Businesses that continually acquire new customers but struggle to keep them are less likely to experience profitable bottom lines results. When a retained customer leaves, the revenue stream from that customer is lost. Along with losing sales, the company also forfeits the advantages of keeping clients, such as cheaper service and marketing costs. A new customer that purchases less frequently and in smaller amounts needs more assistance and is less likely to refer to new customers. Replacing the loyal customer is going to come at a higher acquisition cost. Thus, a business with a poor retention rate must therefore incur additional costs in order to generate the same level of revenue. At its core, a loyalty programs’ mission is to boost the retention rate, a measure commonly used as a typical indicator of a brand's “health”, and a proxy for future revenue.
Customer lifetime value
When businesses focus solely on acquisition, they run the risk of gaining less quality customers that require more effort to retain. Thus, the expected returns from these customers may diminish as they become costly to retain. Ideally, businesses should aim to grow sustainably by retaining & acquiring the right customers. The most useful & widely used measure of this is customer lifetime value. It is the total revenue expected to be generated by a customer during their lifetime.
For DTC businesses, one of the most common conceptualizations of a loyal customer is a customer that keeps coming back & purchasing in higher frequency. Understanding this metric gives a sense of how engaged they are with a brand & measures the effects of the loyalty program on customers’ behavior. For example, F&B and apparel brands are more inclined to consider this measure as an important indicator of loyalty.
Average order value (AOV)
Aside from purchase frequency, another central KPI to look for when measuring the effectiveness of loyalty programs is the average value of orders or spending. It measures the average amount of money that a customer spends when they purchase from your store. When this value increases, it is a good indicator that a brand is retaining higher value customers.
RFM (recency, frequency, monetary)
A practical method for assessing consumer usage and loyalty patterns is recency, frequency, and monetary value analysis. Recency refers to the most recent service contact or transaction. Frequency measures how frequently these customer/company events happen, whereas monetary value examines how much a client commits to spending, investing, or committing to a certain brands’ products or services. This method is also highly relevant for tier-based loyalty programs.
Online retailers have adopted RFM analysis with unexpected results, following the example of direct marketers who are prominent users of this measure. For example, new clients cost apparel e-tailers 20 to 40 percent more than their brick-and-mortar counterparts, whereas retained online customers spend more than twice as much in the first 24 to 30 months of their relationships as they do in the first six months.
To further illustrate, let’s imagine a customer who spends $200 on products she needs from an online beauty store while on vacation, while not having that brand in their country of origin. As the beauty store considers this transaction “high value”, they place this customer in their “favorite” customers list, enroll them into their loyalty program and start sending them costly emails, SMS & other marketing assets with no follow-up transactions. If they applied the RFM approach, they would quickly find that this customer doesn’t adhere to any of the 3 RFM dimensions.