Effective Loyalty Programs – Keeping Costs Under Control

The third in a series around features of successful loyalty programs that have helped certain companies stand out from the rest, with program offerings that are recognized as best-in-class.

You can download PDF version of this whitepaper here.

Keeping Costs Under Control

The most appreciated loyalty programs from a customer perspective are those that are perceived as generous. Customers desire to be recognized for the value they add to a company, and thus, want their loyalty programs to award them generously.

In certain sectors and their respective loyalty programs, there are minimums that customers expect back as a payout – traditionally 1-2% in supermarkets, 3-5% in telecoms, 10%+ in retail (particularly clothing and restaurants). Paying out less is simply not acceptable for two reasons – one, when your competitors are being generous to their customer base and thus your program is not best-in-class, and two, when your customer base is wary of your tactics and can calculate your stinginess.

So what to do when you can’t convince your Finance Department or executive ranks to be generous? Revise your business model and offerings. Here’s an example of how to make the customer think they are getting 2% back, but in reality, it affects your company’s bottom line by .4%:

Begin with a 2% payout rate. Traditionally, successful loyalty programs have participation rates of 75%, and redemption rates of around 60%. This right away brings the payout to .9% (2%*.75%*.60% = .9%). If you don’t have Execs on board yet, there’s more.

Bring in a partner that offers an attractive redemption alternative from customers to not only improve the overall strength of your program, but to reduce the overall costs. Here’s how a blended offering would work at a grocery store if they brought on board a restaurant chain as a partner.

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With the above rules in place, two additional topics come into play – one, the discount to be obtained from the partner, and two, the cannibalization effect:

1.) Traditionally, such partners are willing to give a 50% discount on the reward in question – our loyalty program engagements dictate this (this depends somewhat on the negotiating power of the grocery store). The above mentioned 10 USD restaurant voucher in essence costs the grocery store only 5 USD, but still makes the customer feel they are getting 2% back.

2.) Cannibalization in this case refers to the concept of whether the 10USD voucher in question is cannibalizing from a normal purchase the customer would have made regardless, and thus, is technically lost revenue. In most cases, the reward does cause significant cannibalization – the customer is a regular shopper and would have given you the 10 USD in question at their next visit but now won’t. Thus, this entire amount can be considered foregone revenue (in some sectors like airlines and banking, this cannibalization occurs to a much lesser degree, especially if the reward is not pure cash but rather lest often used benefits and services).

Taking the .9% ratio and considering half of the restaurant partner redemptions are subsidized, the payout is whittled down to a .67% ratio. There are ways to bring this down even further by modifying internal benefits to ultimately help you achieve a payout ratio of .45%, but the rewards should always be kept relatively attractive – in this case, the internal voucher is a necessity.

Thus, the original 2% payout ratio is stabilized in this case at .67%, one third of the original figure. Added back in would be .1-.2% traditionally to cover launch and ongoing marketing costs around the program. Other one-time costs around systems may also apply.

Most important here is that the customer perception around the generosity of the program is maintained, and management is hopefully persuaded to go forward with a launch.

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