Reward Programs: Use Them Competitively

The last five columns looked at various reward programs in an attempt to understand the science behind their effectiveness. Today, we’ll look at how these programs interact with each other in a competitive environment. The science of concurrent reward schedules is extremely complicated. It’s a subject of ongoing research in the scientific community. In this column, we’ll look at basic principles and answer the following business questions:

• Do my company’s promotions compete with or cannibalize each other?
• Do my company’s promotions affect my competitors’ promotions?
• Do my competitors’ promotions affect mine?

Concurrent Reward Schedules and Classes

All reward types (continuous, interval, and ratio) can be classified based on the type of reward given. Any schedule with the same reward type is said to be in the same reward class. In other words, promotions that offer 20 percent off are in the same class, whether that 20 percent off is offered every time, every 10th time, every Tuesday, or once a year.

In fact, any reward that offers a percentage off is technically in the same class. A 20 percent off reward is in the same class as a 40 percent off reward, even though they vary in magnitude. (In B.F. Skinner‘s experiments, this means food rewards are in the same class, whether the reward is two or four food pellets.)

It’s been shown animals and humans work to maximize a reward’s frequency, not its magnitude. This is somewhat counter to our intuition and understanding of evolution but basically true. This is the basic principle behind understanding how to use rewards competitively.

Put simply, “how often” is usually more important than “how much.” Although the four-pellet food reward is more attractive than the two-pellet, a mouse responds to each reward system in direct proportion to how often rewards are given. It interacts more frequently with a reward schedule that rewards it more frequently.

If a competitor offers 20 percent off the first 10 days of the month, how should you respond? Would you be willing to offer 30 percent? 40? If you’ll offer a similar promotion on the same days, you must increase the reward’s magnitude.

But because people are more sensitive to frequency than magnitude, there’s a better way that won’t cut into margins so much. If you stay strictly within the fixed interval reward schedule, offering 10 percent off every Monday is more attractive to people. True, 10 percent isn’t as great as 20, but it happens more often. That’s the important measure.

Token economies (such as a point system) have a similar competitive quality, complicated by “delay.” Point systems are compared based on two factors: how quickly points accumulate and how quickly they can be used. Because two point systems are generally in the same class (they both give “points”), reward frequency matters: how quickly can points be obtained?

Further research shows delay in using points also matters. If I can use the points immediately, I’ll show preference to that system over one in which I must wait longer.

Different Strokes…

Though similar reward classes actively compete with each other for people’s attention, things are different among dissimilar reward classes. Studies show concurrently running schedules of differing classes, such as a free shipping reward and a 10 percent off reward, don’t directly compete. They really don’t affect each other at all.

Basically, you aren’t asking people to compare apples to apples and decide which to go with, as with two percentage-off programs. With dissimilar reward classes, people compare apples to oranges: do they want 10 percent off or free shipping? These ideas are so dissimilar, people can’t pit them against each other to the extent one negatively affects the other. This is true not only of offers you run against your competitor’s offers, but also offers you might run concurrently within your company.

If one online store offers free shipping with a purchase of $50 or more, how should your company respond? You could offer free shipping as well (as many companies have). If you match the offer, you level the playing field. But you might get into a price-margin war, as each one slowly decreases the order size requirement until you ship every order free.

Instead, you could respond with a completely different reward class. You might offer a half-priced item for every three items purchased, or 10 percent off orders of $60 or more. Neither is directly comparable to free shipping. Consumers won’t have a gut reaction as to which is a better offer. The offers succeed or fail on their own merits.

On the flip side, because the promotions aren’t directly comparable, your promotions won’t directly affect your competition. You won’t render their promotion useless or undesirable. But you will increase your own traffic based on the strength of your promotion. Similarly, when the competition makes its free shipping offer more attractive (by cutting its margins), it won’t affect your promotions. You needn’t respond in kind.

Offering a different reward class with a reward schedule that shows greater frequency and a slower decay rate is a winning recipe for a competitive promotion.

Quality Is Still Important

Concurrent reward schedules are much more complicated than what’s covered here, but these are the basic principles. As with everything discussed in the last five columns, you must test these ideas to find the best mix of reward schedules and classes.

But loyalty doesn’t come from a program. One facet of reward schedules drives that point home: reward quality. Two rewards of the same class might differ in quality.

In Skinner’s experiments, a pellet of corn and a pellet of wheat are in the same reward class (food). They differ in quality because the mouse may prefer wheat over corn. That factors into the mouse’s maximizing strategy. It prefers the wheat reward and does its best to maximize getting it.

Similarly, if your company has terrible customer service, limited product offerings, and a poorly designed Web site, a 20 percent off reward may be less desirable than your competitors’ similar offer. People may simply prefer them to you.

Loyalty vs. Retention

People are loyal because of your product quality, terrific user experience, personalized attention to detail, and customer service. A well-designed reward program or series of promotions aids customer retention. It entices people to come back and transact with your company based on the rewards they get. You may even need these rewards as a cost of entry in your business (e.g., every airline needs a point system because they all have them).

Customer loyalty is a different matter. Customer preference is based on the intrinsic quality of the brand experience. If that experience is lousy, no “loyalty program” is very effective. That said, if you must use promotions and rewards in your business, I hope you now have a better understanding of how to implement reward systems effectively and competitively.

Let me know what you thought about this series. There are many more related topics I’d like to cover if there is enough interest.

Until next time…

Jack