How Retail Loyalty Programmes Make Money - and What They Are Really Buying

South Africa’s loyalty market is booming, with projected growth of 11.2% annually and a forecast value of US$384.3 million by 2024. [11] Yet behind the drive to capture retail customers lies a more sophisticated calculus. Loyalty programmes are not just discount engines but profit centres undergirded by a science of incremental margins, supplier-funded rewards, and a valuable asset: customer data. [8, 13]

Loyalty as a Profit Engine, Not a Discount Scheme

At their core, loyalty programmes are designed to deliver a profitable return on reward spending. The key economic formula is simple: A profitable programme's total profit contribution is the gross margin gains from incremental retention, raised spending, and increased market share - minus the cost of paying out the rewards. From there, programme ROI is total profit contribution divided by reward costs. [5]

In practice, this means profitability doesn’t come from total member spend alone. Rather, it flows from incremental changes in customer behaviour. [13] Take a 3% revenue cost loyalty programme: It breaks even when the programme captures 10% more of a customer’s total spend, and can generate returns of around 100% when that incremental share hits 20%. [8] The rewards are ultimately funded by that uptick in buying power. [8, 13]

How Rewards Are Funded: Margin, Suppliers and Breakage

While the discount is what programs attract with, that discount doesn’t just hit the retailer's margin. For starters, the cost of rewarding customers can come from various pots, including the retailer's own wallet, supplier and credit-card funding, and even direct membership fees. [1] Suppliers and partners, in fact, often contribute a chunk, with the 2023 BCG report explicitly asking how retailers can attract supplier funding to cover a significant share of programme costs. [15]

Moreover, a key lever in loyalty's money lab is breakage: The portion of points that expire without being used. [10, 6] A specialist points towards 15% - 25% breakage as a target, [10] suggesting that a 5% cashback programme might prove to have an actual effective cost of 2.0% to 2.5% in the long run when factoring in those calculated, unspent points. [6]

In South Africa, a local guide recommends tiered programs aiming for 20th, 60th and 90th percentile annual spends - and recommends finance sign-off on a point redemption cap before launch. Backing out a safe margin give-up per rand translates into higher incremental sales. [3] Retailers themselves must at least be able to fund that point redemption cost from gross margin. [10]

Programme Structures: Points, Tiers and Cash-Back

But what’s the structure of a profit-generating loyalty programme? It depends on what a retailer is selling - and how they are selling it. Points-based programmes, for instance, require a complex back-end for tracking, rewarding and point liability - and often come with some of the heaviest front-facing costs. [12] Tiered programmes, meanwhile, trade lower operating costs for variable reward cost, as escalating benefit loads hit higher spend thresholds. [12]

Cashback and reward payment programmes directly impact profit, but keep customers’ spending in direct proportion to what they earn. [10] Some retailers experiment with one-way networked programme structures, sharing a loyalty framework across multiple brands. There are pros - it smooths operations - and cons: It means dealing with point redemption demands from multiple brands.

Retailers aiming for tier differentiation can tap actual basket data to shape spending tier thresholds. A South African guide recommends carving thresholds at annual spend percentiles and using that real purchase data to calibrate benefits. [3] Even so, points, tiered, cashback or coalition, retail trade observers argue the main effect of loyalty programs comes from sales keyed to loyal customers - not the costs of funding loyalty. [12, 9, 11]

The Real Asset: First-Party Customer Data

But if retailers are giving away rewards, what are they getting in return?

The evidence is increasingly clear: It's not just buyer loyalty, but buyer data.

Focusing on personalisation at scale, the 2023 BCG report shows grocery retailers implementing best-in-class loyalty (which depends on incentivising ongoing, zero-cost data collection) typically boost revenue and profit by 3% to 5%, while framing supplier-funded loyalty as covering a sizable chunk of programme budget. [15] Another South African program attributes some of its success to collecting and targeting customer data. [9]

This makes the data collecting function key to loyalty program profit, and that strategy imperative comes through in Reach Digital's local loyalty strategy guide: "Before launching the programme, ensure your data foundation is strong". [3] After launch, retailers look to take another bite of incremental value through retail media demand - where suppliers pay for custom, data-driven offers. [15]

South Africa’s Loyalty Boom and Its Stakes

What’s clear, then, is that in South Africa's dynamic retail market, loyalty costs and benefits are not straightforward. Retailers can't just give out discounts and hope - they need to approach loyalty as a science-hard on incremental sales, balance sheet liability management, and data selling. And retailers, as suppliers, not owners, of loyalty programmes must be willing to put money in to make incremental money out.

The data speaks for itself. South African loyalty growth is nothing to sneeze at, with projected growth of 11.2% annually and a estimated value of US$384.3 million by 2024. [11]

Hidden Dynamics: Pricing and Supply Chain Effects

While the focus is on incremental margins, retailers would do well to note the wider supply-chain effects of loyalty programmes. A key channel that shapes that supply chain is retailer-vendor partnership, with suppliers providing trade funds, discount cards and specials. [1, 15, 3, 11]

The base cost impact can be hard to measure; a 2022 study concludes that loyalty effect on pricing can lead to higher prices at retail and upstream supply chain levels. Academic evidence links the effect to incentive design, prize tiers and membership cost. [4] In effect, the science of programme design leads to a change in the pricing structure and incentives across a channel, not just a shift in customer behaviour.

That this effect is complex, and not limited to South Africa, shows maybe programs aren't a loyalty cost but a loyalty-driven economy where retailer and supplier collude to share price distortions - and the (incremental) spoils.