How to calculate the cost of a loyalty program and why it's important

Loyalty programs are a potentially effective method to encourage repeat customers and reduce marketing spend. Consumers get rewarded for their continual business, while retailers can work on improving retention and package it in a way that shows they care about their customers. A recent industry study found that consumers in the U.S. hold 3.3 billion memberships in at least one rewards program in 2014, a 26 percent year-over-year increase.

There is undoubtedly an opportunity for ecommerce businesses to benefit from loyalty programs, but an oversaturated market requires precise strategy and careful analysis.

How is the cost of a loyalty program calculated?

Determining the cost and net gain from a loyalty program is a tricky process, dependent on the structure and incentives of a given program. Finance firm PWC suggests a simple formula to evaluate the performance of a loyalty program: incremental revenues subtracted by incremental costs.

Incremental revenues include:

• Ancillary revenue such as membership fees, point sales or partner payments
• Increased purchase frequency or volume
• A willingness to pay premium
• Lowered customer churn rate
• Higher referral rates

Incremental costs include:

• Cost of soft benefits, such as perks, recognition and member events
• Rewards redemption and accrued liability
• IT investment and subsequent maintenance
• Marketing and advertising
• Business overhead like payroll and staffing benefits
• Research and development
• Vendor contracts

Some of these metrics — such as referral rates — are very difficult to track. In addition to the more specific methods above, overall business performance metrics should be included in the loyalty program conversation. Social shares, direct website visits and backlinks are indicative of happy customers who are spreading the word, some of which can become full-fledged brand ambassadors. Also pay attention to customer reviews — these can be directly linked to an effective loyalty program that pleases shoppers.

What are the business benefits of a loyalty program?

If you're weighing the pros and cons of launching a loyalty program, propose the following benefits to the primary decision maker.

• Higher AOV and/or order frequency: Loyalty programs often require a minimum purchase or significant threshold to begin generating customer benefits.
• Direct/Referral Traffic: Pay attention to these sources in Google Analytics and see if any websites that send referral traffic mention the loyalty program.
• Increase in ARPU (Average Revenue per User): More orders and efficient marketing spend equate to higher revenue for every user who lands on your website.

What makes a good loyalty program?

There is no uniform solution for building the perfect loyalty program, but the following best practices will help it resonate with customers.

• Use more than one channel: Allow customers to engage with your ecommerce business in more than one way
• Incorporate personalized messaging: Use customer analytics to provide relevant and timely offers
• Create a custom strategy: Identify your business goals, evaluate what you're already doing, understand customer expectations and use the right technology
• Effective communication: Reach out to clients through channels that they frequently use