How Do Loyalty Programs Work?

To be able to answer the question “How do loyalty programs work?”, first we have to look at the why before the how. Why are loyalty programs so beneficial to companies? Why invest in one?

Why do businesses want loyalty programs?

  1. To retain customers and channel partners. These programs are designed to engage customers and partners and generate loyalty. Businesses desire loyalty programs because they keep customers coming back for more.
  2. To set themselves apart from the competition. When two companies have similar products, customers have no reason to choose one over the other. Loyalty program software gives a business the opportunity to steal away customers and gain market share by offering a unique benefit the competition doesn’t have.
  3. To motivate channel partners or customers to perform some task. The task could be long-term, in which case, it would be beneficial to diversify the products they offer in order to keep customers interested over a long period of time. Or, the task could be short-term, meaning the business could incentivize with a sales promotion or specific products to get an immediate response.

Additional benefits of loyalty programs include:

  • Brand reputation.
  • Brand recognition and awareness.
  • Better customer experience.
  • Brand value promotion.


Okay, now the how. How do loyalty programs accomplish the above? How do loyalty programs work?

  1. Your customers/channel partners see an opportunity to earn rewards.

    First, the reward must appeal to the audience.

    Remember that customers span different demographics and will be interested in different things. Explore the different generations and what kind of reward or incentive each customer might want and need in order to motivate them. Take a look at this chart to help get started.

    loyalty programs loyalty rewards

    The reward needs to be proportionate to the behavior you want participants to engage in. The kind of incentive reward you offer matters! For example, how would you feel if you finished a big project after months of work and were instrumental to the team in its completion, and only got a $10 gift card? A small reward for a big effort is usually worse than no reward at all. It devalues hard work.

    Conversely, a big reward for a small effort costs money, creates low expectations, and decreases employee motivation. And, inconsistent rewards are worst of all because no one is clear on what is expected of them so they probably won’t change their behavior for the better.

    The competition may offer a loyalty program that isn’t advanced enough to offer diverse or tiered rewards. This is where you can get a leg up. Offering diverse rewards with a fairer payout system can make your loyalty program better.

  2. Participants alter their behavior and earn a reward.

    How do loyalty programs work? Definitely not by rewarding participants for something they’re already doing! If you do this, you could be throwing your money away. You could even de-motivate participants to continue doing the desired task. So, when offering a reward, make sure the participant has to go above and beyond to earn it.

    Now, you reward them. There are many different ways to reward customers, but here are the most common loyalty reward ideas:

    • Use loyalty software to reward points redeemable for merchandise in an online rewards catalog.
    • Give recognition/praise. This is more appropriate for employee or HR reward programs, but showing customers and channel partners your appreciation goes a long way.
    • Offer cash – CAUTION. (Keep reading to find out why!)
    • Offer gift or debit cards. Cards are good for short-term promotions because they’re quick and easy to distribute, and people don’t have to save up reward points.
    • Offer incentive travel trips. Save this as a reward for BIG accomplishments or initiatives. The investment is large, but the payoff is larger than any other reward, and brings your partners together with you, in a fun environment, to learn and share experiences. A study commissioned by the US Travel Association found that corporate companies that use incentive travel generally enjoy a ROI of 4:1 – for every dollar invested in incentive travel. It’s hard to argue with that kind of payoff!

    Once you reward a customer or channel partner, they either see value in the loyalty reward and are motivated to earn the reward again, or they don’t see value in the reward. How can you make sure it’s not the latter?

    • Offer non-cash rewards. People say they want cash instead of non-cash, but oops. They don’t.

      People unconsciously prefer non-cash rewards even if they say they prefer cash. Biometric responses were measured in a study by the Incentive Research Foundation and found that, “Participants exhibited a stronger response (attraction) to highly salient non-cash rewards than to cash at the unconscious level. After participants are given time to examine and consider their non-cash and cash reward options, most will choose a non-cash, hedonic reward over the equivalent cash.”

      Cash becomes an entitlement. You have to spend more and more to keep them interested. A recent study found that, “cash rewards cost about $0.12 per incremental dollar vs. $0.04 per incremental dollar for non-cash incentive rewards.” Basically, you are spending more for less impact.

    • Avoid giving the same reward every time. Two reasons:

      You’ll never be able to offer one reward that motivates everyone. People are too different. Refer to the earlier table about different generations.

      Psychologically, people are motivated to work harder for longer if there are different kinds of rewards to earn. A Psychology Today article, “The Secret to Achieving a Big Goal Is…,” states, “Mentally separating these [rewards] into bins or categories increased participants’ time commitment to the transcription by playing into their desire to minimize the risk of “missing out.” In other words, people experience FOMO (fear of missing out). This is why online rewards programs are so beneficial and work so well.

    • Deliver the reward the right way.

      In answering the question “How do loyalty programs work?”, you have to keep in mind that the way you present a loyalty reward can matter as much as the reward itself—maybe even more! As mentioned in the Incentive Research Foundation article, IRF 2016 Trends in Incentive Travel, Rewards, and Recognition, “The perfect reward poorly presented would have half the impact. Businesses should invest as much time and resources in understanding the total award experience employee, channel partner, sales people desire as they do in the award/reward purchases themselves.” It’s important to deliver with the right amount of recognition that matches the effort as to not minimize a participant’s effort.

  3. The loyalty program has a system.

    How do loyalty programs work? Last but not least: by having a system in place. A system to track the progress of the loyalty program—the highs and lows of program activity or reward redemption, for example—will help the loyalty program become more successful over time. Successful loyalty programs look slightly different within each organization because every organization has slightly different needs and business goals. Therefore, not every organization would answer “How do loyalty programs work?” the same. But a system will help keep the program running smoothly and effectively:

    1. The objectives and goals of the program are tied to your organizational goals.
    2. The rules are clear and consistent from the beginning. A loyalty program doesn’t work without participants, and participants won’t participate if they don’t know what’s going on.
    3. Participants receive necessary information and communications about their reward balance, delivery status of a redeemed reward, program updates and alerts, etc.
    4. Reports, analytics, etc. are available to gauge the effectiveness of the program, improve it, and identify growth opportunities.

And that’s how a loyalty program works! Follow all of the above and you’ll be on your way to a successful loyalty program!