In my wallet, I have:

-- a punch card from a beauty supply store
-- two airlines' frequent flyer cards
-- a coffee house frequent buyer card
-- a "hosiery club" card
-- a frequent parker card for the airport parking lot
-- three hotel chains' membership reward cards.

Customer loyalty programs have exploded over the last decade, as companies have realized the importance of retaining their customers, not just attracting new ones. But do customer loyalty programs actually work and how can you use such plans in your own business?

In October, 1999, the consulting firm McKinsey and Company conducted a study of consumers in 16 product categories. They discovered loyalty programs often did little to increase sales. In fact, 82% of members of loyalty programs at casual apparel stores and 52% at grocery stores said they would spend no more, or even less, at such stores. "Free Riders" -- customers who enjoy benefits without increasing spending -- may constitute up to 50% of all loyalty program membership.

The key to creating a successful loyalty program is understanding what you're trying to achieve. Some goals for a loyalty program include:

-- Customer retention: Even if customers spend no more than they would have without a program, how much are you willing to do to keep them in your store rather than a competitor's?
-- Maintain spending habits: Perhaps more important than retaining a customer may be inducing them to keep their current level of spending. McKinsey found that significantly more customers change spending habits than actually defect from a vendor. In the case of a bank, for instance, customers who left reduced the bank's deposits by 3% but those who reduced spending cost the bank 24% of its balances.
-- Rewarding customers: As airlines have learned, frequent user programs can often be most effective by giving rewards to their best customers. Feeling appreciated can be a powerful tool for maintaining customer spending and loyalty.
-- Information gathering: One benefit of loyalty programs is finding out what your customers -- individually as well as collectively -- want. Grocery store loyalty programs use this as a way of selectively marketing products based on customers' buying habits.
-- Increasing sales: The hope is that customers will actually spend more if they feel loyal to you.

What kinds of loyalty programs do I recommend?

Buy-ahead discount: My nearby coffee house sells a prepaid card for $20, and I get one free drink at the time of purchase. My neighbor gets a 10% discount when she pre-purchases a series of exercise classes. The benefit is immediately apparent to the customer, and you get money in the bank now.
Free reward after reaching purchase level: The long-term airport parking lot gives me one stay after I stay 35 days; I get one free pair of pantyhose after I buy 16. Besides encouraging me to keep coming back, I carry these cards with me ñ which serves as a constant ad for the business.
Upgrades/special treatment: Giving extras to your loyal customers may cost relatively little but mean a lot. Some examples: an upgrade at a hotel, free dessert at a restaurant, free alterations at a clothing store.
Surprise rewards: Periodically, I receive a coupon for a big discount or $20 or $50 off from companies where we do a lot of business -- office supply stores, copy shops, etc. Itís like getting an unexpected gift from a friend.

What kind of loyalty programs do I find less effective?

Discount after reaching purchase level: Unless these discounts are substantial, these tend to feel more like a promotion for the business rather than a reward.
End-of-year rebates: Waiting 12 months defers gratification way too long. The customers who are likely to be motivated by such programs are those who are most cost sensitive, not necessarily your most profitable.

Regardless of the type of loyalty program, no program can overcome bad service and bad products. A few years ago, I switched airlines even though I had Premier status, because I continually received rude treatment, not to mention they kept canceling flights. Treating every customer like they're platinum helps keep you in the gold.

Copyright Rhonda Abrams, 2002

Rhonda Abrams writes the nation's most widely-read small business column and is the author of The Successful Business Plan: Secrets & Strategies . To receive Rhonda's free business tips newsletter, register at