better for all.   In the words of B F Skinner “A failure is not always a mistake, it may simply be the best one can do under the circumstance.  The real mistake is to stop trying"

Sunday, 16 November 2014

Digital - A Coming of Age

141316083 toddler tablet

Within any generation there is always someone who is a link between the old order of things and the new.

We’ve just commemorated 100 years since the First World War started, and for me it feels remote, but real.  I didn’t know anyone who served, but my grandparents did who I knew, so I feel a connection.  With the Second World War, things are different.  When I was 10, I remember celebrating at school 40 years since the end of the war.  At 10 that seemed a long way past, but my grandparents served in it and could bring it to life with stories and artefacts.  For my kids though, all of this is a fading memory - stories we tell, but it may as well be like the Battle of Waterloo.

This connection between the old order and the new is explored in a book I’m currently reading called The End of Absence by Michael Harris.  In it, he discusses the time we’re in now and how anyone born after 1985 is essentially a digital native - someone who has never experienced a world without the internet; a world without always on connectivity.  For us others - those born before this time - we’re essentially digital immigrants.  Describing this group, Harris says:-

“For those of us who have lived both with and without the vast, crowded connectivity the Internet provides, these are the few days when we can still notice the difference between Before and After […] there’s a single difference that we feel most keenly; and it’s also the difference that future generations find hardest to grasp.  That is the end of absence - the loss of lack.  The day dreaming silences in our lives are filled; the burning solitudes are extinguished."

This is thought provoking stuff.  Realising that my kids (and a lot of those I now work with), just simply think differently.  They’ve never experienced a time when there was genuinely nothing there.  No kids telly on, nothing on demand, no chat, no connectedness.  When I tell my son to get off his computer, I turn around to see him on his phone.  Kick him off his phone and he’s flicked the telly on.  It takes real effort to switch everything off so he’ll actually consider walking out the door to call for friends… and then they sit around their house playing Xbox.  I tried.

So this got me thinking about the implication of this within the working environment.

For many of us, we work in companies established pre-1985 or staffed with management from before this time.  We have computers, tablets and smartphones; intranets, instant messaging and email.  We even have social networks for staff, with “friends” and wall posts and “status updates”. We’re thoroughly modern and fill every piece of time, every empty space within some activity.  Responding to a ping on the phone, an email arrived - we sit in meetings only half listening as we type on our laptops and then check our phones.  This is a state Harris references and one that writer Linda Stone referred to back in 1998 as “continuous partial attention”.

Yet despite this, we’re not as modern as we like to think.  

Many companies still have a Digital department of some kind or a Head of Digital role - as if all things digital is somehow separate to what we do.  It’s as if we’re in both the Before and the After - one part of the company in the pre-1985, pre-digital age and the other ring-fenced in the digital age.  This does some ludicrous and you can’t imagine a company such as Facebook or Google having a Head of Digital role - they are simply digital companies (although strangely they do).  The point is, the world has changed, people have changed, but the way we do business seems to still be a mismatch of old and new.

This point was brought to life in an article I was reading about airlines entitled Passengers Become Data Mines as Ryanair to Emirates Hone Offers.  In it, Ryanair CEO Michael O’Leary is quoted as saying:-

"I used to say that my ideal customer had a pulse and a credit card, but I’ve revised that view radically. […] In the next five years, with each of my 90 million customers, I’ll know when you’re traveling, where you’re traveling, and I can send you a direct offer.”

This shocked me.  

We’re in 2014, this is a relatively new airline (setup in the 1980’s) and yet it seemed a surprise to them that there may be value in the data they hold and process for 90m customers.  This is though also understandable because companies still aren’t digital natives - they still have their digital marketing and data analysis functions somehow separate to their older, more established traditional sales and marketing functions.  They’re an add on or an extension rather just being one single company.

If we go back to Marketing 101 and the 4Ps of the marketing mix we have Product, Place, Price and Promotion - this was something created in the 1960s by marketer Edmund Jerome McCarthy - a set of marketing tools based on the age but which is still taught today.  

A company like Ryanair has really focused on these 4P’s - it’s “Price” has been refined by pairing back its “Product".  By choosing carefully the airports it uses to get the best rate for a given destination even if it’s not quite the best airport in terms of distance, it has truly honed “Place”.  Promotion you could argue has been a mixed affair, but there probably isn’t a person alive in the UK who doesn’t know the airline, it’s CEO and the kind of message he had long stood for (such as removing toilets from planes).

But within this 4Ps mix, there is nothing about the customer.  It’s the old world order of making a product people want, at a price they are willing to pay - and then shouting about it loudly in the right places.  It’s all push.

Take a look at the new world however through a different lens.

Freemium models support many of the latests products/services, with apps (and some products) giving away their product in the knowledge that they can monetise customers either through targeted advertising or in-app purchases - and this is where data comes into play as a key part of the marketing mix.  Even airlines have a form of this with their ancillary services - the basic service is paired right back and then customers are encouraged to top this up with ancillary services as they need - a kind of pick and mix of products.  This is all pull.  

Speaking of this, CEO O’Leary is quoted as saying:-

"Ryanair’s data will let the carrier know how often travelers head to particular destinations, whether they travel alone or as a couple or group, if they routinely book insurance or car rental, and be able to customize its offers accordingly and target the passengers with special offers […] We know who you are [and] the clever airlines are going to make a fortune in the next 10 years”

This thing which will make a fortune is the missing piece - it’s the digital native addition to the marketing mix.  It’s the bit about the customer, about what they do and about what they want.  

It’s personalisation and it is truly the 5th “P” of the marketing mix.  I’m not the first to point this out, but it really is the difference between the Before and the After.  The increased connectivity and the computing power, scale and flexibility this has afforded, as well as the increased expectation of a customer base in “continuous partial attention” mode means that personalisation is critical to success.

As we transition from companies and people born of this pre-digital age to the next generation of digital natives, there will be change, there will be new ways of doing things.  We cannot stop it but for many of us, and for many of the companies we work for, we’ve yet to embrace it.  In the book End of Absence, Harris says of this:-

“Technology is neither good nor evil.  The most we can say about it is this: It has come. […] We can only judge, only really profit from judging, the decisions we each make in our interactions with those technologies.  How shall we live now?  How will you?"

Friday, 3 October 2014

The rise of the alternative (loyalty) currency

Barter

You can’t have failed in recent months to see the rise of alternative currencies like Bitcoin.

With SIBOS, one of the worlds premier financial services events dedicating a whole day to Bitcoin discussions and Paypal enabling Bitcoin support amongst it’s digital merchants, there is no doubt that this crypto-currency is heading mainstream.

Whilst there is a lot of focus on the fluctuating price of Bitcoin and the how the currency itself comes into existence, there really isn’t that much difference between it and a more traditional currency like Sterling.  In both cases, there is essentially a digital ledger that manages payments and deposits.  Within a traditional system, these ledgers are managed by a trusted 3rd party such as the users bank and these in turn are typically managed through some form of central bank such as the Bank of England.  The money itself is held as a digital record and we simply place trust in the centralised 3rd parties that this will be managed accurately.  With Bitcoin, this ledger is decentralised and essentially owned by all users (know as the block chain).  Trust is managed through sophisticated cryptography to ensure that changes are accurately represented and can be trusted.

As with any currency then, whether centralised or de-centralised, it really just comes down to whether the users of the currency place a value on it as a medium of exchange, a trust in it as a store of value over time and a unit of account that can be used to measure any particular transaction.

In this sense, you could argue that loyalty points are a currency.  They are a closed loop currency and you work to attain it by doing specific behaviours with the value issued directly in relation to your “effort”, be this purchase behaviour, frequency or other interactions such as social activity.  This makes it a medium of exchange which is normally measured based on the corresponding value to the issuer such as the retailer.  

The problem with this currency however is that in many cases, it's simply not that good.

It has relatively low liquidity - I can have lots of loyalty currency, points or miles from lots of programmes, but essentially they are all siloed.  I can’t move them, share them or aggregate them easily.  I can of course convert them to other assets such as rewards, gift vouchers or other loyalty program currencies, however the transaction costs for this can vary, making the exchange in many cases less attractive.

I’m also constrained by how much I can earn/attain based on other behaviours.  As these other behaviours are related to share of wallet activities like grocery shopping, it’s harder to increase my earning velocity past what I naturally need - so a change in pricing for example would not necessarily result in a significant change in demand and hence loyal behaviours recognised.  Sure I can centre my purchases with one retailer and possibly up-sell to higher value products - but there is essentially a ceiling to how much I can spend and hence earn.  Coalition programmes like Nectar help this to some degree by widening the opportunities to earn, but it’s still limited based on the amount I can actually spend.

It’s interesting however to look at a loyalty currency as an actually currency - a retailer issued, closed loop monetary supply.

As a retailer currency, why can’t I purchase currency upfront?  Why can’t I exchange the currency with friends?

Sure there are good reasons when you look at it as a reward mechanism.  

If it’s too portable, then does it lose it’s stickiness?  If I can simply give my points to someone else, am I less likely to try to build a balance?  If my points can be shared with others will this increase breakage and mean that high numbers of points will ultimately be redeemed?

The answer is likely yes to many of these questions.

However, if people can “pay” each other in loyalty points, will this increase the attractiveness of the currency (and hence the retailer)?  If customers could convert real money into a retailers closed currency upfront, how much is this “potential purchase value" worth? 1% discount? 5% discount?  If other, complementary retailers can issue the loyalty currency, does this increase the liquidity of the currency and create more customers and more purchases?

It has been reported that Starbucks now see 30% of their purchases being made with their loyalty currency, Starbucks Stars.  Of course, Starbucks could have just reduced their prices, but in doing this, the customer saving would have been in the most liquid asset - cash - and the chances of Starbucks seeing that cash being spent back with them would have been low.  However, with their loyalty currency, they’ve managed to both discount their product whilst keeping the value within their own closed loop currency.

Now at this point, that currency is no different to any other loyalty program we’ve been doing for the last 80 years, whether physical stamps or a digital record.

However, what if Starbucks allows the currency to be exchanged between people - what if they increased it’s liquidity?

Could I pay for a taxi ride with Stars?  Could I pay for a haircut with Stars?  Could the barber issue my change in Stars?

How much is a Star worth to me if I have all the coffee I need - would I trade it for less than it’s value at Starbucks to someone who values it more?

This may sound a little farfetched, but it’s happening today.  The Economist reported last year that in many markets in Africa, mobile airtime is becoming a defacto currency, with retailers issuing small amounts of change in mobile airtime rather than cash.  People are settling personal debts through the transfer of airtime and with the ability to move airtime credit globally, it’s not just a local phenomenon, it crosses borders and continents.

It’s even more interesting when you look at this through the lense of the new crypto-currencies like Bitcoin.

Rather than being “earned” based on behaviours, these crypto-currencies are typically mined - in a virtual sense.  Based on a complex algorithm which takes (ever increasing) computer power to work through, the algorithm rewards the computer user with coins every so often.  For a currency like Bitcoin, there is a finite number of coins to be found and as more are found, the remaining ones get even harder to find, taking longer and taking more processing power.  In this way, the Bitcoin market is essentially constrained, making a Bitcoin value flexible depending on what the market will pay.

Back in 2011, Stan Stalnaker, founding member of the Ven currency wrote an article entitled Bitcoin, Ven and the End of Currency built on this theme saying:-

“To be traded, [a digital currency] must be assigned a value.  And if it can be assigned a value, it can be interchanged with anything else of assigned value.  The Internet is enabling exchange of all types of value, and helps us to measure and publish these values. [..] How many Likes is a Facebook Credit worth? How many Credits make a Ven? How many Ven make a lasagna at the Olive Garden? How much do you have to Like the Olive Garden to get a lasagna? We’ll know soon."

As alternative currencies rise in popularity, we’re going to see more examples of people exchanging products, services, time, attention and share of voice for something other than the national currency.  I think loyalty currencies have a positive role to play in this new and emerging economy and it will be interesting to see how they change and are transformed to become more flexible and possibly decentralised.

 

Image credit http://williamstake.files.wordpress.com/2012/09/barter.jpg