Maximize loyalty ROI with dynamic redemption values
‘Dynamic pricing’ is normally discussed in terms of the pricing of inventory – such as the cash price for a given hotel room, airline seat, or commodities, etc. based on supply and demand. But this concept should also apply to the redemption value of loyalty points and miles.
The redemption value of a loyalty currency is fixed by most brands. But for a few years now, some travel and most coalition loyalty programs have been experimenting with dynamic values, and the results for improving loyalty ROI and customer engagement are encouraging.
Non-dynamic valuation implies it always costs the same number of points for a given reward, independent of availability, day of week, location, etc. It often involves the use of traditional redemption tables that define the number of points needed for a specific room type within a single class of hotels – though it might also mean defining the number of points required to get a tea set.
The word ‘dynamic’ implies that algorithms are applied which vary the redemption value per point, often in real-time, rather than the value being fixed or being decided manually, case-by-case.
The optimal reward value for a given points transaction could be influenced by a very wide range of factors, the impact of which changes over time. Key factors would include the profile or tier status of the member, level of demand for the inventory, expected utility of data collected, and the projected impact on customer lifetime value. But it could also include ‘macro’ factors – such as the weather, the time of year, or the economy.
Dynamic valuation of points/miles should not be confused with revenue-based accrual when the number of points/miles earned is based on the amount spent by the customer.
With Artificial Intelligence (AI) starting to impact how brands operate, the ability to optimize ROI and value for members can be optimized at scale.
In this article we will:
- describe how redemption values are already varied by brands, in order to understand the benchmark and how it can be improved upon
- outline two key areas for improvement: dynamic valuation based on the projected customer lifetime value (CLV), and based on the risk to loyalty in the event of ‘breakage’ (where points expire before customers can use them)
- discuss how partnerships between collaborating loyalty programs can enhance the use of dynamic redemption values.
The customer’s perceived value of a loyalty point can range from almost zero if they can’t find an interesting reward, to quite a significant value if those points can get them a great experience, memory, or product.
Similarly, the cost of that same point for the business should be engineered to be much less than the customer’s perceived value. The ability to play with values is magical and too few loyalty programs take as much advantage of this as they should.
And this is precisely why points are so much more interesting than cashback or discounts as customer incentives.
The Holy Grail would be that any inventory can be offered as a redemption to the individual member that values it most highly – while the cost of fulfilling that reward incurs the lowest cost for the loyalty program. This can only be achieved with advanced technology like AI, and after a great deal of experimentation.
But there are practical steps you can take towards this now, in order to maximize ROI for your program and deliver the greatest incentives for customer loyalty.
How redemption values are currently varied, and opportunities for improvement
Many brands already alter redemption values in order to keep perceived customer value high, while keeping direct costs low. Maximizing the gap between these two values is the key to optimizing the effectiveness and ROI of your loyalty program.
Points may have a nominal value of 1 cent, 5 cents or 1 dollar, but these numbers are arbitrary. They cost virtually nothing for the brand to issue, and they’re worthless to the customer unless they redeem on something.
The number that really matters is the redemption cost per point, because this is where the brand incurs real costs, and where the customer realizes the value – hopefully a much higher perceived value than the cost.
Points issued to loyalty program members represent a liability for the business that issued the points, based on the anticipated cost when the points are redeemed. There is no cost in real money until the points are redeemed, but there is a journal entry to record the liability.
The eventual pay-out could be nominal if those points are redeemed with the same company which issued the points for a service or experience with little cost. However, in most cases there is a real cost for the goods or services provided which could be 60-80% of the retail price for something delivered to the customer.
This might be the purchase cost for products, or the variable cost of services provided. Examples include 15 cents of direct cost for a coffee worth $3, or $8 in direct cost for groceries worth $10.
Having said that, this cost could be close to zero in certain circumstances.
It could be that the redeemed inventory has little or no direct cost – such as digital media, training, or other services where the direct cost barely changes regardless of how many customers redeem.
Or, it could be distressed inventory: a product or service that will have zero value if not consumed by a specific date. Examples include fruit or vegetables that will rot, or plane seats or hotel rooms that will not be occupied. It also includes merchandise that would have to be liquidated, or spare capacity at service-based businesses such as hair stylists or mechanics.
This inventory typically has a low direct cost, whereas the major cost to the business is the opportunity cost of failing to sell the inventory when it is available, because the contribution margin of a sale is relatively high.
In each instance, the customer’s perceived value will likely be the street price if they had paid cash.
Let’s start with an example using Avios – which are issued by British Airways, Iberia, Aer Lingus, Vueling, Qatar Airways, and Finnair. If a future London to New York flight is predicted to have 30 empty seats, British Airways may give the customer 3 pence worth of value per Avios – because they want to fill the empty seats. In this scenario, the customer’s perceived value may be £1,200 for the ticket, but the actual cost to International Airlines Group (IAG) may be about £25 for some ticketing cost and food.
If on the other hand, this flight from London to New York is predicted to sell out, they could generate £1,200 in incremental revenue. Or, they still may allow a loyalty program member to redeem for a seat, but at an unattractive value of 1 pence per Avios. The customer would be less likely to burn all their hard-earned points in this way – but if they did, at least the contribution margin in erased liability would be closer to that of a cash sale.
Obviously, IAG prefers the cash revenue when they can earn it, and they want to encourage the Avios member to redeem for distressed inventory on another flight. IAG might even give the customer 4 pence worth of value if they fly to Dublin and connect on a New York flight with Aer Lingus, if that flight is predicted to be emptier.
If that same member wanted to redeem their Avios for a toaster or hotel booking, then IAG would have to pay real cash to a supplier. Therefore, they are highly motivated to make the value proposition for the member so great that they redeem Avios for their own distressed inventory.
The key is that the member’s perceived value is 2-20 times higher than the actual cost. This helps you pump up the perceived value of your program, while lowering costs so customers are motivated to earn in the first place.
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We have frequently discussed the value of loyalty partnerships, on the Currency Alliance blog, in creating attractive redemptions at lower direct costs. And later in this article we will examine how these are useful in the context of dynamic reward valuations.
Hotel and airline brands have an advantage here, because traveling is so aspirational. This makes them the most desirable partners for brands in other categories, and also allowing them to create the greatest step-up in perceived value in their own ecosystems. Tour operators, cruise operators, and entertainment operators can also offer attractive redemption options when they have distressed inventory.
Normally, these brands have 30-35% spare capacity that could be used in this way. But in the past two years, travel brands have had little distressed inventory because of high travel demand.
So first, it’s worth discussing the different factors that should influence redemption values dynamically – since this logic can be applied for any points transaction, regardless of available inventory.
Optimizing loyalty ROI through dynamic redemption values
Dynamic values are helpful because they allow points to adapt to the level that creates the optimal motivation for each member to complete a desired action or behavior. This is based on a lot of different factors, but if done well at scale, it can increase engagement across all members segments and help recruit more customers to join the loyalty program and remain active. For large organizations, this complexity puts the ongoing management of reward pricing to maximize revenue or minimize cost beyond human capability.
Hotels and airlines can generally predict, within one standard deviation, whether a room or a seat will go unsold on a given date. With this insight, redemption values can be varied based on these forecasts.
But with brands making thousands of items of inventory available, there is significant scope for improved profitability if more sophisticated algorithms were used to allocate inventory and determine reasonable internal transfer rates.
The profitability of releasing a seat or room at a given price will vary as the date of use approaches, but will also be affected by wide-ranging other factors. This includes relatively simple, short-term factors, such as the weather forecast for the date of travel.
But other important data could also be factored into redemption values, with very significant potential ROI for the brand.
Dynamic redemption values based on the customer profile
It is well-established that loyalty programs offer better accrual rates to the members in the highest tiers. A Gold member may be able to earn a 50% bonus, while a Bronze member gets no bonus.
The same logic can be applied to redemptions, but few brands have yet become this sophisticated. However, there can be a number of twists. You may have a large number of Bronze members who actually spend a lot in your category, but you are getting a low percentage share-of-wallet. Offering such Bronze members better value on redemptions should significantly shift the share-of-wallet obtained.
There is sound rationale to these approaches, the obvious point being it helps to reenforce loyalty with your best customers or capture more loyalty from target customers. For example, Gold members are responsible for a lot of points liability; when their points are redeemed for owned inventory, those points can’t be redeemed on partner inventory – which would end up costing the brand real cash.
Dynamically valuing points can reduce cash outflows.
There are pitfalls to this approach.
This type of step-up in value creation can be a bit of a trap. Such value creation at scale works well during tougher economic periods and pretty well in normal times, but when there is high demand, the brand often does not have enough distressed inventory to meet demand. For example, when airlines are operating with 90% average load factors, their desirable inventory has 100% demand from people willing to pay cash. This makes it very challenging to allocate inventory to loyalty program members who want something on which to redeem their hard-earned points.
Part of the solution here is to increase redemption options via your partner network so members can find alternative rewards.
But I would argue that brands need to look beyond supply, demand and elite perks, in order to determine the optimal price of a reward in points.
Among the elite members, there will be a mixture of customer preferences. Some will feel genuinely incentivized by the attractive redemptions. Others may rely on your products or services to the extent that they require no incentives to purchase. Without the ability to tell these customers apart, the brand may be reducing ROI on some of these offers or redemptions.
Beyond the elite members, a typical large loyalty program may have hundreds of thousands of customers who are not currently particularly loyal, but who could be with the right incentives.
In that context, dynamic redemption values need to take account of predicted Customer Lifetime Value (CLV). That could include things such as the life-stage of the customer.
Any customers aged 23-29 who pay cash for a 5-star hotel twice in a year, or who collect 50,000 points on a credit card, may not be elite members – yet. But they have likely landed prestigious graduate jobs, or come from wealthy backgrounds in order to afford luxury travel.
The predicted CLV of this segment is such that you might offer them equal redemption value to your elite members. That could create a great memory of your brand, help you figure out which of these customers are truly wealthy, and potentially secure some great customers for life.
A very wide range of data could influence such decisions – including partner data showing whether the customer buys premium gas or eats in nice restaurants – and it could apply at all tiers of your loyalty program.
Truly dynamic redemption value would imply varying redemption prices algorithmically, from one customer to the next, as customer data builds, based on predicted long-term ROI for the brand.
Dynamic redemption value based on the loyalty impact of breakage
You could make a similar argument about the need to avoid breakage in your loyalty program, and the opportunity cost of points devaluations.
When accounting for the outstanding liability, brands can estimate the percentage of points that will never be redeemed and eventually expire. If that percentage is 20%, then the overall liability can be estimated at a 20% discount. Of course, a higher percentage of points expiring represents a higher percentage of customers or members who will be frustrated when they discover that they cannot get meaningful value from their historic loyalty.
It has been our experience that striving for 85-90% of points getting redeemed is optimal for most types of businesses. Hopefully you agree that a very high percentage of points should be redeemed in order to drive customer engagement by delivering value to your members.
Most loyalty programs today should have sufficient data to calculate the loyalty impact of breakage, arguably even at the level of individual customer segments.
Consider, for instance, a customer who has worked hard to save points for an interesting redemption. The trouble is, by month 20, they only have 60% of the points they need, and some of those points will start expiring in month 24.
This customer is clearly committed to your brand, but faces the worrying prospect of all their efforts being wasted. In such cases, you might offer bonus redemption value to this customer, as a one-time gesture, to avoid turning off this customer for life.
A lot of hotels do something like this, empowering staff to spend up to $2,000, in some cases, to avoid a negative customer experiences. This comes at a direct cost which the hotel group believes is worthwhile to maximize CLV.
By contrast, offering improved redemption values to certain loyal customers usually has virtually no direct cost. Most customers would be incredibly grateful to receive an offer so that they can use points which may soon expire; it demonstrates you care about their outcomes. Or, you could extend the expiration to hopefully drive more engagement during the subsequent 12 months as a member strives for their desired reward.
Such initiatives deployed at scale, across the customer base, will help you find better customers – and avert the near-certain opportunity cost of engendering disloyalty to your brand through breakage.
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The crucial point here is that high redemption rates do not need to have high redemption cost. This is how smart brands maximize the gap between the member’s perceived value and the actual cost to enable those rewards.
With sufficient data, brands can dynamically vary redemption value by a wide range of factors, in addition to supply and demand, in order to find the optimal price for a given inventory item, or for a specific customer.
If this is calculated algorithmically across all available data, in real-time, brands might even prioritize such redemptions over cash sales, even at times of peak demand, because the potential CLV for certain customers can be dramatically increased.
Currently, this would be a stretch for all but the most technically advanced loyalty programs. Some brands have 1 person looking after the loyalty program – or even fewer if this person has other responsibilities. Other programs could have 100 or more professionals involved. Larger teams would be supporting 20m to 120m member strong programs (although active participation may be modest across any size program).
In all cases, the loyalty team can pay special attention to a few hundred to a few thousand top members per month. But there is no way they have the necessary time available to pay special attention to members in the second, third, fourth, or fifth decile.
Modern CRM, Campaign Management, and AI can help here. It is not the purpose of this article to discuss the martech stack, but you can find more information in our blog on how microservices architecture can enable more effective loyalty marketing.
If you leverage modern technology, these systems can help automate personalized treatment and offers for members outside the top 5-10%. That can help you extend your reach, and help these segments achieve a significant step-up in perceived value at modest to low cost.
How loyalty partnerships can enhance dynamic redemption value
There are certain advantages to being a currency owner (i.e., a brand which issues a loyalty currency), and an inventory owner, in your ability to take advantage of dynamic redemption values. Many successful loyalty programs fall into both categories – for example, you can earn Avios when you shop with International Airlines Group, and burn the points on airline seats.
But other brands, such as American Express, rely on partner inventory to provide redemption options.
Both types of loyalty program can leverage the partner network to optimize their loyalty ROI. Here are a few of the ways in which this can be useful.
Circumventing non-compete clauses with marketplace operators
Marketplaces such as Booking.com and Expedia sell airline and hotel inventory on the grounds that the brands do not undercut their pricing, under what are known as ‘price-parity clauses’.
This has the potential to be frustrating, because as time passes, the probability of failing to shift distressed inventory increases.
The cost to fill a vacant hotel room is about $7 to clean the room, so anything above $7 is better than nothing – plus, the additional customer will probably buy high margin goods from the bar or restaurant.
So, if there is less than 24 hours left to fill a $200 hotel room, your dynamic algorithm could determine that room should be filled for as little as $7 cash (or possibly for nothing, for a customer with very high projected CLV). However, you have likely agreed with Booking.com that the room cannot be sold publicly for less than $200. This increases the risk of a total loss for the business.
But in a closed ecosystem such as a redemption platform, or via a partner’s private booking channel, you could offer a room for any reasonable amount of points or cash. The partner network is particularly valuable here because it provides the scale, in the form of a much broader customer base, which is helpful to maximize the chance of securing a booking.
The goal for a currency owner is to collaborate with partners to help them liquidate their distressed inventory at a low cost to you, but at more than they would likely earn via alternative efforts.
The best-case scenario (and probably what is happening in reality) is that an Avios member earned 50,000 Avios by flying, spending on the AMEX credit card, or among other partners, and IAG earned £500 by selling Avios to the partner brands. They then enable those Avios to be redeemed for distressed inventory that costs IAG about £25 in direct cost – a whopping £475 contribution margin on top of a very happy customer and partners who experienced positive customer engagement.
This type of value-creation is now being tested and optimized among hotel groups, airlines, and entertainment companies like Live Nation/TicketMaster. It takes technology and operational sophistication to achieve these outcomes, which is one of the reasons why I anticipate that over the next few years, we will see many medium and smaller brands cease to issue their own loyalty currency. Instead, they will simply embrace Avios, Payback, eBucks, HHonors, MileagePlus, Bonvoy and other popular loyalty currencies as their own – because these programs are more popular, but also because they can help create greater perceived value in a broader ecosystem of complementary brands, which in turn drives customer behavior within the ecosystem.
Manipulating loyalty value in both the brand’s and the customer’s favor
There is a balance to strike between offering fair and transparent valuations – which customers find helpful – and not being transparent so that the brand can more easily manipulate the value in favor of greater ROI.
Most brands can define various different values for their points depending on where they’re redeemed: whether internally, or with partners. The brand can define the anticipated cost per point to determine the liability on their balance sheet for all points in circulation, and set the value accordingly.
Of course, this is harder to do if you are overly transparent about the redemption value of the currency, because this can cement customer expectations.
Programs like Norwegian Rewards that have a very transparent value of their loyalty currency cannot easily benefit from these types of dynamics. This is a key part of why they are now collaborating with Strawberry Hotel Group to create a new coalition loyalty program, with a less transparent value of their loyalty currency. But there are 2 factors which make this easier.
One is if you own your inventory, which most airlines and cruise lines do. Now that most large hotel groups are asset-light, they would need to agree with the hotel owner to offer deeper discounts. A tour and activity booking platform would also not have much margin to play with, but the actual tour operator could offer spare capacity at almost any price that covers the variable cost of adding one more participant.
The other way is through partnerships with brands that can supply distressed inventory. Customers may be highly motivated for anything ranging from 2x perceived value to 10x perceived value – without ever really knowing or questioning what the inventory actually costs the brand.
The greater your network of redemption partners, the further you tip this balance to your favor, particularly if those partners are travel brands and others with aspirational inventory. With a larger partner networks, dynamic algorithms are likely to be needed to manage and optimize the use of this tactic at scale.
Redemption value should be geared for maximum customer engagement
Manipulating the value in your favor should not imply extracting disproportionate profits. As we have seen, the larger loyalty programs in the world tend to put their own interests ahead of their members. This has taken place via frequent devaluations, and securing much more attractive KPIs for their own business than any partner might be able to achieve.
Often, the brand’s market power allows them to get away with this – but it can also damage brand respect. As loyalty programs continue to become more competitive, therefore, brands will need to think harder about striking this balance.
The loyalty team should recognize that, aside from the direct financial profits from the loyalty program, far greater ROI can be derived from motivating customers to spend more cash directly with your brand. This is a lot more likely to happen if they consider the loyalty value to be worth collecting in the first place.
Ultimately, the priority should be to collect sufficient data and identify as many customers as possible with a high CLV. This can be done more intelligently when dynamic values are applied, since the redemption value can always strike the optimal balance between customer value and ROI for the brand.
