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Customer choice is endless and acquisition costs are at an all-time high, so it makes sense that marketers are turning to customer loyalty programs to stand out.
But these programs aren’t a silver bullet. Take Bed Bath & Beyond‘s well-known yet generic 20% off coupons, for instance. They’re a classic example of a “loyalty” scheme that ultimately wasn’t enough to avert the brand’s bankruptcy.
While it’s easy to find advice on how to structure and build loyalty programs, it’s not always easy to understand if they’re working—or more importantly, how to measure their success. If a program isn’t driving business value, it’s time to adjust your strategy.
The first step for any brand is to set distinct goals for their loyalty program. One of the most effective goals comes down to incremental revenue—revenue gained as a result of the program through increased customer retention, higher average order value or more frequent purchases. The focus here is on “incremental,” implying revenue that wouldn’t have been realized without the program.
The cost side of a loyalty program includes both variable costs, like rewards, and fixed costs, such as software or administrative expenses. These inputs need to be meticulously tracked to understand the program’s financial impact, and the method used to calculate incremental revenue is key.
Traditional methods involve comparing the average revenue of loyalty program members with nonmembers. However, this approach is flawed due to self-selection bias, where members of a loyalty program are inherently more engaged or valuable customers. To address this, more sophisticated methods can be employed.
From our experience, difference-in-difference analysis is the most effective. This method measures incremental revenue by comparing the change in revenue from loyalty program members before and after joining the program against the change in revenue from a control group of nonmembers over the same period. This helps to control for external factors affecting both groups, providing a clearer picture of the program’s true impact.
Other approaches include randomized controlled trials, where customers are randomly assigned to either the loyalty program or a control group. However, this approach might overlook unobserved factors that influence both the likelihood of joining the loyalty program and spending behavior, leading to biased results.
Propensity score matching (PSM) is also sometimes used, which involves matching each loyalty program member with a nonmember who has a similar profile, or “propensity” to join, based on characteristics like past purchase behavior or demographics. A key issue with PSM is that it can be logistically challenging and expensive to implement.
These methods help in accurately isolating the impact of the loyalty program from inherent customer behaviors, but similarly, understanding the costs involves dissecting rewards into categories:
- Tangibles: This includes the cost of items given as rewards, factoring in costs of goods sold.
- Services: For rewards like exclusive events, the cost is determined by the expense of delivering the service, divided by the number of customers benefiting from it.
- Discounts: The cost here is the revenue foregone by offering products or services at reduced prices.
- Intangibles: Rewards like early access or special features typically have no marginal cost to the brand.
From there, you’re able to truly understand the ROI of the program. This is determined by dividing the incremental revenue by the cost of the loyalty program. As you’d expect, a positive ROI indicates that the program is generating more incremental revenue than its cost, while a negative ROI suggests a loss. In addition to these, fixed costs like technology and training should be considered, as they do not scale with the program but are essential for its upfront setup and operation.
It’s also important to remember that numbers are just one part of the equation. While quantitative analysis is vital, so is understanding the qualitative aspects. Asking customers why they joined the loyalty program and how it influences their behavior can provide invaluable insights into the program’s true impact.
Measuring the success of a customer loyalty program is not straightforward. It requires a combination of clear objective-setting, meticulous cost analysis, sophisticated revenue calculation methods and customer feedback. With the right care and consideration, brands can gain a deeper understanding of their program’s ROI and make informed decisions to enhance effectiveness and grow the business.