Beyond happy and loyal customers, your loyalty program should be driving profits. How can you measure your loyalty program’s ROI and financial contribution?
Obviously, there are quantitative measures like share of spend, frequency, basket, etc. However, I also believe that qualitative research is equally important – really getting under the skin of shoppers to gauge how effectively loyalty campaigns get your customers to love you more.
Here you will find not only ROI calculating formulas and examples, but also practical takeaways that will help you estimate the success of your loyalty program based on data and not only gut feelings.
Let’s dive into the interesting subject of loyalty program ROI!
Why is calculating and measuring loyalty program ROI important.
Loyalty programs are shifting from a nice-to-have to a necessity, but it’s not as simple as setting it up and forgetting about it. The program should consistently evolve and grow to match your brand and customers’ behaviors and needs.
To build a loyalty program that works for your brand and increases revenue and profits, you need the right loyalty strategy and platform. Once you successfully set up the basics, you will start to see results.
But as you know, setting up the basics requires upfront investment that can worry retail leaders and executives, specially if they cannot quantify expected returns.
Many CMOs and Loyalty Managers find the calculation of loyalty program ROI tricky, but loyalty program ROI is fundamental both in early development stages and beyond. ROI serves as a benchmark for shaping marketing strategies for the future, and helps loyalty managers and marketing teams determine what tactics are working and what areas can be improved.
Before we dive in, let’s mention an important issue around loyalty ROI: Investment Risk
Forrester defines 2 types of investment risk associated with launching a loyalty program: implementation risk and impact risk.
Implementation risk is the risk that a technology investment may deviate from original plan resulting in higher costs than anticipated.
The following implementation risks are identified as part of Forrester’s analysis:
- The cost of software and hardware resources required is greater than anticipated.
- Internal development cost can be higher and may take longer than originally planned.
- The amount of time and effort spent building an effective strategy roadmap may be higher than originally planned.
Impact risk refers to the risk that the business needs may not be met by the investment, resulting in lower overall total benefits.
The following impact risks are identified as part of Forrester’s analysis:
- Actual increase in additional cross-sell and upsell opportunities may be lower than original expected.
- New customer acquisition may be lower due to changing market conditions.
- Ad and channel partner revenue may be lower than originally expected due to lower customer adoption of web channel or rich internet applications.
- Productivity gains for customer contact center and direct sales may be smaller and take longer to materialize than originally anticipated.
- The number of online documents processed may be lower than originally anticipated, leading to reduced workflow reengineering cost savings.
The greater the uncertainty, the wider the potential range of outcomes for cost, benefit and ROI estimates. Capturing investment risk results in more meaningful and accurate estimates and better projection of the ROI.
How can retailers measure the ROI of a customer loyalty program?
Building a loyalty program that works for you may require a sizeable investment of both money and time. Loyalty programs can be expensive to implement and unless the loyalty program is built properly, it may become a cost center and not a source of additional revenue.
At Loyal Guru, our mission is to make sure that does not happen.
So… how can you measure your brand’s loyalty program’s performance and calculate the return on investment?
Some of the key metrics that can be used to measure the success of a loyalty rewards program are:
- New program members
- Engagement rate
- Repeat purchases frequency
- Growth of average basket size
To better dive into these and other metrics, make sure to download our free resource: 7 metrics to measure your loyalty program success.
These are 4 steps to calculate loyalty program ROI:
Step 1: Estimate Incremental Revenue
How do you estimate the incremental revenue generated by your loyalty program?
To determine incremental spending, you need to measure against a comparable control.
Summarize the average spending per loyalty member over the 12-month period. If you have multiple loyalty tiers, you may want to do so by tier level. This is the total spend per member.
Most retailers will analyze the pre-loyalty program purchase behavior of members and identify similar performing customers (cohorts) who are not loyalty program members (typically over 6–12 months) and compare behavior during the program measurement period. Typically, there is a statistically significant lift in loyalty member spending vs. the non-member cohort.
Step 2: Quantify Program Expenses
The 2nd step is to quantify your loyalty program expenses, mostly organized in 2 categories:
- Dedicated program expenses
- Reward and soft benefits costs
2.1 Dedicated Program Expenses
Increasing loyalty typically requires a partnership between IT, sales, and marketing. As a result, to invest in loyalty, teams across the organization are required to commit to investing budget dollars together.
As in other big investments, you will need bear in mind the amortization: If your program is new or was recently updated, you may be able to pay off the design and build investment over the term of your partner’s contract. Check with your accounting team for more information.
In this table you can see what cost areas US companies include as part of the justification for an investment in loyalty programs, compared to EMEA:
What expenses should you be counting specifically in each area?
- Technology: Includes annual licensing and support, management, and support fees.
- People: Includes dedicated employees supporting the program, or allocated headcount.
- Dedicated direct marketing: Includes the cost of email, direct mail, SMS, app messaging, and other direct communications solely for the loyalty program members.
- Advertising/Creative: This includes dedicated point of sale materials, banners, and promotions with loyalty messaging as a material element.
- Other Expenses: Some examples include ongoing vendor, agency, or partner support fees, employee training and others.
Keep in mind that you should only be counting expenses that are directly incurred because of the loyalty program. In some cases, expenses may be shared between your loyalty efforts and other marketing or corporate functions (i.e., communications, customer service, etc). In these cases, you should allocate these costs based on the pro-rata loyalty program level of resource share.
2.2 Rewards and Soft Benefits Expenses
This is the dollar value and cost of rewards redeemed.
Every point and offer issued is free currency your company is giving away to customers. Ensure your team is equipped with the right information to enhance the customer experience, while controlling margins at the same time. With the right reporting and forecasts, retailers can access a wealth of information related to point and offer liability; to protect against fraud and to ensure your rewards program isn’t having a negative effect on the bottom line.
To do so, track the value of rewards earned and rewards redeemed separately, as there is often a significant difference between the two.
The value a retailer should give to the reward is the value to the customer (for example, $10 off towards their next purchase).
However, if your program rewards specific items for specific number of points (for example, a free beverage for 50 points, a free experience for 100 points, etc.), the reward should be expensed at the variable direct cost of the item redeemed. This means that although the beverage might have a $2 dollar value for the member, it only costs $.75 to the retailer.
If you have additional soft or “hard” benefits for your program such as free delivery, exclusive events, birthday gifts, or other member perks, include the incremental cost for these benefits.
Exclude the cost of any benefits available to all customers (not just members).
Here are some examples of loyalty and offers data that retailers should be tracking:
- Daily and monthly point report: Points issued, expired, redeemed.
- Offer Status: Breakdown of offers currently issued, expired, redeemed.
- Amount saved on discounts
Step 3: Quantify Incremental Direct Variable Margin
When you put the initial investment into systems and team aside, it’s unlikely that your program will drive significant incremental fixed costs or additional variable costs for each sale.
Now that you have estimated the incremental revenue generated by your loyalty program members, you will need to estimate your incremental direct variable margin. The margin is based on what was earned from incremental revenue estimated during the first step. Note that in most cases, margin is the best measure of incremental program contribution.
If your loyalty program’s financial and customer database is sophisticated enough to capture margin information from member sales at an individual member level, you can use actual margins earned. If not, it’s usually fine to apply an overall average direct variable margin rate for the measurement period.
Step 4: Calculate & Review Loyalty Program ROI
The final step is to summarize and review your loyalty program expenses and ROI. With the above steps completed, you can use the formula below to calculate the estimated return of your loyalty program investment.
Using this high-level framework, you can estimate your current loyalty program’s bottom line. With this estimation of how your loyalty program is currently performing, you can determine if you need to make changes to your customer loyalty strategy.
Formula for Measuring Loyalty Program ROI
Conclusion: A word on continuous improvement
Obviously, there is no such thing as ‘setting and forgetting’ when it comes to optimizing your loyalty program for maximum ROI. That’s why retailers need the information necessary to test, improve, and analyze their loyalty program strategy.
Whether you’re determining the best strategies for increasing member sign-up, understanding which channels are driving the most transactions, or understanding which items are your bestsellers, the answer lies in a strong foundation of customer data.
These are areas of continuous improvement that the Success Managers at Loyal Guru handle on a daily basis:
- Managing the loyalty program
- Developing loyalty strategy
- Integrating loyalty program with customer and retail touchpoints
- Advancing analytic capabilities
- Experimenting with new customer engagement strategies
- Testing new loyalty program rewards and benefits
- Advancing loyalty program technology and digital loyalty capabilities
- Hiring and training dedicated team members for loyalty or customer departments
Understanding success metrics upfront is crucial.
If your loyalty program isn’t delivering the return you expected, or if you would like an independent review of your program and its potential, Loyal Guru’s experts can help you review your current results and growth opportunities. We can also measure the health of your program against industry metrics and provide data and recommendations on how best to improve the health of your program.
If you’re a retailer and you’d like to talk about any of the loyalty strategies outlined in this article in more detail, then get in touch with our team – we’ll be happy to show you examples or talk through your brand’s unique challenges.