4 Steps to Better Loyalty Program ROI

With apologies to Thomas Jefferson and the Declaration of Independence, the truth is: Not all customers are created equal.

Most companies are aware of the Pareto principle, or the 80/20 rule, which states that 80 percent of your revenue is generated by 20 percent of your customers. But did you know that the top 20 percent of your customers typically generate more than 100 percent of your profits? This means that your best customers actually subsidize your weakest customers—the ones who use up a lot of your marketing budget but don't spend a lot in return. And your worst customers actually have a negative ROI.

While these customer truths are less severe within a loyalty program (which naturally draws in your better customers), it is still the case that program ROI can be improved dramatically by shifting your member recruitment focus from "getting the most customers" to "getting the best customers." Remember: When your goal is to maximize the number of customers you bring in, you inevitably are going to bring in a large number of customers who turn out to be unprofitable—and that will be harmful to the ROI of your program.

The first step toward making this shift is to fill the insight gap on customer profitability within your loyalty program. A bit of advice: Don't overcomplicate this. You are just trying to differentiate between customers, not create a new accounting method. Here's the basic process:

• Estimate customer profitability by subtracting total marketing costs from total revenue for each customer (for the past one or two years, depending on your customers' average purchase cycle);
• pull out the most profitable customers (top 20 percent);
• perform a demographic profiling exercise (off-the-shelf cluster profiles like Prizm or PersonicX are good for this) to understand what your most profitable customers look like and where they are coming from; and
• modify your program recruitment targeting to focus on bringing in members who look like your most profitable members.

If you need to convince yourself (or management) that this will be worth it, here's a tip: Once you have your customers ranked by profitability (step No. 1), calculate the change in ROI you will achieve by increasing the number of most profitable customers by 10 percent and decreasing the number of least profitable customers by 10 percent. It will surprise you.

Andy Cutler is chief strategy officer at Mercury, a Boston-based, insight-driven marketing agency. He can be reached at acutler@mercury-agency.com.

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