The Price of Loyalty

Frequency marketing programs are designed to engender loyalty and increase share of customer. Historically, they don’t cut corners. But cost control is crucial to get a program off the ground and keep management support long-term.

Marketing managers should be worrying about more than keeping the chief financial officer happy, however. Shaving costs in the wrong areas can be just as hazardous as overspending. It’s not just how much you spend, it’s how you spend it.

A million-member frequency program typically incurs annual administrative costs of $2 to $2.50 and communication costs of $1.75 to $6 per member. Rewards, which should be the bulk of a program’s expense, cost two percent to 10 percent of member spending, depending on the industry in question and other competitive factors.

That means a company will invest $4 million to $8 million per year – plus up to 10 percent of affected revenues – to increase sales among its one million best customers. A little forethought can maximize that investment.

Here’s the good news: Technology for administering and testing programs is catching up with database systems targeting consumers. Better up-front design and ongoing management can slice millions of dollars off the cost of a successful program. Here are four places to look for potential savings.

MEMBERSHIP AND COMMUNICATIONS:

A program’s membership base is its biggest cost driver, so it’s crucial to manage it effectively. The goal always is to include only your highest-value (actual and potential) customers, but memberships tend to grow unwieldy over time. A database bloated with inactive members adds needless communications costs and a debilitating (even if it’s imaginary) liability for unredeemed rewards.

You should let in only those people for whom you have a strategic purpose. Hotel programs, which drop members after a sustained period of inactivity and a polite warning, are among the best at automatically pruning their membership bases.

A clean database keeps communication costs in check, but it helps to keep searching for cost-effective media. Make full use of in-store or P-O-P channels, the Internet and e-mail, and cheaper forms of direct mail. Continental Airlines uses boarding passes to give members their account balances and mileage rewards. It’s a great replacement for direct-mail statements. Such a simple move can easily save $500,000 to $1 million or more per year in a program of five to 10 million members.

But don’t outsmart yourself. Credit card co-branders are tempted to piggyback program information with card statements. That may cut costs, but it could also diminish impact. The road warrior may be so shocked by his $10,000 credit card balance that he won’t notice anything else in the envelope.

Other marketers tend to under-utilize their targeting potential. If Victoria’s Secret can custom-price merchandise 18 different ways in its catalog, why can’t it add a note to frequent shoppers?

Want to know your least-costly-yet-still-effective option for direct mail? Test alternatives. If you usually mail a full-color, eight-page newsletter every 60 days, test a 90-day frequency for one group, an oversized postcard every 60 days for another, the postcard every 90 days for a fourth segment, and nothing at all for a fifth group. Say recipients of the 70-cent newsletter spend $4 more than the no-communication group, and recipients of the 21-cent postcard spend an incremental $3. Assuming your gross margin is 50 percent, it doesn’t take much math to see that the newsletter isn’t giving you that much more return than the postcard. Switching to postcards carves $3 per member per year off your communication costs with no revenue loss.

FUNDING RATES:

You can waste money by underfunding or overfunding rewards. Look at overfunding: A consultant can tell you an industry range, but can’t say exactly what rate will work for you. If your industry’s average is three to five percent, start at 2.5 percent with bonuses up to five percent for top customers. But test first. Once you start a program, it’s impossible to know what would have happened at a lower rate. And scaling back rewards is really tough (although not impossible).

Now consider underfunding: If members don’t value your rewards, they won’t bother collecting or redeeming points. A large cache of unredeemed points may never need to be paid out, but it makes financial managers nervous and could constrain future funding. Plus, you waste money on talking to and managing inactive members.

The solution seems easy enough: Increase the rate structure. But you may have already lost your customers’ attention, and if there are lots of unredeemed points out there, you may have lost top management support as well.

ADMINISTRATIVE COSTS:

Running the program should take only 15 percent to 20 percent of your budget, although costs may run higher for smaller business-to-business programs.

You can cut costs by sourcing your own rewards. Work with a consultant who in turn works with a fulfillment house and you get double markups – so you’re offering a $400 television that sells for $169 at Best Buy. One hotel offered three Callaway golf clubs for the same points as a 10-night stay anywhere in the world. Such absurd value propositions may reflect costs, but they warp and devalue the program’s point currency. Whenever possible, deal directly with suppliers and offer your own products as rewards.

SYSTEMS:

The biggest administrative cost is often the software system that runs the program, which can cost $1 million to develop and install.

Real-world testing is the best way to control costs. But traditional systems could eat up as much as 80 percent of start-up costs for testing alone.

Newer loyalty systems now available can run pre-launch tests for about $50,000 and make it easier to run ongoing tests without a lot of technical hand-holding. The right system will permit the up-front and ongoing tests necessary to keep costs in check without slowly starving the program.

Consumer packaged goods marketers should help retailers analyze their loyalty program data – and pay more attention to private label. That’s the advice of Cannondale Associates in its sixth annual study on category management.

Retailers have stepped up loyalty marketing as they consolidate, but manufacturers have yet to jump in with enough promotions or analysis. Retailers are using frequent-shopper programs for targeted promotions (36%), broad promotions (29%), and data (27%).

CPGs that help grocers analyze shopper data cement category management roles and get better information themselves. That can improve promotions – a goal grocers and manufacturers share (see chart at right).

While 75 percent of retailers seek promotional support for their loyalty programs, nearly as many (60 percent) want manufacturers’ help reading data. “With little manufacturer analytical involvement to date, those manufacturers who do become involved will have the first foot in the door and advance quickly,” Cannondale concludes.

The study quotes a retailer thusly: “I am not interested in hearing what sells. I know that already. I want to know why it sells. If we can combine our understanding of purchase behavior from our frequent-shopper database with [manufacturers’] knowledge of consumption behavior from other research – now that’s a powerful combination.”

CPGs could use the data to make trade promotion more efficient – a top priority for 90 percent of those surveyed. “Manufacturers are at the breaking point with the cost of trade promotion. Retailers need to recognize that it’s more difficult than ever for manufacturers to build their brands [with ad budgets down and media so fragmented.] Using frequent-shopper data to understand consumer dynamics behind trade promotion will improve efficiency” for both, Cannondale suggests.

Most retailers and manufacturers believe it’ll take less than a year for promotion-related frequent-shopper initiatives to pay out (see chart at left).

CPGs are starting to wise up on private label, a priority for 84 percent of retailers (but only 52 percent of manufacturers). Private label is key as consolidated grocers hone their branding and marketing skills. Top-tier national brands need to address it better in category management, and smaller brands must differentiate or risk getting cut.

“Private label is of most interest because it has such a strategic fit with category management, but there’s such a divide in how retailers and manufacturers see its role,” says senior consultant Sven Risom.

So who’s good at category management? Retailers rate Procter & Gamble, Kraft Foods, and General Mills as the top practitioners. Kraft’s marks went up this year, while Quaker Oats, Frito-Lay, Kellogg, and Coca-Cola slipped in grocers’ estimations. Manufacturers rank H.E.B., Safeway, and Wal-Mart as tops in retail, with the last two’s reputations on the rise.

Retailer consolidation worries manufacturers, but shouldn’t, Risom says. “When one side changes, the other side gets nervous. It’s not a big issue. It’s just there.”

In fact, he sees a power shift “to more balance, where manufacturers can partner with retailers.” Besides private label and loyalty data, Risom cites solutions marketing – home meal replacement, for instance – as an area CPGs and retailers can work together.

How can all marketers improve? Collaborate better via new technology and information; empathize on private label and trade promotion inefficiencies as priorities; and incorporate frequent-shopper data into category management to focus on most valuable shoppers.

Cannondale conducted written and phone interviews with 250 manufacturer and retailer managers in summer ’99. The study was released in January.