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Identifying Profitability for Loyalty

In the initial two phases of loyalty strategy, we identified key KPI’s that will lead to success and influence the program structure. In phase three, we will quantify the program’s likelihood of profitability through a financial model.

The overall goal of a loyalty financial model is to extrapolate the shift in desired customer behavior at all value points, segments and channels to determine incremental customer spend. The model then compares that to costs associated with the program and execution. In essence, it analyzes ROI over time to determine how the program should be structured and designed.

A financial model requires two things that sound easy, but become exceedingly complex as the model progresses.

First is a full view of the customer. What’s paramount for your customer insights is that they need to be measurable.

We’re not talking about demographics, brand targets, social influence or any fluff metrics. This is actionable intelligence—POS data—transactions, distance to store, purchase frequency and more. Identifiers in each example are needles we can move based on actions we take within the program. They are not simply correlations; they have a cause-and-effect relationship to customer interactions.
They’re measurable and they provide hard data that can impact revenue.

Customer profiles provide the data necessary to extrapolate how many members can be expected to join, what tier they’ll enter the program, as well as their program mobility—their chance of moving up in status or tiers.

Second are the financial metrics associated with product, price, operational costs and margin. Those metrics are rather standardized for financials, but they’re necessary to understand the brand impact.

Essentially both consumer behavior (input) and brand cost (output) are needed to determine an expected lift.
In essence, the root purpose of a financial model is to assess the capabilities of the program to modify consumer behavior to enhance brand goals.

To comprehend those modifications, we need hard data which is dependent on a customer profile and brand financials.
If you’re considering a financial model, below are some guidelines to consider:

Keep it simple
Loyalty has massively complex interactions and consequences for brands that are sometimes unpredictable. There are some proven tools, tactics and experiences out there that can add great value to programs, but they need to be added over time and siloed to measure impact and consequences.

Especially when it comes to financial modeling, the financial impacts are difficult to quantify for some of the experience-driven tactics. Consider staging roll-outs over time with the initial launch focusing on measurements and adjustments with the financial model as your litmus. Only add viable benefits as the program develops its foundation.

Behavior modification
No matter what type of loyalty program a brand offers, the goal is always behavioral modification. In each scenario, the program’s intent is to evolve customer interaction to the next segment or tier.
While that sounds simple, it’s extremely complex, especially with the number of segments that can develop when breaking down customer types. A brand might have several tiers, but there could be 10 segments within each tier.

A great financial model tracks purchase behavior at a granular level; a great agency provides tactics to move each segment up over time.

Another impediment to targeted behavioral shifts is that loyalty is a lodestone for bureaucracy within brands. Each department will attempt to warp the program to help their needs, which is understandable. But often the goal of the program is forgotten. Loyalty done correctly is an enterprise strategy with financial and behavioral drivers that deliver benefits and experiences for members.

Cost per member
Financial models show the good and the bad for profitability. One area many brands often find concerning is the upfront expenditure on cost per membership. Depending on the collateral and channel distribution your program utilizes, cost per membership is usually a large upfront investment, but you’re in this for the long-haul.

Of course the numbers need to match up, but again, think about the lifetime value of these individuals and how that can offset the initial costs over time.
As always, the statement holds true that you need to spend money to make money.

Liability
Liability in its most basic form, is the held cost on a balance sheet for issued points or program currency until they expire. Essentially, even if the points are not redeemed, from an accounting perspective they must be held as a loss on your company’s balance sheet as a promise of a service to that specific customer. Basically liability is the dead weight that can drag profitability down.
It’s also the most important attribute in a financial model that many brands skip, or pay little attention to during the review cycle.

While liability is an inevitable piece of loyalty, there are some logistical impacts that can reduce the overall percentage of unredeemed points that are often overlooked.
Consider how often your program will communicate with customers about certificates. Of course it would be far too easy if programs could simply hammer out communication to redeem points, but there’s always a trade-off. In that instance, it’s the customer experience. The more you message, the better the chance you lose the customer.

Another example is batching versus an automated technology for reporting. No matter how well a batching program is run, there will always be a cutoff date, where certain members get placed into a longer-term bucket than they were expecting.

That could lead to a purchaser not receiving their certificate for an inordinate amount of time, in some examples it even ranges up to a month.
By that time, the member might have forgotten those points existed, or even have lapsed within the program even though you’ve awarded them program currency.
There are many more strategies to cut down on liability. Your loyalty provider should provide an in-depth overview of liability within the financial model and they should be able to provide technologies and tactics for reduction.

Don’t sacrifice tomorrow for today
So many individuals are involved in the decision-making process for loyalty. Naturally, rational decisions are often missed in favor or fragmented views and ideas that don’t take the customer into account. It’s understandable given the pressure for sales goals, to quickly turn a program profitable and to quickly push a program live with a minimum viable product.

Yet those decisions are the most impactful ones that come back to bite brands down the line. Don’t sacrifice ten dollars tomorrow for the quick dollar today.
Some brands don’t invest in automated technologies and rely on batching programs. Some don’t invest upfront in membership and marketing material. While others offer cherry-picked, poor product as rewards to their most loyal members.

Remember when reviewing your financial model, this is loyalty and it must be shown to your customer just as much as they show it to your brand.

While a financial model is the most important phase in identifying an approach to loyalty, strategic development and execution are sometimes afterthoughts for brands. In phase four, we will identify a strategic foundation that harbors cross-functional alignment and the best interests of the brand-member interaction.