Loyalty programs, which give consumers rewards for repeat purchases from particular merchants, are almost as common among retailers as cash registers. McKinsey research found that about half of the ten largest US retailers in each of seven sectors have launched such programs, and the rate is similar among top UK retailers (Exhibit 1). Moreover, loyalty programs are popular with customers: in the United States, 53 percent of grocery customers are enrolled in them, to say nothing of 21 percent of the customers of casual-apparel retailers. Of those who join grocery programs, McKinsey research indicates that 48 percent spend more than they would otherwise, though the figure is only 18 percent in casual-apparel programs. Yet even 18 percent represents a sizable number.

If anything, we expect interest in loyalty programs to intensify. Faced with slowing revenue growth in many categories and the emergence of competing Internet start-ups, retailers are eager to deepen their relationships with existing customers and to increase their share of wallet. Retailers that have stand-alone loyalty programs—in other words, programs without corporate partners—must work out ways of dealing with alliance programs, which bring groups of retailers together to offer rich rewards as well as rebates beyond the...