What is loyalty program?

A loyalty program gives customers points, discounts or perks in return for repeat purchases. Its purpose is to increase how often people buy, how much they spend and how long they stay. Because every reward is a cost, the real question is whether the extra spending it causes is larger than what the rewards give away.

How it works

Customers earn points on purchases and redeem them for rewards. Points sitting unspent are a liability for the business, since each one is a promise of future value. Two quantities decide the outcome: the earn rate, how many points a purchase gives, and the burn rate, how many are redeemed. If the earn rate is generous and redemption is easy, the cost rises fast; if redemption is too hard, customers lose interest and leave.

There is a feedback loop. Rewards bring customers back, which creates more purchases and more points. There is also a threat of mere subsidy, where rewards go to customers who would have bought anyway, so the cost brings no new revenue.

Example

Say a coffee chain gives 1 point per dollar, and 100 points buy a $5 drink, so the reward is worth 5% of spend. A member who spends $200 a month earns 200 points and can claim $10 in rewards. Suppose the program lifts that member from 6 to 8 visits a month at $4 average margin per visit. The extra margin is 2 x $4 = $8, but the reward costs up to $10, so the program loses money on that member unless redemption is below 80% or visits rise further. The numbers are an illustration.

How to model it in Machinations

Use a Source for points issued with each purchase, a Pool for outstanding points, and a Converter that turns points into rewards. Send the reward cost to a Drain and the margin from extra visits to a second Pool for profit. Add a state connection from the points balance to the purchase rate to draw the loop. Make the earn rate and reward value Levers, then Play and chart profit to find where the program stops paying for itself.