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Loyalty Finance Part 2: Loyalty Programs, a Liability or an Asset?

Loyalty Programs: A Liability or an Asset?

For many accounting professionals, understanding the loyalty program as a liability to the company is hard to avoid given the massive program liability they have to book on the balance sheet.

But under the surface of risk, a healthy, successful loyalty program that contributes to profit is actually a powerful asset. Because a program is a portfolio of members, its value is simply the sum of the value of each member — meaning every member is, in turn, an asset to the company. Just like any other asset, the value of each member is related to the expected profit they will generate in the future, net of the redemption costs implied by the liability.

(To learn more about program liabilities, see Part 1 of this three part series.)

When loyalty programs are viewed as assets, it becomes clearer why successful businesses utilize them. A loyal (and therefore stable) customer base is more valuable than a high-turnover customer base. A loyalty program that can increase the future profit from its members will directly generate long term financial value for the organization.

What does that mean for program managers and accountants?

It means they should leverage modern tools to focus on growing the expected value of individual members over time (growth in value is often referred to as incremental value). It means they should go beyond liability evaluation and put a higher priority on measuring the program as an asset by implementing the tools to provide future-facing program information to company leaders.

This holistic approach to value creation fosters better, more strategic long-term financial decisions for programs — but is a challenge without predictive technologies that inform Customer Lifetime Values, or CLVs.

KYROS' suite of tools give you everything you need for true insights into financial reporting and disclosures, monthly accounting, breakage estimation, program liability and customer lifetime values on an on-going basis, so you can go beyond measuring risk to start accurately predicting and influencing program ROI.

Understanding the Importance of Customer Lifetime Value

Getting a handle on the key indicators for program success is a must if you want to make smarter decisions going forward. So, first things first, let's get our terms straight:

  • Customer Lifetime Value (CLV) represents the present value of profit, net of redemption costs, created over a program member’s lifetime.
  • Customer Future Value (CFV), however, is the present value of estimated future profit produced by each program member. The key difference is that CFV omits any known-to-date quantities about a member's value and focuses solely on future predictions.
  • Member Equity can be defined as the sum of CFVs across loyalty program members. If we consider the loyalty program a financial asset, then its economic value is equal to member equity.

Calculating the Return on Member Equity (RME) is extremely useful for efficiently directing program investments. Simply put, RME is a measure of the incremental value that the program has created over a given period of time — a healthy, profitable loyalty program will see a large positive RME, indicating that the program is changing member behavior and increasing the lifetime profitability of the membership.

Many companies use a “look-alike” approach to measure the incremental value generated by a loyalty program. By splitting a cohort of similar looking customers into those that join the program and those that do not, they track the difference in behavior over time. The delta between these two populations represents the incremental value.

But there are shortfalls with this approach. Specifically, self selection can significantly distort the results.

RME is another way to quantify incremental value that doesn't face the self selection issue. The look-alike method compares member performance to a baseline that serves as a proxy for a world where no program exists. RME is similar, in that it compares member performance to some baseline.

The difference is in the baseline.

RME measures the difference relative to status quo member behavior — that is, the behavior if members continued to act as expected based on recent behavioral trends, rather than if they weren't program members at all.

If the goal of the loyalty program is to change member behavior so they are more loyal and profitable, then RME is a better measure of incremental value because it explicitly states what the baseline expected behavior is.

Common CLV Pitfalls

The importance of customer lifetime value, and having those practices dialed in for your loyalty program can be tricky. Aside from not leveraging the strategy at all, most pitfalls arise from the incorrect use of CLV metrics. Some common errors are:

  • Assuming CLV is solely historic and not predictive. This error occurs when CLV summarizes cumulative value realized to date, but does not predict expected future value. Without the prediction, the use of CLV is very limited.
  • CLV is predictive, but it is defined in aggregate. Failing to recognize that each program member behaves differently results in a single CLV to represent the average member rather than calculating a separate CLV for each member. The highest value use cases for CLV are applications to recognize differences in customers. An aggregated view significantly limits the value you can create from CLV analytics.
    • CLV fails to account for redemption costs. Making this error overstates the CLV, which can result in unsound investment decisions. This lapse also makes it impossible to truly understand redemption cost-benefit trade-offs, making it difficult to convince cost-conscious finance executives of the benefits of investing in loyalty.
  • Assuming the same breakage rate for all members. Using a single breakage rate to determine the redemption cost component of CLV for individual members is wildly inaccurate. Breakage varies dramatically across your membership. Failing to recognize this will result in a distorted analysis and missed opportunities to invest in valuable member groups.

Want to avoid these and other loyalty program errors? KYROS helps program managers look past traditional metrics and overcome pitfalls.

The importance of customer lifetime value can't be overlooked for any forward-thinking loyalty program. That's why KYROS built the analytics tools that provide predictive scoring at the member level within a on-going, self service dashboard so you can make faster, more strategic decisions for your program.

Learn more about KYROS.

Why Getting CLV Right is Your Key to Success

If each loyalty program member is considered an asset, understanding the value of each asset is critical. Moreover, the ability to accurately measure this value enables smarter management and investment decisions.

The importance of customer lifetime value lies in the context that it can add to your program liability and that it can allow your organization to better evaluate cost-benefit trade-offs. They keep you focused on value maximization rather than cost minimization. For companies with large loyalty programs, the program liability can reach billions of dollars. The program asset helps company executives and senior management understand what they are getting in return.

They also lend insights into ROI for your program marketing — return on member equity (RME) connects program management activities to organizational value, bridging the gap between marketing and finance.

Program managers can also make smarter tactical decisions when they leverage CLV and CFV in member segmentation.

Traditional member segmentation doesn't make predictions, but groups members based on similar demographic or historical behavioral traits. At best, these segments give you insight into members' past behavior, but don't provide much insight into what they'll do next. Combining the power of segmentation with CLV and CFV data gives you predictive insight into expected future behaviors for these member groups, allowing you to make program decisions that will drive ROI in the long term.

KYROS provides the tools program managers need to get real insights into their program's performance. From individual CLV and member breakage models to a comprehensive array of both cost AND benefit data, loyalty programs can see a new level of optimization between risk and reward.

The KYROS dashboard puts this power in the hands of program management in real time to empower smarter business decisions that boost incremental value and lead to stronger programs. For industry-leading tactics that maximize program value, check out the third and final part of KYROS' loyalty finance series or schedule a consultation with the KYROS team to see the dashboard in action.

Schedule Your Demo

Len Llaguno
By Len Llaguno
Founder and managing partner of KYROS Insights. I'm an analytics nerd and recovering actuary. I use machine learning to help loyalty programs predict member behavior so they can identify their future best customers, and recognize and reward them today.

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