Loyalty card costs Tesco £1bn of profits - but is worth every penny

Marks & Spencer this week became the latest company to turn to the lure of the loyalty card in an attempt to out-trump its retailing rivals. No doubt the high street giant did its homework before launching "&more". But had it waited until next Thursday, the retailer would have had a handy crib in how to make millions from playing the loyalty card game in the form of a new book charting the history of a past loyalty card master: the supermarket Goliath Tesco.

Entitled Scoring Points: How Tesco is Winning Customer Loyalty, the book is written by two external architects of the group's Clubcard scheme, Clive Humby and Terry Hunt, and the business journalist Tim Phillips. It details the advent of a loyalty programme that set the standard for rivals from M&S to J Sainsbury, helping to transform Tesco into the country's number one supermarket retailer.

Sir Terry Leahy, Tesco's chief executive, credits the scheme for much of the group's subsequent success and says without it there would be no Tesco Personal Finance, no Tesco.com and no chance of stealing a march with its non-food ranges. As marketing director in the early Nineties, Sir Terry oversaw Clubcard's birth on 13 February 1995. Not an anniversary that his management team publicly celebrates, but, as the book says, if they did, you wouldn't blame them.

From 1995 to the end of 2002, the company has waved goodbye to £1bn of profits, handing the cash back to its customers via money-off vouchers to thank them for shopping at Tesco. Yet it makes money from the gesture. Although the group is coy about the material pluses of running such an enormous loyalty scheme - 10 million British households are active members - Mr Humby says the scheme has contributed "hundreds of millions of pounds of profit". When you consider the group made £661m profits before tax in the past six months alone, that might not seem like such a large figure given how much it has cost.

But the scheme's ultimate value lies elsewhere. Mr Hunt, chairman of the direct marketing agency EHS Brann, says that in business terms, Clubcard gives customers an extra reason to choose Tesco. "It's membership of a brand that gives customers a stake in the company and a dividend for their custom." The data gained from each transaction - every toothbrush, yoghurt pot and packet of cereal sold - has turned Tesco into a "consumer-centric business", according to Mr Humby, who runs the marketing analyst firm dunnhumby. He adds: "Tesco has became the first organisation to use customer insight to actually run its business well. In the past, people just used customer data to make their marketing more effective."

Put simply, Tesco can second-guess its customers' needs, tailoring its product and service offerings accordingly. Four out of every six Clubcard discount vouchers sent out through its quarterly mail shoots are for goods that shoppers already buy, while the other two are for related items. In non-food, which at Tesco ranges from trendy winter coats to the latest mobile phones, the group knows what new ranges are likely to interest its customers based on their shopping profiles.

Although Tesco has signed up a number of Clubcard partners - as well as an association with the Air Miles scheme, it sells points to H Samuel, Marriott Hotels and Nationwide, which they can then pass on to their customers - ultimately Tesco Clubcard coupons can only be used at Tesco stores. Thus the supermarket group ensures only it enjoys the sales uplift that follows when customers are spending their "free money".

In terms of how much good the scheme does the company's top line, Mr Hunt reckons there has been a 3 per cent step change in like-for-like sales since Clubcard was introduced. This sets the group apart from its arch rival Sainsbury's, the chain that lost the top supermarket slot to Tesco in 1995, which abandoned its own loyalty scheme last year to sign up to the multiple-member rewards club Nectar that also includes Debenhams and BP.

Rob Gierkink, the chief executive of Loyalty Management UK, which runs Nectar, is adamant his approach is superior because with the opportunity of earning points at nine different companies, customers can clock up more points, more quickly. He says that in a year, the average four-person household that belongs to Nectar can bank 18,000 points - enough for three return flights from London to Paris on BMI. That contrasts with families getting between £6 and £15 off their grocery bill every three months for using Tesco Clubcard.

Although the cons of a multiple-member scheme mean that customers are loyal to Nectar rather than the individual retailing brand, Mr Gierkink says the pros include access to vastly more data about shopping habits at a far cheaper cost. "Tesco doesn't have the 360 degree view of its customers that our members have," he says. Using Nectar's direct mailings, which go to 12 million UK households, the likes of Sainsbury's can target people who currently buy their groceries elsewhere, an option not open to Tesco.

The origins of the loyalty card fittingly lie in the British Co-operative movement of the mid-19th century, fittingly because it was a Co-op store in Bury that first set the then Mr Leahy thinking about the potential of a mass reward scheme. That Bury store, which was experimenting with a loyalty scheme based on a plastic card with a magnetic strip on the back, took the old Green Shield Stamp thinking to an entirely new level.

Rather than merely hand customers dividends in the form of money-off vouchers, or stamps they could exchange for consumer goods, the store intended to swap them for information on its customers' shopping habits.

A trial scheme at three Tesco stores - in Sidcup, Wisbech and the Dartford Tunnel - ended so successfully that the then chairman, Lord MacLaurin of Knebworth, told the men in charge of the trial: "What scares me about this, is that you know more about my customers in three months than I know in 30 years."

For all that Tesco vaunts its Clubcard success, other retailers like the US-owned Asda prefer to plough their cash back into lower prices. This "knowledge light" approach can work equally well - Asda's parent company Wal-Mart is the world's biggest retailer. M&S will just have to wait to see whether its new approach can pay off.

Scoring Points: How Tesco is Winning Customer Loyalty by Clive Humby & Terry Hunt with Tim Phillips will be available from 16 October for £25.