When it comes to free loyalty programs, financial institutions are suffering from revenue model challenges and low uptake, though it's a problem that can be fixed.

Companies such as Buzzpoints, MasterCard's TruAccess, Mogl, Edo, and StrategyCorp's BaZing offer forms of free loyalty programs, which are designed to drive transactions with merchants, and benefit issuers through higher interchange revenue.  It sounds logical, but that's not what really happens.

Consumer adoption of these free programs is very low. In fact, adoption rates rarely get above 5%.  However, even though uptake is so low, the platforms and merchants still make money, but most issuing financial institutions do not. How can that be?

It makes sense that the merchants make money. If 5% more people come into their stores and buy their goods at a small discount, the merchants are pleased, and they profit. The “free” program providers make money because they get paid by the merchants, typically a small commission on each sale and/or an upfront “pay to play” fee.

If the provider distributes these discounts through hundreds or thousands of financial institutions, then the total population of users is large enough that the provider makes money. But each individual financial institution gets left in the cold.

For example, if a provider distributes deals through 100 financial institutions with 5 million total users, they might get 2% adoption, or 100,000 registered users. That’s great for them because it means 100,000 people are using the program. But for an individual financial institution, if 2% of its 50,000 clients use the program, the end result is only 1,000 users, and that small number of users doesn’t do much to boost interchange revenue or wallet share.

There are four reasons for low adoption:

Some of these loyalty programs require users to register their cards in advance. That's a huge hurdle that results in very low adoption. Not only are you asking users to stop what they're doing and pull out their cards to register them, you're also asking them to enter their card numbers into unknown and untrusted third-party platforms. Consumers don't like giving their card numbers away. So don't make them do it.

Many loyalty programs require users to "activate" their discounts before they can use them. This means that users have to go into their online banking accounts and click the deals that they want to use before they actually use them. Isn’t that behavior the opposite from the usual consumer shopping habit? How many of your users will start their online or offline shopping by visiting their checking or savings account? You guessed it: few, if any. Don't expect your users to “change their behavior” in order to use your discounts. This is a recipe for failure.

There is nothing to remind users of their discounts. Most consumers do not keep track of all of their possible discounts at merchants around town (or online). They participate in so many loyalty and rewards programs already, so it’s too overwhelming to remember to take advantage of all of those possible deals.

A “free” program typically doesn’t get the financial institution's marketing weight behind it that a strong loyalty and rewards platform needs. "Free" often carries odd psychological baggage that makes people think that it doesn’t require effort to make it successful, and there is nothing to lose if the program doesn't work. So when an financial institution decides to use a free program (as opposed to a fee-based program), very often there is scant attention paid to it and it withers on the vine.

There is an alternative. Banks and credit unions should look for loyalty programs that are easy for users, encourage card usage, drive local business, and actually save money for their clients. 

Here’s what to expect with loyalty programs that work with and for an issuer: a beneficial loyalty program comes with modest set up and monthly fees based on the financial institution's number of clients; providers of these programs will establish and manage relationships with merchants in your backyard. Some of these merchants could likely be your financial institution's own business clients. The program provider works with the financial institution to develop a strategic marketing plan, and create marketing collateral and tools (like landing pages, videos, emails), and execute the plan if the financial institution needs assistance.

Users will benefit from the program when they can easily take advantage of the deals (and the financial institution will benefit as a result). Look for a program that doesn’t make users keep track of their discounts, register their cards, or activate any deals.

Andrew Bank is Co-Founder of Larky, a mobile loyalty program.