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`Sports Loyalty International
`The Economics Behind Customer Loyalty: Using Coalition Program Assets to
`Turbo-Charge Results
`White Papers
`
`Coalition Loyalty: A Model with Sustainable Advantages for Retailers
`The Economics Behind Customer Loyalty: Using Coalition Program Assets to Turbo-Charge Results
`The High Cost of “Ghost” Points: Will the short-term gains from high breakage gas discount and other “loyalty” programs yield
`long-term pain?
`Is the U.S. the Afghanistan of Coalition Loyalty? Overcoming the challenges of the U.S. market
`The 6 A’s of Coalition Loyalty Success & the Virtuous Cycle of Profitability
`
`Summary:
`
`Part 1 – The Economic Benefits of Customer Loyalty
`
`Loyal customers can be several times more profitable for consumer businesses, driven by the five economic benefits of
`increasing customer loyalty:
`
`1. Reduced defections
`2. Increased spending per customer
`3. Lower cost to serve
`4. Increased purchases of higher margin products/services
`5. More customer referrals.
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`Part 2 – Loyalty Program ROI Economics 101
`
`Well-designed loyalty programs can help drive each of the five economic benefits of customer loyalty, while also driving a sixth
`benefit:
`
` 6. More efficient acquisition of highly profitable new customers (outside of referrals).
`
` The overall financial impact of a loyalty program can be evaluated based on several key customer behavior metrics,
`including:
`
`Retention – the incremental percent of current customers who are program members that remain loyal.
`Lift – the incremental increase in spending by current customers who are program members.
`Shift – the incremental spending from competitors’ customers who are program members and start shopping at your
`business.
`
`Using the “loyalty math” behind retention, lift, and shift, executives can quantitatively evaluate the economic value from
`implementing a loyalty program and answer the critical questions revolving around “What do I need to believe?” in terms of
`customer behavior change in order for a program to drive an attractive ROI.
`
`A well designed loyalty program can be profitable, but only if the incremental value exceeds the program cost, and will only be
`sustainable if it offers a truly unique consumer value proposition.
`
`Part 3 - The Superior Economics of a Coalition Program
`
`A coalition loyalty program maximizes opportunities to generate and reward loyalty and optimizes the ROI to sponsoring
`companies because:
`
`1. A coalition program will accelerate the consumers’ time to earn a reward and therefore drive much greater behavior
`change than a standalone loyalty program.
`2. A coalition loyalty program will almost always be lower cost to operate than a single company program and will
`therefore typically generate a meaningfully higher ROI.
`3. A properly designed and managed coalition loyalty program will always generate better data for results analysis and
`opportunity targeting, enabling participating sponsors to identify high potential customer households who currently only
`shop at competitors.
`Part 1 – The Economic Benefits of Customer Loyalty
`
`Why is Customer Loyalty So Important?
`
`Customer loyalty has become an increasingly important focus area for creating sustainable stakeholder value. Harvard Business Review
`editor Theodore Levitt wrote 30 years ago, the “purpose of business is to create and keep customers”[i]. There is ample evidence that
`not all customers are equal – loyal customers are far more profitable. Frederick Reichheld’s pioneering work at Bain & Company in the
`1980′s demonstrated the powerful economic benefits of increasing customer retention across multiple industries, product and service
`companies. Concentrating management’s attention on attracting and maintaining loyal customers is crucial for businesses to succeed in
`today’s competitive world.
`
`Even small changes in customer retention rates and spending levels of loyal customers can have a very big impact on companies’ bottom
`lines. Also, transforming customers into staunch “promoters” or “raving fans” of your business – referring others to become loyal
`customers too – can turbo-charge profitability as well.
`
`So how does one measure and quantify the benefits of customer loyalty?
`
`Basic Customer Loyalty Math
`
`The following framework for measuring the benefits of customer loyalty was originally developed by W. Earl Sasser Jr. and Frederick
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`Reichheld in a 1990 Harvard Business Review article[ii]. Earl Sasser is a renowned Harvard Business School professor and Frederick
`Reichheld, head of Bain & Company’s Customer Loyalty Practice, went on to publish several books on loyalty including The Loyalty
`Effect: The Hidden Force Behind Growth, Profits, and Lasting Value (1996) and The Ultimate Question 2.0: How Net
`Promoters Thrive in a Customer-Driven World (2011).
`
`The primary economic benefits to a business of increasing customer loyalty include:
`
`1. Reduced defections to maintain base profits
`
`2. Increased profits as loyal customers spend more over time
`
`3. Increased profits as loyal customers cost less to serve
`
`4. Increased profits as loyal customers purchase higher margin products
`
`5. Increased profits as loyal customers refer others to the business they love
`
`Using this framework, we can quantify the economic value of a loyal customer. The following chart shows the potential value of a loyal
`supermarket customer over a five year period.
`
`In this section, we will walk through simple examples of each driver of the incremental economic benefits of increasing customer loyalty
`to a consumer business – in this case, a supermarket company “Super Foods.” We will show the economic impact to Super Foods of
`turning an illustrative customer, who we’ll call “Connie”, into a loyal customer.
`
`For purposes of the illustrative analyses below, we’ll assume that Connie is a fairly typical Super Foods customer who shops there
`weekly and spends $80 of her $120 total weekly grocery budget at Super Foods. (Her remaining $40 of weekly grocery spend is split
`between big box stores such as Walmart and Costco). We’ll also assume that Super Foods has a gross margin of 20%. So assuming
`$80 per week x 20% gross margin x 50 weeks per year, Connie is contributing $800 in annual gross margin to Super Foods.
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`We’ll also assume that, in acquiring Connie as a new customer of Super Foods, the company spent approximately $200 in marketing
`costs (direct mail, mass media, etc.) to entice her to begin shopping there.
`
`Historical research by various sources has shown that 20-50% of customers switch grocery stores each year[iii]. A recent Consumer
`Reports study in 2012 found that 33% of 24,203 surveyed shoppers had switched grocery stores in the past year[iv]. For the purposes
`of this analysis, we’ll assume that Connie will defect to another store after 3 years.
`
`Thus, the overall economic value of Connie to Super Foods over five years would be $2,200 ($800 x 3 years – $200 acquisition costs
`= $2,200), and her individual yearly contribution to the company’s bottom line would look like the chart below. (Note: For simplicity,
`we are not applying a discount factor to arrive at a customer NPV.)
`
`Here’s how Connie’s economic value to Super Foods would increase over the same five year period if she becomes a loyal customer:
`
`1) Reduced defections to maintain base profits
`
`If Super Foods were able to keep Connie as a customer over the full five years, and maintain her current spending of $80 per week, the
`company would generate another $1,600 in economic value from Connie ($800 annual gross margin x 2 incremental years).
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`The Economics Behind Customer Loyalty: Using Coalition Program Assets to Turbo-Charge Results | Sports Loyalty International, Inc.
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`2) Increased profits as loyal customers spend more over time
`
`If Connie were to increase her spending at Super Foods from $80 per week in year 1, to $100 in year 2 to $110 in year 3 and remain
`at that level of spending through year 5, the total contribution to Super Foods’ gross margin from Connie’s increased shopping
`would be $1,100 over the 5 years ($200 in year 2, and $300 in each of years 3-5).
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`It should be noted that increasing Connie’s spending at Super Foods from $80 per week to $110 per week by year 3 does not
`necessarily mean that she is spending more on groceries (or her family is eating more food!) each week. Remember, we assumed
`Connie was spending a total of $120 per week on groceries, and more than likely, she would be shifting only some of the $40 per week
`she was either spending at the big box stores or the occasional “convenience shop” at other local stores near Super Foods.
`
`SLI’s primary U.S. market research confirms that most consumers spread their grocery shopping over several retailers. According to
`SLI’s quantitative research of over 10,000 U.S. grocery shoppers, less than 10% of shoppers are spending 100% of their grocery
`budget at one retailer[v]. We found a significant opportunity in every market we’ve researched for grocers to incentivize current
`customers to consolidate spending at their store and effectively take share from competitors.
`
`3) Increased profits as loyal customers cost less to serve
`
`Let’s assume that Connie is like most customers who shop frequently at a grocery store – she takes less time to shop and check-out as
`she has become very familiar with the store. She also continues to look for ways to shop as efficiently as possible, to minimize the time it
`takes to complete her grocery store visits.
`
`In year 2, Connie discovers Super Foods’ well-designed shopping app and downloads it to her smartphone for free. The app is able to
`send her targeted offers while she is in the store, and allows her to pay with a prepaid card and scan and bag her items as she shops.
`Checkout is simple as she completes her order by scanning her smartphone as she walks out the door.
`
`Let’s assume that this shopping app and payment device reduces the transaction cost that Super Foods incurs each time Connie pays
`for groceries from 2% of sales (typical of credit card purchase s) to 1% of sales for Connie’s prepaid card linked to the store’s shopper
`app. This would lower Super Food’s cost of servicing Connie as a customer, representing an annual cost reduction of $55 per year by
`year 5, and $215 total cost savings for Super Foods through year 5. (Note: these figures are illustrative – transaction processing costs
`can vary for credit cards, mobile payments and prepaid cards.)
`
`In addition, as more and more customers learn how to efficiently shop using the mobile app, and effectively bag their own items and self-
`checkout like Connie, fewer in-store workers would be required to service Super Foods customers. Using conservative estimates, using
`the mobile payment and self-checkout app would save $15 per year per active customer starting in year 2[v] . So adding this $60 cost
`savings through year 5, we derive a total cost savings from Connie using the retailer’s shopper app of $275 through year 5 ($60
`+ $215 saved in transaction costs). See Exhibit A1 in the Appendix for calculations detail, and the chart below for the illustrative net
`contribution from lower cost to serve Connie over the five year period.
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`4) Increased profits as loyal customers purchase higher margin products
`
`As Super Foods is able to learn more about Connie and her shopping habits over time, there will be increasing opportunities for Super
`Foods to target Connie and persuade her to buy higher margin products. For example, Super Foods could offer Connie an incentive to
`try store brand products. If Connie discovers that Super Foods’ store brands are better value than national brands, she will start buying
`them on a weekly basis. Let’s assume that she starts spending $20 (of her $110 total weekly grocery spend at Super Foods) each
`week on store brands by year 3. Assuming a 35% gross margin for the store brands (vs. 20% average gross margin for other products
`sold at Super Foods), buying the store brand products would result in a $150 annual impact in incremental gross margin per
`year through year 5, or $450 total GM impact.
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`The Economics Behind Customer Loyalty: Using Coalition Program Assets to Turbo-Charge Results | Sports Loyalty International, Inc.
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`5) Increased profits as loyal customers refer others to the business they love
`
`Now suppose that Connie has become a fan of Super Foods and convinces her friend Sally to join her for a shopping trip early in year
`2. Sally becomes a customer of Super Foods starting in year 2 and spends $80 per week. Like Connie, she too becomes a more loyal
`shopper over time and spends $100 per week by year 4 and $110 per week at Super Foods by year 5. The incremental contribution
`to Super Foods of Connie referring Sally would be $4,000 over the five year period, as illustrated in the chart below.
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`Adding up all 5 benefits of Connie’s increased loyalty, the total incremental contribution from Connie over the five year period is
`$7,425. So, converting Connie from a typical customer to a loyal customer increased her overall contribution to Super
`Foods from $2,200 to $9,625 over five years – that’s more than a four-fold increase to the company’s bottom line.
`
`Part 2 – Loyalty Program ROI Economics 101
`
`Now that we have explained the benefits of customer loyalty, and illustrated how to quantify them, we will focus on the loyalty programs
`offered by consumer businesses, and how executives can evaluate and measure the effectiveness of these programs. Provided that the
`business offering rewards for increased loyalty has a solid consumer value proposition, a well-designed loyalty program should drive
`greater customer loyalty, and generate value to the company from the five benefits that we discussed in the previous section. In addition,
`a great loyalty platform should be able to more efficiently attract new highly profitable loyal customers in addition to referrals from
`existing customers.
`
`The chart below summarizes the key benefits of a successful loyalty program, adding a sixth item to the list of five from the previous
`section: “other new customer acquisitions.” We’ve also split-out the targeted consumers of a loyalty program between current
`customers and non-customers or competitors’ customers, defined as those who are category shoppers but only patronize competitors.
` This will better illustrate which group is driving each of the key benefits of a customer loyalty program.
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`In an effort to simplify these six key benefits, and to square them up with high level research findings and actual financial results from
`existing loyalty programs, businesses often focus on three drivers of value for a customer loyalty program: “retention”, “lift” and “shift”.
`
`1. Retention represents the percentage of current customers who remain customers over a period of time (typically a year) as a
`result of the loyalty program. Any change in this metric will identify whether a loyalty program is indeed driving reduced customer
`defections.
`2. Lift is the collective sales lift from current customers driven by the loyalty program. This measure can typically be broken down
`further between those current customers who lift their spending (“lifters”), and those not lifting (or even reducing) their spending
`(“non-lifters”).
`3. Shift represents the sales impact from newly acquired customers driven by the loyalty program.
`
`A simplified way to quantify the key benefits of a loyalty program would be to capture the gross margin impact of each of these three
`key drivers of value. The chart below summarizes how these three high level drivers of value relate to the six key benefits of a loyalty
`program mentioned previously. (Note: This analysis does not quantify (i) reduced cost to serve customers, and (ii) increased spending
`on higher margin products).
`
`Loyalty programs typically have a variable cost related to the program, which is the cost associated with the rewards given to
`participating customers in the loyalty program. The rewards can take the form of cash back discounts, free products (12th cup of
`coffee is free) or points redeemable for travel, free merchandise or other products and services.
`
`The resulting “loyalty program economics” framework is illustrated below.
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`This framework provides the following equation to estimate the total value of a business’s loyalty program:
`
`Total profit contribution of a loyalty program =
`
`Gross Margin impact from incremental “Retention”
`
`+ Gross Margin impact from incremental “Lift”
`
`+ Gross Margin impact from incremental “Shift”
`
`– Cost of rewards to ALL program members
`
`Note: This economic framework focuses on variable costs and benefits of a loyalty program, excluding any fixed costs that may be
`required to implement the program (e.g., systems integration, etc.) or to operate the program on an ongoing basis (staffing costs etc.).
`For a well-operated loyalty program, which can leverage economies of scale across many stores, these incremental fixed costs typically
`will be much smaller than the variable cost of rewards. Coalition loyalty programs (described further in Part 3) and other outsourced
`rewards platforms can significantly reduce or even eliminate this fixed cost component for retailers, as these fixed costs are borne by the
`program operator.
`
`This framework can also be used to calculate a loyalty program’s Return on Investment (ROI), as follows:
`
`Loyalty Program ROI = (Total profit contribution from program members’ Retention, Lift, Shift benefits)
`
`÷
`
`Cost of rewards to ALL program members
`
`The following examples help to demonstrate how retention, lift and shift economics work for loyalty programs. For each example, we
`seek to determine what behavior change a loyalty program must deliver in order to drive an attractive ROI. We assume in our
`analyses that an ROI of 15% or more is considered attractive for business purposes.
`
`Note: The analyses that follow center around achieving a 15% ROI for the loyalty program, but can easily be adjusted to solve for
`“breakeven” or 0% ROI, to answer the question: “What do I need to believe for the loyalty program to reach profitability?” We
`also recognize that for certain companies (or in specific markets) there may be other targeted metrics besides ROI that are more
`relevant or pressing for executives evaluating their loyalty program, including market share or overall sales growth. This framework can
`easily be modified for these metrics as well.
`
`“Retention” Economics Example
`
`“Fresh Foods” is a single store supermarket with a 20% gross margin considering launching a loyalty program to improve its customer
`retention. The loyalty program it is evaluating provides discounts as rewards (perhaps for gas and groceries) and will cost an estimated
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`1.5% of total sales. This assumes Fresh Foods pays upon redemption of discounts at 3% total value back to consumers on their grocery
`spend, and is based on an overall 50% redemption rate (i.e., 50% “breakage” of points issued for discounts). For simplicity, we assume
`that all customers are auto-enrolled, and immediately begin earning points in the loyalty program at launch.
`
`Fresh Foods is focused on retaining customers, as 25% of its customers are defecting each year. Therefore their “retention rate”
`currently is 75% year-over-year.
`
`In evaluating the new loyalty program, the key question Fresh Foods executives might ask is:
`
`By how much will the company’s retention rate need to improve in order for the loyalty program to drive an attractive ROI
`of 15%?
`
` If we assume that the only behavioral impact this program will have on its customers is increased retention (or reduce defections), and
`there is no impact from “lift” or “shift,” we can solve for the key variable “r” for retention rate – percent of customers who remain
`customers over the period – in the equation below.
`
`Assuming that the new loyalty program drives no increase in “lift” or “shift”, the required improvement in Fresh Foods’ annual
`customer retention rate would be 16.5 percentage points – from 75.0% to 91.5% retention – in order to drive a program ROI
`of 15%. This would imply Fresh Foods customers would need to become 22% more loyal for the program to be a success (91.5% /
`75.0% – 1 = 22%). Exhibit A2 in the Appendix summarizes the math in more detail.
`
`“Lift” Economics Example
`
`Using the same example of Fresh Foods, we now assume that the primary goal of the loyalty program is to improve overall spending
`from existing customers – in other words, to drive sales “lift”. In this case, the key question that Fresh Foods executives would likely
`ask in evaluating the new loyalty program is:
`
`By how much will current customers need to lift their spending in order for the loyalty program to drive an attractive ROI
`of 15%?
`
`If we assume that the only behavioral impact this program will have is an increase in spending from current customers (“lift”) and there is
`no change in retention or increase from “shift”, we can solve for the key variable “Ɩ” – percent increase in average spend by current
`customers – in the equation below.
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`Assuming that the new loyalty program drives no increase in customer retention or impact from “shift”, the required increase in Fresh
`Foods’ customer spending (or the required overall sales “lift”) would be 9.4% in order to drive a 15% ROI for the program.
`This could be viewed as the average customer enrolled in the loyalty program (including frequent and occasional shoppers) increasing
`their grocery spend at Fresh Foods by $142 annually, from $1,500 per year to $1,642 per year, or $2.83 per week, from $30 per
`week to $32.83 per week. See Exhibit A3 in the Appendix for further detail.
`
`Lifters vs. Non-Lifters and Dilution
`
`Research on customer behavior usually reveals that, while overall sales for a retailer may increase among current customers enrolled in
`the loyalty program and the average spending per customer may go up as a result of a loyalty program, not all current customers
`enrolled in the loyalty program will change their behavior and increase spending. As such, there is always an element referred to as
`“dilution.” Dilution refers to the cost of rewarding customers who are program members, but do not spend more (or engage in other
`more profitable behavior) as a result of participating in the program. We believe this “cost” can be looked at as an ongoing investment
`in rewarding loyal customers for their existing level of shopping (i.e., rewarding them for retaining their business), and also for providing
`information as a byproduct of earning points. Nonetheless, we always include the cost of “dilution” in our economic models.
`
`In order to quantify this “dilution”, executives examining the impact of a loyalty program on sales lift often will dive a level deeper by
`breaking down overall sales lift between: (i) current customers who increase their spending (lifters), and (ii) current customers who do
`not increase their spending (non-lifters).
`
`By adding this dimension to sales lift, instead of having one variable – average percentage sales lift among all current customers enrolled
`in the program – we now have two variables: (a) percent of current customers enrolled in the program who lift and (b) $ amount of
`spend lifted by “lifters” (or percent increase in spend among only those current customers lifting).
`
`Going back to our Fresh Foods example, executives might believe that the new loyalty program could motivate a certain percent of their
`customers to spend $10 more per week (or roughly a 33% increase in spending for this group). Fixing this dollar increase in spending
`among “lifters”, executives might ask:
`
`What percentage of my current customers will need to spend $10 more per week in order for the loyalty program to achieve an
`attractive 15% return?
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` or
`
`What level of “dilution” can we tolerate for this program, assuming the requisite percent of current customers increase their
`spending by $10 per week?
`
`Again, assuming no impact from retention or shift, 28.3% of current customers would need to increase their spending by an
`average of $10 per week in order to drive a 15% ROI for the loyalty program. That would imply that approximately 72% of
`customers do not lift their spending as a result of the program, and any cost associated with rewarding those customers could be viewed
`as “dilution”. See the illustrative math in Exhibit A4 in the Appendix for additional details.
`
`We can also construct a ROI Sensitivity Matrix that illustrates the combinations of (a) percent of current customers lifting and (b)
`average $ amount of spending increase per “lifter” that result in a 15% or greater ROI (cells highlighted in green). Again, this analysis
`assumes no impact from retention or shift, and assumes 100% of customers are enrolled in Fresh Foods’ loyalty program:
`
`“Shift” Economics Example
`
`As we’ve discussed, well-designed loyalty programs can attract new customers. Suppose that Fresh Foods is interested primarily in
`attracting new customers from competing grocery stores, convenience stores and big box retailers who sell groceries. If sales “shift” is a
`key focus of the new loyalty program, Fresh Foods executives will want to know:
`
`What percentage of those customers in my store’s “catchment area” who are shopping only at my competitors’ stores must
`shift their spending to Fresh Foods in order to drive an attractive ROI for the program of 15%?
`
`For purposes of determining the required “shift only” impact of the new loyalty program, we assume that Fresh Foods currently has a
`45% “coverage market share” in its area (i.e., 45% of area consumers shop at Fresh Foods). Thus, if we assume an average of 17,500
`consumers shop at Fresh Foods over the period, a 45% coverage share would imply 38,889 total consumers in the catchment area
`(17,500 / 0.45) and 21,389 non-customers in this same area (38,889 – 17,500). We also assume that those non-customers who shift
`from a competing retailer to Fresh Foods would spend $30 per week ($1,500 per year) at Fresh Foods. Assuming that the only
`behavioral impact from this program is an increase in “shift”, we can solve for the key variable “s” – percent of non-customers who start
`spending at Fresh Foods – in the equation below.
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`Assuming that the new loyalty program drives no increase in customer retention or “lift” among current customers, the required
`percent of non-customers in Fresh Foods “catchment area” that would need to switch to Fresh Foods would be
`approximately 7.7% – increasing the company’s coverage market share from 45% to 49% – in order for the new loyalty
`program to drive a 15% ROI. See the detailed calculations in Exhibit A5 in the Appendix.
`
`Note: The required percentage of “shifters” can vary significantly depending on the business’s local market share. For example, if Fresh
`Foods had a much higher coverage market share of 80%, it would need 37.8% of non-customers to shift $30 of weekly grocery spend
`to Fresh Foods for the program to reach a 15% ROI. If Fresh Foods’ coverage market share was only 20%, it would need just 2.4%
`of non-customers to start spending $30 weekly at Fresh Foods to achieve a 15% ROI.
`
`Retention + Lift Economics Example
`
`Recognizing that loyalty programs can drive returns from all three benefits – retention, lift and shift –executives evaluating these programs
`often find it helpful to analyze several “Sensitivity Matrices” that show how potential results for two or more of these drivers can impact
`overall program ROI. These matrices are useful tools for answering executives’ evaluative questions, when they typically ask “What do
`I have to believe?” for the loyalty program to work.
`
`Below is a sample ROI Sensitivity Matrix demonstrating how sensitive the overall loyalty program ROI is to potential retention and
`overall sales lift results driven by the new Fresh Foods loyalty program as previously described. (Note: this analysis assumes that the
`loyalty program drives no impact from shift). Red cells in the summary matrix denote scenarios where the program ROI is below
`breakeven, and green cells signify scenarios where the ROI is at or above 15%.
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`6/26/2014
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`The Economics Behind Customer Loyalty: Using Coalition Program Assets to Turbo-Charge Results | Sports Loyalty International, Inc.
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`In the Sensitivity Matrix above, you can see the previously discussed required “Retention Only” rate of 91.5% to achieve a 15% ROI
`(top left box in matrix), and it shows the sales lift of 9.4% required to hit a 15% ROI in the “Lift Only” scenario (lower right box in
`matrix). The Sensitivity Matrix also reveals, for example, that a 15% program ROI could be achieved for Fresh Foods if the loyalty
`program increased retention rates by 7.4 percentage points from 75% to 82.4% and current customers collectively lift their spending by
`5%, or $75 per year to $1,575 annually (or $1.50 per week to $31.50 in average weekly spend).
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`Lift + Shift Economics Example
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`Similar to the Retention vs. Lift Sensitivity Matrix, we can also analyze the sensitivity of the loyalty program’s ROI to “lift” and “shift”
`factors only – assuming the loyalty program drives no change to customer retention rates. Here we see the 9.4% lift in sales to current
`customers required in a “Lift Only” scenario to achieve a 15% return (lower right box in matrix) and we also see the 7.7% required shift
`to hit a 15% ROI in the “Shift Only” case (second to top box on the left).
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`Variability Across Industries – Gross Margin Impact
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`It’s important to note that the loyalty