Leveraging CRM spend in retail banking

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1 Leveraging CRM spend in retail banking Insight Newsletter No 2: 2007 Getting What You Paid For: Cost Allocation of a Relationship Loyalty Program By: Gail L. Sneed, Director of Professional Services, Maritz Loyalty Marketing. From extensive loyalty marketing research, we know that in the retail banking business, breadth and depth of the customer relationships positively influence customer retention. And, the value of a customer increases as service penetration expands, both within a Line of Business (LOB) as well as across multiple LOBs. So, for financial institutions that want to develop long-standing customer relationships and increase customer value, marketing that supports the entire customer relationship not just that of an individual product line or service is imperative. Exposing customers to multiple products and services, and giving them the ability to earn valuable points for using these services, will enhance their value. Loyalty programs that provide a comprehensive reward structure across several LOBs effectively leverage the products and appeal to broader customer needs. Program Design When designing such a loyalty program, a bank needs to consider how each of these criteria will affect the individual LOBs: 1. Long-Term Focus The program should have a long-term focus. Rewards programs are not like short-term marketing promotions. Customers build equity over time in effective Rewards Programs. Therefore, it is imperative that a program be designed for at least a 3-year term. 2. Payout on All/Not Just Incremental Behavior It is impractical and counter productive to reward for the incremental gain. However, evaluation of ROI in all cases should be built on the incremental profit derived from the rewardable behavior. 3. Identify Profitable Behaviors Behaviors for each LOB should be deemed profitable, and rewarded as such. 4. Focus on Profitable Customers Although unprofitable customers should not necessarily be excluded, it is important to identify the behaviors of the enterprise s profitable segments and encourage/reward the desired behaviors. Marginal customers will have the potential to migrate to higher levels of profitability once properly incented. 5. Measurable Behaviors that are deemed profitable must be easily measured and tracked within the LOB transactional databases. Page 1

2 6. Positive Behaviors Experience has shown that programs cannot be designed to steer customers away from unprofitable activity; e.g. earn points for fewer Branch teller transactions, rather earn points for debit transactions above a certain dollar amount. 7. Clear Communications Customers must be able to quickly and easily understand the structure of the rewards program and how they may be able to benefit from it. Complicated rules will only cause customers to shy away from participating in the rewards program. 8. Promotable Effective rewards programs are easily promotable to the target audiences. Opportunities to highlight certain programs, products and/or services should be accommodated in the design of the program. 9. Legal and Ethical The design of a Rewards Program must be constructed to reward behaviors that are both legal and ethical. For example, rewarding credit card holders of low credit worthiness to revolve high monthly balances is not ethically appropriate. So, a relationship banking loyalty program sounds like the answer to increasing wallet share across several product lines. The question is, how do you justify the costs of such programs within each LOB? And how do you break down the internal silos to ensure the LOBs are contributing their fair share to these expenses? The first thing that needs to happen: A formal loyalty assessment to determine the financial viability of a relationship loyalty program. Specifically, you need to know if the initial LOBs chosen to participate in the program have sufficient mass and potential to significantly impact the organization s objectives for customer retention and growth. Do they have the opportunity to reach a broad audience of customers and deliver significant incremental profit? Each LOB should go through an assessment to quantify its financial impact, as well as its contribution to the ROI of the program as a whole. Model for Assessment of ROI The following model illustrates the components that drive ROI for each of the lines of business (LOBs). Rate of Improved Retention Rewardable Behavior Incremental from Loyalty Program Cost (Fixed & Variable) ROI Retained Customers Current Rate of Attrition Average Customer Page 2

3 A thorough assessment should analyze the current attrition rates and customer profitability, and it should project improved rates of retention and incremental profits the loyalty program is expected to produce. These projections should be based on industry trends, customer data, and a well-founded methodology to determine the correct rewards structure for each profitable behavior included in the program. Fixed and variable costs can also be determined based on the size of the customer base and the scope of the loyalty solution. Fixed Costs In most rewards programs, fixed costs represent only 30-40% of total costs. They include initial set-up costs, program operations, communications, and member services such as customer service, call center, IVR, web design, etc. Fixed costs can be allocated in different ways, but the recommended way is having expenses incurred at the corporate level rather than at the LOB. In this scenario, the costs are not driven down to the LOB for profitability calculations, and they are treated as a general marketing expense. Often banks will dedicate a team in the Marketing Division to manage all loyalty initiatives, and all costs are assigned to this cost center. This team then monitors all loyalty point issuance, redemption, and breakage from one sole account. Because relationship programs produce bigger picture benefits - derived from improving household profitability, and because the customer becomes loyal to the brand and not just the product - treating this as an overhead expense at the corporate level seems to make sense. However, for initial assessment and benchmarking, fixed costs can be divided equally among all of the participating LOBs. Although this does not represent actual usage of the services, it does allow a comparison to determine which product line reaches its break-even point earlier and serves as a profitability driver, vs. true retention based products that do not always have high profitability, but tie the client in to the bank. Note: this could cause the points to be unfairly allocated which could lead to some disagreement among the products involved. A way to possibly ameliorate that is to take a phased approach after the program is established; allocating, for example, none of the costs in year one, 50% in year two, and so on. This would gain support from the product lines and gain momentum in the program, plus give a truer understanding of actual cost allocation. Another way to look at fixed costs: They can be shared using the same methods as all other allocated expenses. In this method, the LOBs share the expenses in the same manner they are accustomed to receiving other allocations, and it provides continuity with the institution s accounting guidelines. Although this is not necessarily representative of the program itself, it allows each product line to share in the costs and is directionally correct to get a true sense of the impact on the program to each LOB. And finally, allocating fixed expenses according to the total contribution of profit to the company. If the point earnings structure is based upon profitability of the products and behaviors, this method is the most representative of the actual cost to each LOB. However, it also requires the most ongoing management, as well as truing up these allocations based upon budgeted vs. actual participation in the program. Page 3

4 This could change significantly depending on market conditions, competitive offers and product campaign focus. For instance, in one accounting period, home equity usage may be up, causing it to be more profitable than investments, and therefore, get allocated a larger portion of the fixed costs. However, during the next accounting period, the reverse may be true, requiring adjustments to the allocation of these costs. Variable Costs The cost of reward redemptions represents variable costs that make up the other 60-70% of total program costs. A major part of any program is managing the overall cost per point by strategically selecting reward offerings based on customer profitability tiers within the program. Experience shows that point earnings typically increase after the first or second redemption, and attrition significantly decreases in those who have redeemed points. Therefore, redemption should be encouraged in order to maximize the effectiveness of the program. Since the origination of the point earnings can be tracked, they can be charged back to the LOB which benefited from the customer behavior. LOBs can be charged for the redemptions in 2 different ways. LOB Monthly Points % of Total Total Monthly Breakage Realized Issued Redemption Cost ($.01 per point) Credit Card 5,000, $34,956 $15, 044 Debit Card 1,250, ,842 3,658 Deposits 3,500, ,470 10,530 Loans 2,000, ,982 6,018 Total 11,750, $82,250 $35, Points are charged from a central cost center at a discounted rate to account for breakage. For example all points are accounted for in the Loyalty cost center at $.01 per point. The LOBs are then charged by the Loyalty Division $.0075 per point issued for that product. As customers redeem points, the cost of redemption is charged to the Loyalty cost center, with actual breakage remaining in this account. A corporate entity is the comptroller of currency that manages the points in accrual and redemption accounts. Points are sold to the product lines at the issuance based upon the cost per point including redemption and breakage. The cost per point is the same for ALL lines of businesses regardless of what their individual redemption cost may be. In this scenario, each LOB benefits from a portion of the breakage, but still allows the centralized Loyalty cost center to realize some of the breakage as well. 2. In the alternative method, each LOB is charged only at the time of redemption, based upon the percentage of total points earned from that product in the overall program. This allows each LOB to take advantage of all of the actual breakage, and more closely matches the reward expenses to the LOBs participating in the program. Page 4

5 The allocation of these costs can be adjusted annually, bi-annually, or quarterly to reflect true point earnings for that particular time period. Those earnings may fluctuate due to various bonus point campaigns, product life cycles and market conditions. Although this method does not allow each customer s redemptions to match their actual earnings, it does follow the overall point earning trends for the entire customer base. Regardless of how costs are allocated to each LOB, a Relationship Loyalty Program is beneficial for the financial institution and the client. The key is in completing a thorough analysis during program design to determine the best cost structure for the bank, stringent accounting of redemptions and allocation policies during program management. This article is reprinted from the Maritz publication Loyalty Matters, Vol 3, February Achievement Awards Group is a Maritz Associate Partner. For more information About Achievement Awards Group Achievement Awards Group (Pty) Ltd Tel No: Website: Achievement Awards Group delivers customised, full-service incentive and performance improvement solutions. We help companies motivate, reward and recognise employees, business partners and customers. Page 5

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