THE LOYALTY/RELATIONSHIP MARKETING DISCUSSION January 2000 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 program. • 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 satisfaction. 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 marketing efforts. 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 Rate Avg. Yrly. $150 $150 $150 $150 $150 Sales Total Sales $150,000 $52,500 $21,000 $9,450 $5,198 Costs Cost Rate 0.6 0.6 0.6 0.6 0.6 Total Cost $90,000 $31,500 $12,600 $5,670 $3,119 Profit Gross Profit $60,000 $21,000 $8,400 $3,780 $2,079 Discount 1 1.12 1.25 1.4 1.57 Factor 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 Value 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 customers 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 promotion expenditures 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. Awards Considerations 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. Summary 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 business proposition.
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