Free or Fee: When can a Loyalty Program Charge for Membership?

Nov 6, 2015

Many marketers dream of turning their loyalty program into a profit center, especially when Finance is grumbling about Marketing being a cost center. In that context, fee revenue becomes very tempting and appears very feasible given the runaway success of Amazon Prime. There is often a knee-jerk reaction that charging a fee will not be a cultural fit with the brand image, but that can be finessed with enough creativity.

The truth is that charging a fee is always an option as long as the value proposition makes good sense to the customer.

The benefits are usually very easy to list: offsetting start-up costs and making short-term financials look positive very quickly after launch. It’s ancient loyalty program history now, but Hertz was able to fund the special canopies and announcement boards for their Hertz #1 Club Gold customers because the program initially charged a fee.

There’s also the “burning a hole in my pocket” effect – if a customer pays a fee, they will feel they need to come back to make sure they get their money’s worth.

The primary elements for success for charging a membership fee are:

  1. Your brand is dominant in your category – a market position as dominant as Amazon has for their Amazon Prime program is essential to consider
  2. Perception of immediate gratification – e.g. Member immediately receives coupons worth at least the value of the fee
  3. Perception that recouping the fee is achievable – e.g., member feels they will have free shipping on enough orders within the year to cover the fee

Then there are the risks to charging a fee – they should be assessed early and often in your process:

  • What is your Competition charging? If your competition’s program offers free membership, you have to have a much stronger value proposition. It also helps to be the stronger brand in the market. Barnes & Noble is one of the few programs that charged a $25 fee when their competitor Borders was offering free membership. However, that exception proves the rule – the stronger overall brand survived…or at least survived longer during a period of change and consolidation.
  • How many customers do you need in order to pay for your program? There’s no question that a fee limits the program’s reach. Several companies have seen their enrollment rates cut in half when they tested a fee against a free program. Be sure to run sensitivity analysis starting at 25% to 50% lower enrollments than the typical no-fee program. For some companies, limiting the size of the membership and liability initially appears attractive, but be sure your model covers the full customer lifecycle for several years out. Charging a fee may cover start up costs, but may not be able to offset on-going infrastructure costs if your program can’t reach critical mass.
  • Do your customers have a reason to renew? Charging an annual fee creates steep membership drop off at the time of the annual renewal. There was one major retailer who successfully charged a $25 fee in the first year of their program, but even though they tried reduced fees for renewing members, the attrition was so steep that the fee was soon abandoned. It’s trite but true that members will continue to pay the fee every year when they perceive they get their money’s worth every year.
  • Are you charging a fee for the right reasons? Charging a fee is often considered for products that are sold through third parties as well as directly. The rationale is that channel partners will be appeased if there’s a fee associated with buying directly from you. However, in many cases buying directly is already less convenient than buying from a third party; so the fee simply makes the direct purchase even less attractive.
  • Do you have a sub-set of profitable customers who will respond to a stretch goal? Most fees are set to encourage profitable behaviors such as setting up a profile for quicker service, booking in advance, buying through a digital channel, buying more each order, or placing more orders. This can be overdone quickly and turn into volume discounting for sales you would have had anyway.
  • Is there a WOW benefit you could offer if you could charge a fee? An eye-popping value proposition is a clear way to truly differentiate yourself from a competitor. However, a truly extraordinary benefit to the customer, such as a free bottle of wine for a restaurant program, is usually expensive for a company to deliver. Charging a fee allows you to split the cost with the member especially if you can offer something that has a very high perceived value to the consumer and a lower cost to you.

There are two primary risk mitigation strategies:

  • Two-tiered program: In a two-tiered program, some features are available to all consumers who sign up, but elite or unique benefits require a fee. Two tier programs are most often used by online content environments or some retailers where the high value customer is dramatically different from the average customer. These companies get the benefit of enrolling a broad cross section of their customer base and then protecting their higher-level payout or higher cost benefits by charging a fee.
  • Charge and Waive: Another way to finesse the risk is to build in a “charge and waive” strategy. Hertz #1 Club Gold initially charged a $50 membership fee to offset the cost of the program infrastructure needed. Even in the early days of the program, the fee was waived for customers Hertz considered most valuable as influencers of corporate travel. Today Hertz says, “Membership is always fee-waived,” but they still use the fee concept to establish a perceived value for the benefits.

The bottom line is that charging a fee can be a good way to turn your program into a profit center but only if you ensure the customer perceives they will get a better value for paying that fee. In any case, be sure to run the financial scenarios to understand the full impact of having a smaller program. There’s a steep price for being too greedy and charging the wrong fee.