THE LOYALTY/RELATIONSHIP MARKETING DISCUSSION
The business concept behind loyalty/relationship marketing is that it is much more cost-
efficient to retain current customers than it is to acquire new ones. Therefore, it makes
sense to spend money to keep current customers, in addition to spending money to
acquire new ones. A well-structured loyalty/relationship marketing program is strategic,
enabling the development of a provider-customer relationship over time.
The term loyalty in the context of a service provider-customer relationship means that the
customer buys from the same provider all or most of the time when making purchases of
a particular product or service. Loyalty is a repeat purchase concept. Loyalty is not an
emotional relationship between a buyer and the product − it is an economic relationship.
This is an important distinction, because at the core of any successful loyalty program is a
profit for both the buyer and the seller. Many companies launch programs that ultimately
will not be successful, because they have structured these programs without a clear
understanding of the real costs and benefits.
Several elements should be evaluated to determine if a database loyalty/relationship
application makes sense for a particular product or service:
• The provider recognizes that it takes many months for a loyalty/relationship
marketing program to begin to pay off.
• The product/service contains sufficient product margin to fund the cost of the
• The payment system for the product/service already provides for the capture of
purchaser names, addresses and transactional information.
• The product/service has a significant economic impact on the user so that the user
will be interested in participating in a marketing relationship.
• The product/service involves ongoing, repeat purchases on a relatively frequent cycle.
• The provider can construct a reward system with significant benefits for both parties.
Net Benefits of Modern Technology
This interactive age allows for customized strategies and fast response times. New
technology offers simpler, less expensive, yet more powerful solutions. Data processing
and the ability to respond to customer needs in real-time give added-value that
differentiates program providers from the competition. Increased interactivity ultimately
improves the loyalty/relationship marketing program ROI.
The Internet has helped to cut costs by reducing paper, print and postage usage. It also
allows for sophisticated, innovative program execution, which offers greater customer
Retain Customers, Acquire New Ones and Boost Revenue
Within businesses, approximately 80 percent of revenue will come from approximately
20 percent of its customers. Keeping these core customers loyal ensures that they will
become even better customers. The key marketing benefit of a database
loyalty/relationship program is the ability to identify customers who behave a certain way
and then create marketing interventions to get those customers to keep buying, buy more,
buy at different times, buy additional services and refer new customers.
A company must be able to identify its best customers, monitor the frequency of
transactions by those customers, and acknowledge the support those customers are
giving. In addition, the provider should monitor those customers whose purchasing
habits have changed/slowed and also identify prospects who are likely to become
customers if approached correctly. The program needs to be tailored to individual
customers’ needs and preferences. The loyalty/relationship program must be continually
updated, as customers’ needs change, in order for it to thrive.
The cost of collecting the information, creating an integrated database and maintaining
that database can be substantial. To determine if it is worthwhile, a company must
calculate a lifetime value for its customers. Without making this calculation, companies
risk wasting large amounts of money on expensive, non-productive loyalty/relationship
A well-structured loyalty/relationship program should include a customer database with
complete profiles on each customer, tracking systems to update transactions in real-time,
and a method of recognizing and rewarding customers for their loyalty. In doing so, the
program also helps the company achieve its corporate and financial goals.
Lifetime Value − The Determination of Profitability
Lifetime value is the net present value of the stream of profit a company will receive
from an average customer over a specified period of time (usually years). Compute
lifetime value by selecting a sample of customers. You must know average annual
customer purchases, customer retention rate by year and total direct cost. Using these
numbers, calculate the gross profit per average customer. Then, develop a discount factor
to represent the reduced value of the future profits. The discount factor is calculated
using the current market interest rate adjusted up for risk. If the company has a hurdle
rate for capital investment, it could be that rate.
Once the interest rate is selected, there is a simple formula to use to calculate the discount
factor as follows:
Discount Factor = (1+i)n
In this formula, i = the interest rate, n = the number of years of profit stream
The profit for each year is divided by the discount factor to yield the Net Present Value
(NPV) of that year’s profit. The cumulative NPV profit for each year is then divided by
the total number of customers in the original group to determine lifetime value. The chart
below illustrates the concept:
Revenue Year 1 Year 2 Year 3 Year 4 Year 5
Customers 1,000 350 140 63 34.65
Retention 0.35 0.4 0.45 0.55 0.6
Avg. Yrly. $150 $150 $150 $150 $150
Total Sales $150,000 $52,500 $21,000 $9,450 $5,198
Cost Rate 0.6 0.6 0.6 0.6 0.6
Total Cost $90,000 $31,500 $12,600 $5,670 $3,119
Gross Profit $60,000 $21,000 $8,400 $3,780 $2,079
Discount 1 1.12 1.25 1.4 1.57
NPV Profit $60,000 $18,750 $6,720 $2,700 $1,324
Cume Profit $60,000 $78,750 $85,470 $88,170 $89,494
Lifetime $60.00 $78.75 $85.47 $88.17 $88.49
The chart shows the value of a group of 1,000 typical customers over a five-year period
given the current operating situation of this hypothetical business. To produce this chart,
assumptions have been made about retention rate, average sales, costs and the time value
of money as reflected in the discount factor. In this example, a market interest rate of
eight percent has been adjusted to 12 percent to reflect various elements of risk. The
average lifetime value of a customer grows from $60 to more than $89 per customer by
the fifth year.
The purpose of loyalty/relationship marketing is to increase the lifetime value of the
average customer. The purpose of creating this model is to test various activities, to
determine their impact on average lifetime value, before committing the resources to roll
out a complete marketing program.
A relationship marketing strategy can positively impact lifetime value by causing a
change in one or more of these five basic elements:
1. Retention rate can be increased, increasing the revenue received from a customer
2. New customers can be added through referrals from current customers
3. Sales can be increased through upselling, cross-selling or more sales from existing
4. Direct costs can sometimes be reduced by changing channel of distribution (e.g.
direct sales rather than sales through wholesalers, retailers, agents, etc.)
5. Marketing costs can be reduced through more cost-effective use of advertising and
A loyalty/relationship marketing program focuses mostly on retention, but also can
impact referrals, sales and marketing costs. All communications costs, enrollment and
activation rates, and projected earnings, redemption and non-redemption by participants
must be estimated and included in the cost portion of the lifetime value model.
Marketing activities should be tested against the model to determine to what extent they
will increase lifetime value.
Once it is determined that the lifetime model indicates a loyalty application is workable,
awards or benefits to be earned by participants must be developed. When considering
benefits, the following should be considered:
• Benefits should have high perceived value to participants.
• Free offers are more desirable than discounted offers.
• Benefits and earnings opportunity must be competitive.
• The harder participant must work for benefits, the less value in the benefits.
• Redemption should be as easy as possible (800 number, fast response, etc.).
• A broader mix of benefits appeals to more customers, but benefits should be targeted
to the customers.
• Benefits should be constantly updated, while maintaining some consistency.
• Benefits must be affordable to the provider (lifetime value model).
• Marketing partners can help expand benefits at a lower cost or no cost.
Loyalty/relationship marketing is a numbers game. It is less costly to retain current
customers than to replace them. For this reason, the core of this strategy must be the
lifetime value model. This is the only way to determine the current revenue, cost and
profit of each customer and then test various marketing activities to determine if they
can increase revenue, lower cost and increase profit per customer.
Sophisticated Internet technology enables providers to respond to customers faster, and
offer more customization with less expensive, yet more powerful solutions. Increased
interactivity is an added value for customers.
Direct marketing to targeted customer/prospect segments and evaluating each event on
a response rate/sales ROI basis is not loyalty/relationship marketing. It is simply direct
marketing promotion. Individual events can show a positive ROI without creating an
increase in lifetime value. To evaluate the true cost and benefit of long-term
loyalty/relationship marketing, a company must develop and use their own lifetime value
model. The larger the customer base, the larger the financial implications. One million
customers multiplied by any number is a big number. Effective loyalty/relationship
marketing, like any other marketing strategy, must be developed as a sound, long-term