Calculating total cost of ownership in a loyalty program

The total cost of ownership (TCO) of a loyalty program varies widely. Variables include the brand’s business category, geographical reach, size and scale of their partner networks, frequency of engagement with members, and the nature of technology used.

Due to this variation, it’s not useful to attempt to give indicative figures for the TCO. Instead, the purpose of this article is to indicate the major components of the TCO, focusing especially on the areas where companies can save money, and funnel those resources into rewards. This should be a good starting point for calculating TCO in your own loyalty program.

The TCO in a loyalty program comprises…

• capital expenditure (capex): large chunks of money invested in long-term assets, like the cost of buying and installing a new loyalty system
• operational expenditure (opex), or day-to-day running costs, which include the cost of rewards, data center usage (unless a company builds its own data center), salaries and campaigns.

The capex is often necessary because enterprise-scale systems are needed to support hundreds of thousands or millions of members in a personalized and scalable manner. Fortunately, for most companies, the cost of loyalty systems has come down by 50% to 80% in the past decade while functionality has expanded dramatically. This means that implementing or upgrading a loyalty program costs a fraction of what it did a few years ago.

It’s with the opex, however, that brands have the major opportunity to optimize how resources are distributed, and better fund member benefits and growth in their programs.

Today, a company with a points-based program is typically investing around 2.5% of revenue in loyalty marketing, but we estimate that only 1% of that cost is delivered to customers in the form of benefits.

That means that typically 60% of your total budget is opex. Much of that operating cost may be necessary, but we have found that many loyalty programs continue to pay ‘legacy costs’ out of habit, and much of that overhead can be reduced without reducing value for customers.

It has been our observation that very few companies are keeping track of these operational costs, but they should be, because it is often easier to save a dollar than earn a dollar. A dollar of savings is worth the entire dollar, while the value of a dollar in new revenue is only worth the margin earned (often less than 30%).

A good target is that indirect costs are as low as 25% of the total loyalty investment. Then, much of what was administrative expenditure can be used to deliver aspirational rewards to more loyalty program members, producing a direct impact on their motivation to earn points or recognition in the first place.

Brands’ abilities to do this will be a key differentiating factor over the coming years as customers begin to notice the tangible difference in reward value they get for their loyalty.

The main components of TCO that we will discuss in this article include:

1. ongoing loyalty campaigning costs
2. new partner acquisition & lifecycle management
3. technology capex and ongoing expenditure.

Ongoing loyalty campaigning costs

Some loyalty marketing costs are fairly standard, such as customer service costs, or running your content channels. These costs are spread across the member base, so become more efficient with scale, and with the size of the program – so are relatively uncontroversial.

Here, we will focus on the areas which are highly variable and so worthy of greater planning and consideration. These are:

• the cost of points issuance
• funding rewards and driving the redemption moments that matter
• staffing costs in the loyalty team
• advertising costs for customer acquisition or to drive frequency

The cost of points issuance

The cost of points issuance depends partly on whether you issue your own currency or a partner’s.

If you issue your own currency, those points cost practically nothing to issue, but according to fiduciary guidelines, a currency owner should set aside a pool of money to cover liabilities when the points are redeemed. This produces a liability, which converts to a cost when points are redeemed.

Inevitably, some points will not be redeemed (known as ‘breakage’), so your TCO calculation should anticipate that a percentage of your points will expire and have no direct cost to the business. However, the indirect cost of expired points is customer frustration in that they were not able to achieve a reward. A healthy loyalty program really wants the breakage to be as low a percentage as possible since the points are meant to be an investment in growth.

If you issue a partner’s loyalty currency, that comes with the direct cost you have to pay the partner for the privilege of issuing their points. However, issuing the points/miles that customers really want to collect in more popular loyalty programs averts a lot of the work, risk and responsibility of being responsible for managing your own loyalty currency. So, issuing someone else’s points/miles should lower the TCO across other areas of running your program.

As to how you budget for points: it could be tempting to simply calculate 1% of your predicted qualifying transactions on the basis that every customer would earn 1% in points. In fact, if that’s your planned incentives structure, you’re potentially embarking on a somewhat regressive loyalty strategy, because the right amount to issue in points is almost never 1%.

Firstly, many customers are rational and will only join a loyalty program if they can earn at least $25 in points value per year, so unless they shop the brand almost every week or two (or spend larger sums), the overall loyalty value they can earn often isn’t enough to keep them engaged.

To compensate for lower customer frequency in your category, you can:

• offer more than 1% of revenue in the form of points
• engineer rewards so that the perceived value of the points is in the 2% to 10% range.
• create loyalty partnerships, so that customers can accumulate worthwhile value across multiple brands.

But in any case, more useful sums of points value will exert greater influence over customer behavior (and also make you a more attractive partner to other brands).

Secondly, with a sufficiently flexible loyalty rules engine, it’s possible to dynamically vary the points value based on predicted ROI. For example, if a customer has not shopped with you for 6 – 9 months, you might offer a ‘welcome back’ bonus on top of the normal earning rate. By contrast: if you discover that some customers’ behavior is seemingly unaffected by higher accrual rates, it could indicate they’re just not interested in the program or are less price-sensitive, so you might want to reduce investment in that customer.

If you’re setting up a new program, you will likely need to start campaigning to know your optimal cost of points issuance. But outside of high-frequency industries like grocery or fuel/convenience: if a loyalty program is issuing less than 2 – 5% overall, it’s probably too little. In high-margin businesses like car washes or coffee chains, the optimal figure could be 5 – 10%; maybe 20% on a branded coffee cup.

And for all businesses: if more than around 25% of points expire, your brand is probably losing money in the form of lower customer lifetime value (CLV) because your customers are simply not finding interesting redemption opportunities.

Funding rewards and driving the redemptions that matter

When you’re funding rewards, you want to maximize the gap between the direct cost of providing that reward, vs. the perceived value to the customer.

Brands that have a lot of distressed inventory and provide aspirational services can do this easily. An airline can budget around $40 per seat that would otherwise go unfilled; a hotel can budget the cost of redeeming for a room that would not be sold otherwise at around $10 for the cleaning cost. But the customer may perceive that those rewards are worth hundreds or even thousands of dollars – so they could have a powerful influence on customer loyalty. You could make similar comments about most providers of high-margin experiences such as theme parks, concerts, etc. This is precisely why high-margin businesses with distressed inventory make great loyalty program partners.

It’s trickier in business categories that sell physical goods, where the lower margins make it harder to offer discounts, so these companies can be more reliant on partner inventory. And even hotels and airlines benefit from some partner inventory to maximize the appeal of their programs.

So, when you’re calculating TCO, you likely need to budget for redemptions from a wide range of partners. The ‘old’ way of doing this would be to simply outsource this to a redemption catalogue provider. That would make for an easy TCO calculation, but likely at lower ROI compared to assembling the rewards yourself based on your unique insight in your members.

Running your own redemption environment, and the ability to display your handpicked partner redemptions, vouchers and gift cards, is now quite easy with low-cost ecommerce technology.

It’s also worth mentioning that partners may be willing to fund your rewards in exchange for advertising space or visibility among your program members. This practice seems to be widespread among payments startups (who may feel they have little margin for funding rewards themselves, since interchange fees have been curtailed in many markets). The payments firms may also be able to share great insight into which of their customers could represent high CLV to a partner’s business.

The ‘Perks’ account offered by Monzo, a challenger bank, for example, appears to rely partly on merchant-funded offers, whereby the merchant only incurs a cost when the customer redeems the offer, and the bank incurs little to no direct cost enabling the reward.

Of course, not every brand has the prestige or scale to be valued as an advertising partner. But for those which do: their partnered brands will value the opportunity to gain access to their members at a lower cost of acquisition than in other sales channels. And if you can do this at scale, it can significantly reduce your reward budget as a share of the TCO.

Also, rewards can be a lot more affordable if they are not offered equally to all customers, but tilted in favour of those with the greatest promise of ROI. Doing this properly requires modern technology for things like dynamic pricing and personalization. More on this later.

Staff costs

As mentioned above, like-for-like comparisons between programs are not always possible, because the work of running them varies greatly depending on the programs’ scope, aims, and the business category of its parent brand.

Nonetheless, some loyalty programs appear to be doing comparable work with greatly different team sizes. Certain newer regional airlines, for example, are running highly successful loyalty programs with only 2 FTEs, whereas traditional airlines may have 50 to 80 people working full-time for the loyalty program but managing only 5 or 10 times as many members.

One area you can’t really cut back on is partner account managers. Each one should be overseeing a minimum of around $250,000 in partner revenue. This figure will be a lot higher in many cases but nonetheless, your best relationships need to be nurtured, and an account manager can only run so many accounts effectively.

But I know of one enterprise program with 10 partner account managers and 50-80 other staff. It’s in these other layers of management that some loyalty programs could possibly streamline operations to reduce cost.

This should be a big call-to-action for every loyalty team to be seeking to optimize their TCO. The past several years have been good for enterprise loyalty as the industry has grown, but growth curves do not continue indefinitely. When growth slows, staffing levels is often one of the first places companies look in order to keep finances healthy.

Employers will generally prefer to retain those people who have made the greatest net contribution to the business in recent years, so every loyalty professional should be working to become recognized as one of those agents of change.

Advertising costs for customer acquisition or to drive frequency

Aside from loyalty points and rewards, the loyalty team also has to think about ‘general marketing’: brand awareness, communicating with members, promoting new partnerships, B2B advertising to potential partners, etc. These costs could be comparable to many other brand marketing functions.

*

Generally speaking, every mature enterprise experiences some degree of bloat, whereby operational costs become accepted as a standard cost of doing business, and people stop questioning whether the money could be better spent elsewhere.

It is not the purpose of this article to guess all the ways in which money and time are spent on marketing actions. But we suggest making a list of all loyalty program marketing activities and rank order the list by annual cost. Then, evaluate which actions within each category no longer produce the desired ROI, and test reducing or removing those actions.

Optimizing and accelerating new partner acquisition

For any loyalty program whose parent brand sees members spend money less than once per month, building an ecosystem of program partners will probably deliver significant, positive results. It will allow customers to engage with your program and brand more widely via partner touchpoints.

If a loyalty program has a set budget for partner acquisition, the objective should not be to reduce this budget, but to make the process more efficient so that the brand can acquire and onboard more partners for the same cost.

Those partner setup costs will include commercial discussions with potential partners, the legal effort to establish commercial agreements, technical integration effort, planning joint marketing actions, ongoing reporting and reconciliation and settlement.

Currency Alliance specializes in managing the entire lifecycle of multi-partner collaborations efficiently at scale, so we see many data points across clients in which they have reduced traditional costs by 60% to 80%. This frees up valuable resources to focus on higher priority activities.

Read our article on optimizing the partner mix here.

The share of TCO accounted for by new partner acquisition should be as high as you can justify, based on how many partners you can realistically acquire and onboard, and how well those partnerships help achieve your customer engagement goals.

Fortunately, much of the friction and associated costs around new partner onboarding has now been resolved.

Technical & legal obstacles to new partner onboarding

On the technology side: brands have historically relied on hardcoded point integrations between legacy technology platforms which, similarly, might have taken 6 months and cost $80,000 worth of time to implement.

On the legal front: once a collaboration with a new potential partner was reached, the legal team got involved in drafting a contract. However, that agreement could take 6 to 12 months to get done because the legal team’s priorities are typically working on new leases, contracts around the company’s supply chain, dealing with regulations, and other governance tasks. And, maybe no standard partnership template existed, so an agreement needed to be created from scratch.

That’s why Currency Alliance now offers standard frameworks for partner contracting, which reduce the legal burden to almost nothing. Read more about these here.

Such time and cost implications meant that brands only added 1-5 new enterprise partners per year; smaller partners never really got considered because the ROI would have been negative after all the setup cost.

And, due to the difficulties described above (along with a splash of legacy thinking), sales team has rarely been motivated to work on anything except flagship deals with other enterprise brands.

To illustrate how lucrative these partnerships can be, most of the top 10 airline loyalty programs earn between $100m and $1b from their co-branded card partners.

At the other end: some middle-income customers may spend less with luxury brands – but they are far greater in number than high-income customers. Adding partnerships with many different brands in different spending categories, including SMEs, is the best way for loyalty programs to address this mass of mid- and long-tail customers.

Accounting, settlement and reconciliation

The largest loyalty programs issue hundreds of millions of dollars in points value per year, and process accrual, exchange and redemption transactions across dozens or hundreds of partners.

This requires a significant investment in sending and chasing invoices, settling bills and accounting – though a lot of this can be automated in modern loyalty platforms. For one large client, Currency Alliance automated their invoicing of partner brands using their currency, and they made two accountants redundant. It is not our goal to reduce headcount, but rather ensure available resources are working on the tasks that maximize the effectiveness of your loyalty program.

*

Once you start eliminating all these costs and friction, it also changes how you view the TCO of your loyalty program.

The point is, loyalty programs should work to bring the costs of new partner acquisition as close to zero as possible, so that new partnerships produce positive ROI almost immediately.

This was one of the core problems that Currency Alliance was founded to solve. You can browse our loyalty partnership marketplace, send out new partner requests in the platform, and forge new partnerships in a few clicks (subject, of course, to agreement between collaborating brands).

Find out more here.

Technology investment: capex and ongoing costs

Loyalty technology platforms were some of the first marketing technology ever made and so we still find brands running on software that’s 20 years old – and possibly 10 times more expensive than a modern SaaS alternative. That tech, in turn, may be running on legacy data architecture, where modern cloud databases could be several times cheaper or more agile in driving customer engagement.

Seibel from Oracle, for example – which is still in use by some brands – only runs on Oracle databases, which are by far the most expensive in the world. Modern cloud-based systems may be only 10% of the same cost.

Having said that, replacing a piece of technology like an enterprise loyalty platform will both incur significant direct costs, as well as gumming up a lot of other resource internally as the company undertakes development work and change management. So, these older systems continue to exist.

Such changes, though difficult, are essential because loyalty programs still running this legacy tech are spending $3-4m which could help fund customer rewards.

But the ‘big change’ of an out-and-out platform replacement can be deferred via the ‘strangler fig methodology’ whereby modern tools are built around the legacy platform, gradually, until the legacy platform can be removed with reduced disruption.

The goal should be to define a long-term investment program that ensures the best-fit technology and services are available in your marketing software stack, when needed, to drive customer engagement.

Now, let’s consider the different areas of technology investment which you may want to consider as part of your TCO calculation.

Simpler setups for SMEs

For SMEs, additional technology investments may not be necessary, since modern loyalty platforms such as Antavo, or Capillary’s loyalty solutions, come with most or all of the technology you may need for a scalable system that can adapt to needs as they evolve.

But every business may also consider investing in some or all of the following areas depending on their requirements.

Additional marketing and loyalty technology

Similarly to the partner management features, many larger brands may find the native features of their loyalty platform insufficient for marketing.

This has been true for a long time, particularly with CRM technology. But now that AI-based targeting and personalization is becoming a reality, more enterprises will want to take advantage of this new technology with specialized tools.

CRM

Every business should seek to work around a single source of truth on the customer, so ideally, the native CRM within your loyalty software should be integrated with your main enterprise CRM so that all campaigning can be synchronized.

Such integrations are mostly out-of-the-box these days, but many smaller companies may want to make a modest investment in tailoring the integration to their needs.

Pricing, promotions & personalization

Once a loyalty team has full command of its customer data, it unlocks an altogether more powerful range of possibilities for marketing. It makes it possible to start incorporating other technologies which allow incentives and promotions to be personalised and tailored dynamically based on optimal ROI.

Rewards in loyalty have historically been showered on the best customers, i.e., first-class seats for frequent flyers. This only makes sense up to the point where the customer would have bought the first-class seat anyway. Beyond that point, that budget could be better spent influencing another customer to increase engagement with your brand.

To keep TCO at an optimal level, rewards should be tailored to your customer segments, and the value should vary dynamically, based on:

• the context of the customer and predicted CLV
• the reward inventory and whether it may become distressed
• external factors that may influence a buying decision – such as the time of year or the weather.

This should make far more productive use of your reward budget. The TCO may not come down, but the predicted ROI on these activities could be higher.

Varying reward value dynamically will require technology including:

• an API-first redemption environment such as modern ecommerce platform, so that customers see personalized offers rather than generic ones. Ideally this would sit behind a login by the customer, so what one member sees does not have to be shared with all other members
• a highly flexible loyalty rules engine which can interact with a range of variables
• an AI-enabled data processing layer which runs an algorithm to determine optimal reward value for a given customer at a given time
• and data sources feeding that algorithm, including the CDP (customer data platform), revenue management system, etc.

This can be as complicated as you want to make it, but enterprises would certainly not want to underinvest, since the power of personalized rewards directly affects ROI.

Modern data architecture & AI processing

Many enterprise brands are now investing in similarly sophisticated technology setups for the purposes of everyday promotions and media advertising.

Such developments are happening in sync with the evolution of enterprise data architectures in general. Companies are investing rapidly in cloud data storage and MDM (master data management) as they seek to orchestrate much of the data in the business and put it to work.

The advantage of running AI is that disparate data sources can be combined to produce business intelligence and allow decision-making to be automated at scale. This unlocks many of the possibilities we’ve discussed around dynamic pricing and redemption values, personalized campaigning and inventory management.

But it also creates the opportunity to avert waste in areas such as human error, cybercrime, and responding to business disruption.

In just one of many hypothetical examples, AI decisioning could be used to predict the impact of a natural disaster, an epidemic or a war on the travel industry, and start adjusting program economics to help the company optimize trade during those changed circumstances.

We don’t recommend factoring such events into the TCO, but plans should be in place to rapidly adapt cost structures and revenue streams in such eventualities to protect the long-term business.

Read our article on usage of AI in loyalty marketing here.

Investing for a more competitive loyalty landscape

Until a few years ago, the major enterprise loyalty programs could behave as if they were not in a competitive market.

Most companies’ loyalty costs have been defined by their own internal, historical decisions. Nor has there been much price competition because there has been little industry alignment or benchmarks against which to compare operations.

The immediate future of loyalty looks very different.

Today we have a radically more dynamic loyalty landscape, where members expect to be able to shift their loyalty value around to where they get the greatest value, and for their favorite brands to be the enablers of that flexibility.

Now, therefore, the only sustainable way forward is to maximize the effectiveness of a loyalty program for the lowest possible TCO.

If you compare the motor industry, comparable brands (e.g., Ford, Toyota, etc) all have about the same cost of goods sold because they have been forced to become disciplined by the competitive market. You could make a similar comment about most ecommerce, and also about the other marketing functions of many consumer brands; travel brands, for instance, all work to roughly the same cost per action (CPA) from paid advertising.

The lack of benchmarks in loyalty remains an ongoing reality, so each leader should do their own analysis and set their own priorities by trying to accomplish the best results for the most streamlined cost. The results should be meaningful benefits for all stakeholders (the company, the member, and fair KPIs for any partners).

Some cultural and structural transformation is needed.

Where some loyalty programs run relatively independently as subsidiaries, in most cases, the head of loyalty does not control their own budget; instead, this resides with the parent brand’s CEO.

This can produce disincentives for both parties to control costs. The CEO will have little time to think about optimizing recurring fees (and maybe even less time if that process requires some upfront capex). The head of loyalty, meanwhile, will naturally fear telling the CEO that their department is overfunded. And indeed, loyalty teams are not accustomed to continually optimizing their own processes in the way that teams are in industries such as logistics, ecommerce, etc.

That said, the phrase ‘total cost of ownership’ is now widely used in discussions about enterprise technology and it’s exciting to hear this now coming up in loyalty as well. Those companies that translate discussion into action will be running far more cost-efficient, resilient, and ultimately more popular loyalty programs in the coming years.