lululemon athletica (NASDAQ:LULU) began testing a loyalty program last year that could significantly pad the company's revenue growth. Management is slowly introducing it one city at a time, making tweaks along the way to find the right balance between price and reward.

The company started testing in Edmonton, where for a fee of more than $100, customers received several benefits, including products made exclusively for the program. Customers also have access to sweat classes and other curated events, in addition to personal development and free expedited shipping for online orders.

A group of women practicing yoga during a class.


Management first disclosed the program in the third quarter of 2018, and in subsequent quarters, leaders have had nothing but positive things to say about the customer response. Most importantly, customers have felt they are getting value out of the program, and because of this, management believes there is the potential to raise the price from when testing started.

We'll look at the potential upside for the company -- and at the pitfalls that cause most loyalty programs to fail.

An overlooked growth catalyst

Since starting in Edmonton, lululemon has extended the loyalty program to Denver and Austin. As it expands to new markets, management is learning what works and what doesn't and adjusting accordingly. The slow and methodical approach makes me convinced the new program will be successful.

During the most recent conference call, CEO Calvin McDonald said, "In each market the results have been well above our expectations going in very favorable from the guest and we continue to tweak and learn and do plan to roll into more markets and we'll have more to announce at a later point in time."

One analyst with Stifel is very optimistic about the potential financial impact. The analyst expects the program will be successful in doing what it's designed to do, which is drive higher incremental spending from Lululemon's most loyal customers. The analyst believes the program could add at least $0.50 per share to earnings once the company begins to roll it out more broadly.

The analyst's more optimistic scenario has the loyalty program adding more than $1.00 per share to the bottom line over time. Currently, the consensus analyst estimate calls for adjusted earnings per share to be $4.64 this year and $5.51 in fiscal 2021 (the company's fiscal year runs through January each year). There is clearly significant upside to profits that most investors might not be factoring into their expectations right now.

What makes a successful loyalty program?

The early progress updates from management are very encouraging, especially because loyalty programs have a high failure rate for most companies. One study has found that roughly half of customers who participate in one eventually opt out. There are several reasons customers might withdraw, but the top reason is usually that they don't feel they are receiving enough value in return for the cost.

On that score, it's a good sign that Lululemon has been able to raise the price of the program during testing due to the engagement and response from those who have tried it out.

Loyalty programs at apparel companies have some of the lowest customer satisfaction rates. The industries that rank high in retention are grocery, credit cards, dining, and gas, which makes sense, because those products are things that people buy frequently. If you're going to buy groceries and gas on a weekly basis, you might as well sign up for a reward program to get something back in return.

It might seem that Lululemon's loyalty program would struggle to have the same success as one like Starbucks' program. But the activewear specialist has a few things going for it.

Lululemon is known to have one of the most loyal bases of customers in the industry. Brand loyalty has been one of the key factors that leads to higher success rates with reward programs. It's also good that Lululemon's brand stands for something (e.g., a healthy, active lifestyle) that serves as positive reinforcement for how its customers feel toward the product. When customers feel positive toward a company's brand, it can lead to repeat purchases.

What is this really all about?

In the long run, Lululemon is trying to make it more cost effective to gain new customers. The athletic apparel industry is booming, and along with rising demand comes greater competition among the athletic-wear brands to gain a loyal customer base.

By offering rewards to buy its product, Lululemon can increase its profit through higher incremental purchases from existing customers while spending less on marketing to win new customers. The extra profit can go toward innovation and building the stores of the future, which, in turn, should entice more people to shop the brand.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.