The metrics of loyalty

Question: Do loyalty programs work?

Solid answer: Depends.

Sorry. I know you were expecting a quick, definitive answer. So was I. But there’s not one. Over the past year or so we have seen the sudden appearance of computerized loyalty programs in the motorcycle space. It quickly became the buzzword, and everybody was asking if they should jump on, or not. After all, we all use them (think: frequent flyer miles), we are all influenced by them, and (come on, admit it…) we even base some buying decisions on them.
So now we have loyalty in motorcycle. And the question is, “Does it really work?”

Well, I didn’t know for sure, so I decided to dig in. Spoiler alert here. My answer is not going to be pretty. But it may help.

The first layer of the answer is, please ask a better question. “Does it work?” doesn’t quite cut it. Work how? More money in than out? Customers come back more often? There is a decrease in discounting? What do you want to know?

So here’s my take on it. But, before we start, could we agree to limit this discussion to parts sold over the counter? I know, major units are involved, but that is a much more difficult question to answer. For now, I would like to limit this to just parts over the counter.

And that answer comes in layers. Here’s the first layer:

Do I have better customer retention with a loyalty program than I did without it?

And even this is hard to answer. To get to a “yes” or “no,” I first have to know what your customer retention was before you installed loyalty. Results will be measured from this baseline. And to get it requires several years of data that is hard to dig out, and even harder to understand. For this reason, I am going to dodge this part of the answer, and tackle it in a later article. Stay tuned.

Now, the second layer: Am I getting my money out of this program? Do I get more net cash back with it, than I would without?

Let’s get back to that baseline thing. You want to know if you are getting your cash out of loyalty. Well, I need know first what you were spending to “buy” your customer’s loyalty. Whatever that cost was, that becomes my measuring point to see if you are getting money back on your investment.

So, what is your cost of buying customer loyalty? Yeah, it could be the rides, the food, the events, or the community service that you fund. But in reality, it comes down to what you sell your stuff for. Is the price you charge low enough that the customer sees good value in returning to you? And that’s about it.

Discounting: Buying loyalty

Which brings us quickly to discounting.

Think about it. Aren’t discounts simply buying the customer’s loyalty? And if the other intangibles aren’t enough (your location, your beautiful store, your hours, your personable salespeople, your presence on the floor, etc.), they go away. So you sweeten it by adding cash in the form of discounts to the equation.

And that cash outlay is the starting point for understanding the value of loyalty. Just how much cash must be returned to the customer to make them loyal?

I started by looking at 81 dealers who have installed loyalty in the past year. I looked at their install date, and then figured the amount and size of discounting they did for the 12 months prior to the install day, and then the 12 months after.

Chart A is what I found. Now, my sample size here is a little small — we’re in new territory here — but it does give us something to go on. I divided discounting into two components: First, the percent of parts counter tickets that have a discount (after first excluding internals and wholesale), and then, the depth of that discount, or how much was taken off on the average ticket where discounting was present.

Chart A shows three different dealer types, and the percent of invoices that were discounted in the 12 months prior to adaption of a loyalty program and the 12 months after adoption.

We see that V-twin dealers dropped their discounted tickets from 36.5 percent to 31.9 percent (down 4.6 percentage points, or 12 percent overall decrease).

Metric dealers went from 33.6 percent to 27.7 percent, and a handful of Canadian dealers went from an astonishingly high 46.3 percent of customers with discounts, down to a “respectable” 28.4 percent.

Ok. That’s half of what we want to know. The other half is, what happened to the rate of discount on each ticket?

Chart B tells us: The rate for V-twin went from 9.3 percent off, to 8.7 percent off. Metric dealers dropped from 8.6 percent off, to 7.9 percent off. And the Canadian folks cut that discount rate by almost one-third after installing loyalty, dropping from 14.1 percent to 9.2 percent.

Gross margin gains

And what does all of that mean? First, we throw out volume and level the playing field so we can see the effects of just the discounting. I took a flat 30,000 invoices for each group, each with their own average ticket, and found that gross margin changed as follows before and after the installation of a loyalty program:

• V-twin gained $19,000 in gross margin with loyalty.
• Metric gained $21,000 in gross margin with loyalty.
• Canadian gained $133,000 in gross margin with loyalty.

That is the effect of decreasing both the number of tickets discounted, and then the rate of discounting on those tickets.

And this becomes the currency I will use to pay for the costs of my loyalty program. If this literal cash amount is greater than the cost of the program —including the cost of the merchandise I have to hand over the counter for free — I win. If not, it was a losing proposition.

So what was the cost? And the answer? Well, I don’t know. BUT, I can approximate it based on four different assumptions. Four variables affect the cost of the loyalty program. Here we go:

The First Variable: The rate at which points are given to the customer.
I see a range from 3-5 percent of purchases for this. For example, if the customer buys $1,000 in parts, he or she gets anywhere from $30 to $50 in credit, with which they get “free stuff.”

The Second Variable: How many of my customers with points will come back and ask for goodies?
Guess what. Look in your wallet. Tell me how many gift cards you have that have that have expired or will expire. Various sources tell me that this is running about 20 percent. So you will probably see a request for free stuff only about 80 percent of the time.

The Third Variable: What is your cost of goods sold? What is your gross margin rate?
If you are maintaining a high margin in your pricing structure, your cost of giveaways will be lower that the low-baller down the street who runs on cost plus nada. Every dollar in merchandise he slides over the counter costs him a dollar. For you, it might be only 60 cents. And this becomes a major factor.

And the Fourth Variable: What is your fixed monthly cost to license the program? I see that this cost ranges from $175 to $300 per month.

With these facts, I’m going to construct two cases. The first case will be a high cost program that has the following conditions:

• High accrual to customers at 5 percent of purchases
• High loyalty redemption rate of 80 percent
• Low gross margin on merchandise at 30 percent
• High fixed cost of $250 per month ($3,000 annual) for the loyalty program

The low cost program will be:
• Low accrual rate to customers of 3 percent
• Low redemption rate of 70 percent
• High gross margin on redeemed merchandise at 40 percent
• Low fixed cost of $175 per month ($2,100 annual) for the loyalty program

The results of these two cases are summarized in Table 1. But before reviewing the table, keep in mind that there is no value given here for an increase in customer retention. And (let’s hope) there certainly should be.

But given only the measureable facts that we have, we see in Table 1 that the V-twin and metric folks come out ahead only if they tightly monitor the conditions of the program. They pick up $4,200 and $8,300, respectively, over the year. But the Canadians — largely due to their abundance of currency from cutting both the rate and frequency of discounting — are making a cool $114,800 on just these 30,000 invoices.

Now, what if we move all these dealers to the high-priced spread? Give away a ton on the percentage of points, make sure that everybody comes back in to get their free stuff, and have that free stuff marked at low prices so they are sure to get a wheelbarrow full?

If they do, the V-twins and metrics are suckin’ air. And the Canadians? They are still killin’ a fat hog. We’ll be talking a lot more about this, I’m thinkin’.

Oh, and one more thing. You want a little more cash to pay for this thing? Change the discounting culture in your store. No more. It’s got to go. Give those good customers points. Keep your cash, and hopefully, watch them come back for more.

There’s the facts, folks. Read ’em and weep. Or better yet, carpe that diem.

Hal Ethington has been associated with the powersports industry for more than 40 years. Ethington is a senior analyst at ADP Lightspeed. Contact him at Hal.Ethington@adp.com.