Cost Justifying a Loyalty Program – Part 1

Being in the loyalty marketing business for so many years, we have seen just about every reaction possible from CEO’s and CFO’s when we accompany the CMO to discuss the possibility of developing a program…especially one that includes “rewards”.   Usually, the CEO is open to the idea and the CFO is quite skeptical.  Sometimes the other way around.  Regardless, they always have the same question:  “How much money can we make from this?”  They’ll usually let the CMO run with the development and management of the program, but they want to know that it’s going to work…financially.

The CEO and CFO are looking for specific rationales for investing in a loyalty program.  After all, they are resource-intensive and high profile initiatives.

So, how do you provide the compelling case for a loyalty program and show how it will create an economic return for the business?  The answer depends on the type of business you have.

Here are a couple of examples.  We’ll follow-up with more in subsequent posts.

The Hockey Stick Effect

Some businesses have very high customer acquisition costs and low maintenance costs.  These guys literally live and die on customer retention.  Take the insurance industry for example.  There are considerable costs to establish the relationship, pay commission to an agent, set up the customer, fulfill all the materials for compliance, and much more.  It may take several years of premiums before that customer relationship becomes profitable.    This is a classic “hockey stick” business.  The customer must persist for several years before the relationship breaks even.    While there are opportunities to grow the customer relationship, (e.g. selling them additional insurance products) in Hockey Stick businesses the driver of profitability is customer tenure. There are lots of examples of ‘hockey stick’ businesses:  Insurance, credit cards, cable TV, wireless phones.

In hockey stick businesses, maintaining the customer relationship to the break-even point is likely the driver of the business case for loyalty.  Keeping switching costs high is important.  Rewards programs increase switching costs.  Rewards also provide a currency for maintaining retention in the face of customer service issues.  Dolling out points has overcome many service issues.

Playing Defense

Some businesses are very “top heavy”.  They have relatively few massively high value customers.   Airlines are a classic example.  Top end business travelers who travel every week and buy business class fares can spend close to $100K per year.  Moreover, for every “diamond” customer in a frequent flyer program there are scores of leisure travelers who fly once or twice per year.   These diamond members are truly the 1%; the ‘whales’ among the minnows.

In these businesses, the top 1% of customers may have an annual value of 10x to 20x more than an occasional customer.  Defense is the rationale here.  Even a small defection rate among these whales can make a considerable dent in the bottom line.  Hence, retaining these top customers is a huge driver of the business case for loyalty.  Providing high value rewards, especially increased service levels that have a high perceived value and low incremental cost, will help increase loyalty among elite customers.  Other example “whale businesses” are luxury hotels, casinos, fine dining, cosmetics, and fashion retail.

Here is an example of how to cost-justify a loyalty program for a business that is trying to defend its “whales”.

Situation:

The business is suffering defection among its highest value customers and the loyalty program’s reason for being is retaining these whales.

Use Case/Business Case:

  • Our top decile of 40,000 customers are worth, on average, $12,000 per customer per year in revenue and $4,000 per year in margin. The annual defection rate among these customers is 30%.
  • Defection among the top 10% of customer is costing $144MM per year in revenue and $48MM in margin.
    • (40,000 customers x $12,000 revenue x 30% defection = $144MM lost revenue)
    • (40,000 x $4,000 margin x 30% defection – $48MM annual lost margin)
  • By implementing a loyalty program, we believe we can reduce the defection rate among these top customers from 30% to 25%. Reducing the annual defection among these top customers by 5 percentage points will deliver $24MM annually in incremental revenue and $8MM in incremental margin.
    • (40,000 customers x $12,000 revenue x 5% reduced defection = $24MM incremental revenue)
    • (40,000 x $4,000 margin x 5% reduced defection = $8MM annual lost margin)

For more on this and some tips on how to create the “reason for being” and the business case for developing a loyalty program, please download our white paper, 7 Sure-Fire Ways to Justify a Loyalty Marketing Program.

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