The Economics of Loyalty Marketing

By Roger L. Brooks

Simply referred to as ROI, these three little letters are not always so simple to understand, yet they play a ma­jor role in any crucial business decision. Return on investment is often the topic of discussion, an essential exercise and the moment of truth that every business faces when vetting the viability of a new initiative — especially a loyalty program.

So why is measuring ROI such a chal­lenge? Why is it so complex? Why isn’t there a mathematical formula to plug-and-play when analyzing the econom­ics of loyalty in the convenience space? Hold tight. This mystery may be closer to a solution than you’d think.

To understand the ROI of loyalty pro­grams, you must ï¬?rst understand the fun­damental principles of loyalty. Loyalty programs are not a quick-ï¬?x solution for increasing customer spend and gaining market share. Loyalty programs do not come with a leprechaun that offers loyalty consulting services pro bono. Initiating loy­alty within any organization requires three behavioral adjustments: a change in mind-set, total company buy-in and a transforma­tion of your existing marketing strategy.

In essence, loyalty programs reward proï¬?table-purchasing behavior. They are sophisticated tools to identify customers, track spending, motivate behavior and re­ward performance. Loyalty programs re­quire company-wide acceptance, and are not always easy to implement or maintain. Loyalty programs require the dedication, determination and desire to better under­stand and service your customers. Since your loyalty program acts as a microcosm of each customer segment you service — which can be measured precisely within your overall loyalty scheme — loyalty be­comes your new marketing strategy.

Taking the time to learn the basics of loyalty can be complex and sometimes overwhelming. So why should you go through the drama and hard work to plan for — or even start to think about — a loyalty program? The short answer is this: The results can be staggering.

There is a reason CVS, Kroger, Barnes & Noble, JetBlue, Marriott, American Express, Dick’s Sporting Goods, T.G.I. Friday’s, Best Buy and countless others have loyalty programs. These leading brands have established their proprie­tary loyalty program as a means to reward their customers and remain competitive. A few operators in the convenience space have found success with loyalty, but com­pared to other retail channels, conve­nience lags behind.

Overcome the Resistors
Every organization must overcome a few similar objections to loyalty programs:

  • Loyalty programs are complicated. (The program will be as complicated and as hard to implement as you make it.)
  • Loyalty programs are too expensive. (The key is to investigate and deliver a loyalty program that best ï¬?ts your business objectives.)
  • Loyalty programs are hard to imple­ment. (An internal champion should oversee every aspect of your loyalty program to smooth the way.)
  • Loyalty programs require additional resources. (Preparing your employees for a change in mindset to embrace loyalty will limit the need for addi­tional resources.)

Additionally, there are common chal­lenges speciï¬?c to operating loyalty pro­grams in the convenience space, and many moving pieces to consider — elec­tronic pumps, point-of-sale systems, back-ofï¬?ce inventory software, scan­ning and payment networks to name a few. In spite of these challenges, how­ever, companies such as Flash Foods, Speedway SuperAmerica, Mirabito Fuel Group, TETCO, Certiï¬?ed Oil and others have triumphed. Each has found suc­cess with their own version of loyalty.

The Secret Formula
One industry pioneer driving the growth of loyalty programs is Patrick Lewis. Lewis and his partners operate a chain of convenience stores (Oasis Stop ‘N Go in Idaho), but he’s also the CEO of Kick-Back Points Rewards Systems, which he initially created for his own stores. (Lewis is also a NACS board member and the vice chairman for PCATS.)

Lewis presented a simulated case study at NACStech this year during the "The Economics of Loyalty Marketing — Can You Afford It?" workshop and shared his formula and model, which he has de­veloped over the years, to project ROI.

When asked why he decided to share it with the industry, Lewis responded, "Because now’s the time." The case study itself is too lengthy to print; how­ever, Lewis provided a detailed over­view of the hard costs, ongoing expenses and ROI associated with operating a typical loyalty program at a single loca­tion. The study assumed the operator ran a points program and all rewards were redeemed within the location. Lewis’ ï¬?nancial assumptions came from the NACS State of the Industry Report (powered by CSX).

Lewis’ rewards projections were conservative industry averages used to calculate the following:

  • Member participation: 40 percent
  • Rewards percent back to customers: 1.5 percent
  • Rewards redeemed: 85 percent
  • Monthly hidden costs: $370
  • Monthly support costs: $325
  • Program investment: 0.5 percent of to­tal sales, or $2,063.20/month

The ROI formula took into account four areas:

  1. Decrease in defection: 5 percent
  2. Increase in ticket average: 3 percent
  3. Increase in frequency: 5 percent
  4. Increase in margins: 0.5 percent

The results projected an improvement in overall average customer loyalty of 4.3 percent, and the calculated ROI was an astounding 335.09 percent! Of course, the economics of loyalty take into account many variables.

From the technology provider to the loyalty promotions, each can have an effect on ROI. Lewis’ model may work within the product he has developed, but it may not work exactly as outlined if certain mar­keting objectives were modified.

Loyalty = Marketing
With a loyalty program in place, ROI be­comes more measurable than your cur­rent strategy. You’ll be able to provide measurable answers to the following questions:

  • What ROI did you receive on your new POS system?
  • What ROI did you receive on the upgrade of your ISP?
  • What ROI did you receive on the billboard ad?
  • What ROI did you receive on the new automatic doors?
  • What ROI did you receive on new branding?
  • What ROI did you receive since you replaced the rotary telephones?
  • Most importantly, what ROI did you receive last year utilizing your existing marketing budget?

Measuring ROI outside your loyalty ini­tiative is not always easy however. Rou­tine upgrades and enhancements need to be made on a recurring basis. It’s a simple fact of doing business.

Think about the credit card reader at your pumps. What if you didn’t make the investment to install new pumps with credit card readers? If your antique pumps were still in place, what would your ROI be on the number of gallons pumped?

Loyalty programs are no different. You take basic marketing principles and apply them to a program that exists in an electronic card. That card be­comes the focal point of your program and serves as a miniature billboard in the wallets of your customers every day. In addition, loyalty programs take marketing and customer segmentation to new levels — like taking your coffee club punch card and putting it on a high dose of steroids.

Ideas for Improvement
To further improve ROI on a loyalty pro­gram, consider repurposing your exist­ing marketing budget, and discontinue absolute discounts to the general public. Discounts are only for customers who carry your rewards card. All others, in­cluding transient customers, would and should pay full price. In addition, in­clude participation from your vendors and suppliers as part of your plan.

Josh Petty of TETCO shared his com­pany’s vision on the ingredients for a successful loyalty program. Petty co-presented with Lewis at NACStech and covered the development of loyalty partnerships.

TETCO realized that, if done right, suppliers can help retailers offset a por­tion of loyalty program costs and obtain valuable data that allows them to reach customers who may have never pur­chased their product. With the loyalty card identifier and customer transac­tion history, suppliers can work with re­tailers to target various customer segments. Loyalty promotions can be established to communicate and moti­vate customer behavior based on trends or cross-product endorsement.

Petty stressed the importance mea­suring ROI with reporting. TETCO ana­lyzes data based on what products are purchased most frequently on select days and times. They also analyze demo­graphics based on geographic location, age and gender. This data is compared to basket content in order to set up targeted promotions to segmented customer groups, which stimulates customer spend efficiently and profitably.

As a rule of thumb, loyalty programs yield a return of 1 to 3 percent to the cus­tomer in the form of rewards. This per­centage can fluctuate by industry, but it is the norm. It’s what you do with the 1 to 3 percent that will set you apart. Rewards range from cents-off-per-gallon to in­stant discounts or even the accumula­tion of a point currency that can be redeemed at a later date. The success of the program requires innovative think­ing and next-generation marketing prac­tices, including potential partnerships with vendors and non-competing mer­chants. Forge a partnership with a local grocery store, tire chain or dry cleaner. Leveraging traffic from your coalition partners will pay dividends.

The best retailers use loyalty programs as a strategic tool in conjunction with ex­cellent customer service, innovative ideas and providing the best possible product or service to your loyal customers. Measur­ing the ROI of your program will be based on the key decisions you make in the de­sign of your unique program.

As you’ve learned, these three little let­ters are not always simple to understand, yet ROI remains an essential element in deciding to implement and sustain a suc­cessful loyalty program.

Roger L.Brooks is the vice president of loyalty marketing for ValueCentric Marketing Group, Inc. He can be reached at (607) 584-5109.