Study: Freebie offers often a sign that companies about to go under

May 9, 2007

GAINESVILLE, Fla. — There is no free lunch in company giveaways of sandwiches, airline flights, hotel stays and other goodies. That’s because there is a significant risk that the so-called “future rewards” will diminish in value when claimed — or the business might not last long enough to hand out the goodies, a new study finds.

There is a strong correlation between firms offering these rewards and a decline in their number of employees, said , a UF professor who did a historical analysis of giveaway programs and an empirical analysis of the firms that offer them. He also found these companies devaluate their supposedly free giveaways by charging transaction fees, limiting the availability of these giveaways and imposing other restrictions.

The promises of giveaways are often just a quick means to raise immediate cash while incurring substantial future obligations in exchange for immediate patronage, he said.

“We found that companies most likely to promise these future rewards are the ones that are cutting their employees,” said Shugan, who analyzed consumer surveys of various reward programs, as well as sales, assets, number of employees and other characteristics of companies that offered them. “Our theory is that such reward programs are often used to compensate for the loss in service caused by fewer employees and to minimize customer defections as competitive offerings become more desirable.”

Many of these so-called reward or loyalty programs are really “shams,” said Shugan, who presented his research, which focused on the travel industry, at numerous conferences and universities, including the INFORMS Marketing Science Conference in June 2006. Instead of building customer loyalty the traditional way by beefing up staff and increasing service, companies provide a lower-quality product in the form of reduced service, hoping to avoid sales losses by promising customers future rewards, he said.

When these firms offer consumers free future sandwiches in return for 10 previous purchases or a free future night’s stay at a hotel for having already spent a certain amount of money at the hotel, businesses create liabilities rather than assets in the form of loyal customers, he said.

Quality discounts can certainly be profitable and a quantity discount program can provide direct discounts to high-volume, price-sensitive buyers, Shugan said. However, when firms inadvertently create substantial future liabilities in the attempt at creating customer loyalty, firms will have the incentive to renege on those future liabilities, he said.

“The airline, the hotel or the sandwich shop owe the customer, incurring a cost that can result in large liabilities in the future,” he said. “A review of United Airlines’ liabilities when it went bankrupt a few years ago showed that its frequent flyer liabilities were huge. They owed lots of free flights to people.”

By failing to follow through on their commitments, companies appear deceptive and untrustworthy, and their brand name is worth less, exactly the opposite of what a true loyalty program aims to achieve, Shugan said. The practice, until recently, also has misled investors with balance sheets that fail to reflect the hidden expenses bringing about huge sales increases, he said.

There are better ways to build customer loyalty, Shugan said, such as a restaurant giving regular customers special tables or tailoring menu items to their preferences. Firms can do things such as customize their offerings, teach consumers to get more from their products and increase switching costs, he said.

The Internet may put a premature end to some of these loyalty programs because of the availability of Web sites devoted to third-party reviews, particularly for offers in the airline and hotel industries, Shugan said. People can read about other people’s experiences with various companies and whether they actually honor their promises of future rewards, he said.

But such criticism should not be taken entirely at face value either, Shugan warns. “Often something bad said about a company might be a competitor disguised as a customer,” he said. “Or it could be from ex-employees who are unhappy about the company because they got fired or didn’t receive a raise when they thought they deserved one.”