Restaurant Loyalty and The Prisoner’s Dilemma

From 1983 to 1994, ready-to-eat cereal manufacturers raised list prices 90%, double the rate of overall inflation.? Why?? Because everyone was doing it!? The president of General Mills said in 1994 that “…the practice of increasing prices and then discounting them with coupons and half-price sales had grown to the point where 60 percent of all cereal purchases in the last 12 months were made with some kind of coupon or discount.”? At that point in 1994, General Mills announced a dramatic cut in list prices, along with an offsetting reduction in trade promotions and coupon distribution.? Other leading manufacturers did not immediately follow suit, but ultimately were forced to do so, as they saw their market share drop when they tried to maintain higher prices.

?This is often discussed in business school classes as an application of The Prisoner’s Dilemma.? From Wikipedia:

The prisoner's dilemma is a game theory thought experiment that involves two rational agents, each of whom can cooperate for mutual benefit or betray their partner ("defect") for individual reward…In casual usage, the label "prisoner's dilemma" may be applied to any situation in which two entities could gain important benefits from cooperating or suffer from failing to do so, but find it difficult or expensive to coordinate their activities.

So for cereal manufactures, cooperation was as simple as following suit in raising prices when one of their competitors did so.? They all did it, so essentially were operating for mutual benefit.? And the defection occurred when General Mills unilaterally cut prices, allowing them to gain market share (their individual reward) until the point at which their competitors were forced to again “cooperate” by cutting prices as well.

Why is this relevant to restaurant loyalty today?

Let’s go back in time almost 20 years, to 2007. Something on the order of 25 out of the top 150 restaurant chains offered some form of loyalty or rewards program, which at that point were still more the province of airlines and some retail chains.? By 2012, the National Restaurant Association reported (https://www.mdgsolutions.com/learn-about-multi-location-marketing/restaurants-optimize-rewards-programs-to-gain-customer-data-and-boost-loyalty/) that 30% of restaurants offered some form of loyalty program. At those penetration levels, loyalty was definitely a differentiator, and driver of incremental visits, which is why they were increasingly being adopted.

Fast forward to today. An examination of NRN’s most recent Top 500 chains report (https://www.nrn.com/data-research/top-500-restaurants) reveals that over 65% offer a loyalty program. In some sub-categories, like Bakery/Café, it is well over 80%.?

Do those with loyalty programs outperform those without?? A top-line review suggests they do not: among the Top 500 chains in the most recent NRN report, the average year-over-year sales per unit change was +9.4%; those with a loyalty program had a change of +8.5%, while those without a loyalty program saw a +10.2% change.? (Results were fairly tightly clustered, even excluding outliers.)? Obviously there are a number of factors at play impacting performance so you can’t draw conclusions from this simplistic observation, but you would expect to at least see evidence of a positive impact to support the existence of such programs.

That raises an interesting question: if everyone in your category offers a similar program, what is the benefit to each individual brand? Because such a program is no longer a differentiator (interestingly, 75% of programs use the term “rewards” in the program name), it has simply become table stakes, or a cost of competing in the category.? And of course, the benefit of loyalty as a data harvesting mechanism is only realized if you are able to leverage that data to drive incremental spend, which is harder to do when everyone has the same communications channels and ability to deliver personalized offers… We’re almost back to the years prior to 2007, when there was a different type of parity.

Now, back to the Prisoner’s Dilemma and how it applies to loyalty programs. If you’re uncertain if your restaurant’s loyalty program is delivering incremental sales and profits compared to not having a program, you’re not alone, and you’ve got a stark choice. ?Stay with the program – meaning you are essentially “cooperating” with competitors to keep prices higher and offer offsetting discounts, as with the cereal manufacturers of the 90s, or make a unilateral decision to sunset your program, akin to defection in the Prisoner’s Dilemma, acting for individual reward. Of course, unlike in the chart shown above, your reward is uncertain: you will certainly realize the benefit of removing the cost of running the program and offering associated discounts, but the impact on sales will take time to determine.

If you’re wondering about the value of your program, what should you do?? As always, it depends.?

What is your category position and relationship with your consumers

• Leading brands with strong consumer relationships will have more latitude to make a change. ?We’re already seeing that with brands like Starbucks, Domino’s, Panera and others moving from spend-based to visit-based rewards, effectively cutting the cost of their programs. They won’t always feel the need to cooperate and will continue to step down the value of rewards over time, essentially “defecting” without being susceptible to competitive moves.
• Similarly, brands that have less market power and a weaker bond with consumers are more likely to consider a change or even dropping the program if they don’t feel they can sustain the cost of the program given the level of incremental revenue it drives.? For example, a chain with negative year-over-year sales per unit with a program giving back $5 for every $75 spent will have to answer the question: does the loyalty program drive enough incremental revenue to offset the programs’s potential cost of 6% of sales combined with declining business results?
• If a rewards program is a cost of entry in your category, which seems to be the position for most in the middle, you do face the Prisoner’s Dilemma and will have to be creative about how to achieve some level of differentiation.? You might consider, for example, temporarily upping the giveback to only your best customers to truly separate from competitors, in essence creating a type of tiered program.?

How well do you understand the metrics around your program?? How recently have you conducted a program review?

• If you don’t have a robust measurement and analytics structure in place, start with an honest assessment of the impact and value of the program – requiring rigorous analysis and an objective viewpoint.? If the value of the program is unclear, utilize consumer research paired with more sophisticated analytics, including forecasting and sensitivity models, to assess potential paths forward.? At minimum make this a periodic exercise, to ensure you’re getting ahead of market conditions and competitive changes.
• If you do have meaningful measurement and analytics in place already, you are in a better position to continually evaluate the impact of the program, and to recommend ongoing recalibrations.

In any event, don’t just stick with an existing program because of inertia, because it’s always been there, or because you don’t have solid analysis available. Do the hard work, understand if the program is truly delivering incremental benefits and competitive advantage, and break free of the Prisoner’s Dilemma.