Loyalty Library: Forecasting ROI in Loyalty Marketing
Forecasting anything is an inexact science, but understanding a few key ideas and following the framework below can get you much closer to a defensible proposal for a loyalty marketing program. With buy-in from your bosses on the initial numbers, you stand a better shot at getting the resources you need to build out a full strategic plan with a real forecast, building on the elements covered in my prior two columns “Transforming Strategy into Program Design” and “Developing a Basic Loyalty Strategy“).
The main question you must ask yourself before embarking on the third part of your loyalty marketing proposal adventure is how detailed your ROI estimate must be. It is easy to start digging into your assumptions and end up with an estimate that has dozens of inputs. The key here is to avoid assumptions that your CEO or CFO will question. Build your model on solid and reasonable assumptions, and it will be much easier to defend.
What’s the benefit?
Start off with the upside. How much incremental margin will the program generate? For most purposes, your forecast will include four benefit elements:
œ Incremental transaction size–how much of an increase will you see in your typical transaction size? Wefve seen as high as 35% in multichannel retail, although more-typical results are in the single digits. In subscriptions and continuity programs, this translates into an increase in the value of the subscription, although it is a relatively small number.
œ Incremental transaction frequency–how much more often will your customers buy from you? This is one of the main benefits of loyalty marketing With a promise of rewards based on consolidating share of wallet with a single provider, consumers tend to adjust their choice behavior and will likely shift a larger percentage of visits to you. There are no typical metrics for this value, since it depends so greatly on the nature of your business. But wefve seen values ranging from 5% to triple digits among certain customer segments. This generates much of the first-year ROI.
œ Retention improvement–what improvement will you see in repeat purchasers? This is the other main benefit of loyalty marketing. Over time, this improvement compounds and can have a substantial impact on revenue and profits. The financial impact depends directly on which customer segments are affected– keeping 1% more first-time buyers may not be as valuable as keeping 1% more of your top customers, for instance–but it really depends on the quantities and values of customers involved.
œ Advocacy improvement–how much more financial impact is there from customer advocacy? This can be very difficult to estimate or measure. If your company has systems in place to track and measure this, great; otherwise there is little you can do to forecast this. In the coming months and years, however, this will become a very important element in understanding the impact of loyalty marketing programs, as companies such as customer-ratings provider Bazaarvoice and customer-portal developer Lithium gain more traction and integrate with loyalty marketing platforms.
What’s the cost?
The cost side includes direct costs of the benefits that youfll be providing program participants, plus the marketing, training, and technology costs necessary to support the program:
œ Rewards/benefits cost–what is the estimated cost of benefits provided? It is crucial to understand that there will be breakage in the program and to avoid overstating the cost of benefits. So if your program has a 4% fund rate (that is, promises $4 in benefits for every $100 in purchases), you may have up to a 75% breakage rate, meaning that the actual cost of benefits is only 1%. Using 50% breakage is a safe starting point, although it can vary widely based on the final structure. In addition, you must work with your CFO to be sure you are accounting for the cost of benefits properly. In some cases, you need only include benefits at cost (that is, the cost complement of the retail value of a redeemed benefit).
œ Program support costs–what does it cost to deliver and maintain the program? Your company should understand the cost of marketing materials, technology, and training.
In certain cases, indirect costs should be included, but we have found that the incremental sales generated can be supported with the existing cost structure.
Finalizing the model
Estimating the ROI itself is straightforward once you understand and calculate the components: Incremental revenue minus costs divided by costs. Itfs a way to compare the investment in a program with another incremental expense such as direct mail or advertising, or with a capital expenditure such as a store remodel or an alternative technology investment. Ideally you will construct the forecast for at least three years, to show the compounded impact of retention improvement.
Scoring points with the boss
There are two other components to the forecast that you should include to make your CFO happy.
First, prepare at least three scenarios: best case, worst case, and most likely case. Presenting the various possibilities will make it easier for the finance team to develop the expected value of the program.
Second, prepare a basic sensitivity analysis on the most likely scenario. This consists of calculating how much of the incremental revenue and ROI is generated from each input. Recalculate the model with each input set to no impact, and see how much the final result changes. For example, if your most likely scenario shows $1 million in incremental margin over three years, and changing the retention improvement to zero reduces the incremental margin number to $600,000, the sensitivity of the model to that input equals 40%. Repeat this for all of your inputs. Armed with this knowledge, you can negotiate assumptions with your CEO and know which inputs have the largest impact on the model.
You now have all the tools to put a solid proposal for loyalty marketing in front of your CEO. Get help if you need it, by all means, but now you should be familiar with most of the elements that will be necessary to sell the idea internally. Good luck!
Michael Greenberg is vice president of marketing for Loyalty Lab, a San Francisco-based developer of customer loyalty programs for the retail industry, and writes a monthly column for CHIEF MARKETER. He can be reached at [email protected].
Other articles by Michael Greenberg:
Empowering the Lonely Loyalty Champion
Microsegmentation for Macro Returns
Balancing Visible and Hidden Relationship Programs
Evolving Loyalty: How to Stay Current
The Best Marketing Investment You Can Make
The Case for Simultaneous Concept Testing
Planning for the Coming Online Standard
