Does customer loyalty really exist in the casino industry, or are we just buying loyalty? The casino industry has changed dramatically over recent years as competition increased.
As an independent casino marketing consultant, I find myself reviewing the same situations I once saw as a casino marketing executive, but now I look at them differently.
Casino executives often view many programs as developing customer loyalty. Consultants tend to consider programs as a measure of loyalty versus profitability—but how does one maintain balance?
In the real world, the process for maximum profitability and maximum customer loyalty is called “optimizing.” Most loyalty programs now target slot players because it is easier for casinos to accurately track play via player’s club cards in conjunction with player tracking software.
However, this is not a simple, clear-cut analysis, and casino management needs to carefully evaluate many variables. In other words, management needs to understand the math.
Slot marketing programs are actually quite interesting because there are many motivators available to choose from. Nevertheless, they are all predicated by rebating a pre-specified percentage of the slot handle, or coins-in, back to the slot customer in one form of incentive or another.
In some cases, slot customers play for casino comps such as free rooms, food, or shows. In other cases, players earn points based on the number of coins they slip into slot machines. Players can then redeem earned points at the casino for services, such as rooms, food, beverages, entertainment, spas and salons, or retail purchases. Normally, these points (one point usually equals $1.00) cannot be used for gaming.
A second version of the program, called “cash back,” allows points to be converted back into cash, which is returned to the patron in the form of currency.
A third version converts points into cash in the form of “cash rewards,” but with the restriction that players must play a given amount through a machine at least once before they can cash out their currency. Therefore, cash back does differ from cash rewards.
There are a number of other variables that may come into consideration, including the type of machine a customer plays (for example video poker versus video slots), the average slot-hold percentage, and the slot tax for that jurisdiction.
There is also one additional subtly masked common denominator: customer loyalty. Casinos offer incentives because they work—they help to bring players back to a casino. These are not much different than the airline frequent flyer programs that also develop customer loyalty. Therefore, one must assume that more incentives will translate into more customers, which will also translate into more profits for the casino.
Casinos constantly try to massage all variables in an attempt to tweak the formula for success and develop the perfect balance for maximum customer loyalty and profitability.
Unfortunately, there is one major risk or flaw in this thought process. If the formula used to initially calculate the incentive is incorrect, then it is possible for the incentive to quickly change into a casino liability because the more players that accept the flawed incentive would equal increased losses for the casino, instead of increased profits.
I have seen many strange slot marketing programs that just do not make good business. A thought occurred to me: The casino must be using their slot loyalty program as a “loss leader”—similar to what food chains or restaurants do to drive traffic to their location to steal market share from a competitor, such as a casino’s $3.95 prime rib dinner special.
However, when you see the program continue over long periods of time you have to ask yourself if management ever really analyzed the true costs of their promotion or incentives. I would bet that they had not. Once again, understanding the math is important.
It is actually very important to understand the math and the cost of cash back as a percentage of theoretical win. As part of my research for this article, I found some excellent analysis by Andrew MacDonald from Sky City Casino in New Zealand.
MacDonald developed and maintains the gaming industry’s leading educational portal www.urbino.net which contains a number of helpful analyzers. I also found some similar research by Samson Tse who is a very talented gaming analyst with the MGM Grand. I further verified these analyses with Eli Abramovich who is a highly regarded gaming analyst and statistician in Israel. These analyses are fairly technical, involving a second-order polynomial with a quadratic equation that considers the following variables:
C = cash reward percentage of drop
T = tax rate for that jurisdiction
H = hold percentage (slot win /drop)
R = 1/h (turn ratio to exhaust funds)
X = percentage of slot theoretical win
Cash Back Formula:
T% x C%/{H% x (1-C%R)}
By using this formula, Tse was able to solve for C (cash reward as a percentage of handle) and MacDonald was able to solve for
potential growth in turnover and win, as a function of introducing cash back. If no reinvestment occurs, and players cash out their cash back incentive, rather than use it for additional play, then the growth factor will equal zero percent. However, if reinvestment occurs, and players play until exhaustion of cash back funds, then growth equals:
C% = cash back percent of turnover
P% = return to player level
1 / (1-P%) = R turn ratio to exhaust funds
T% = tax rate
1-P% = H% hold percentage
Potential growth in turnover and win as a function of introducing cash back,
formula:
{C% x (1/(1-C%R))} / (1-P%) or
{C% x (1/(1-C%R))} / H%
Entering the correct numbers into the formula (depending on jurisdictional tax rates) will reveal some interesting information. For example, MacDonald’s analysis was based upon information from Australia, and he determined:
Cost of cash back as a percent of theoretical win:
Range from: 1.96 percent (play until exhaustion)
Range to: 4.67 percent (no play)
Growth in results due to cash back:
Range from: 0 percent (no play)
Range to: 4.90 percent (all recipients play until exhaustion)
These numbers are important for budget purposes. For example, by knowing what percentage of the slot play comes from slot club members, we are able to more accurately calculate the dollar amount that management needs to budget to cover the cash back expense. If we derive approximately 40 percent of turnover from slot club members, this would equate to 1.87 percent (40% x 4.67%) of total slot revenue that management must budget as the cost of the cash back program using the examples cited above.
The point is that giving cash back to players may generate growth in the first year over previous year’s results, and management needs to consider this when analyzing results. The cost of providing cash back may be simple to calculate when no incremental play occurs from those funds.
However, the real cost to the company may be as little as the gaming tax, if players use cash as incremental revenue and play until ruin. In jurisdictions where the gaming tax is relatively low, the real cost of the cash back will also be low if no incremental re-investment occurs.
MacDonald further states, “In reality, the real cost of cash back will lie somewhere between these extremes, and this factor should be considered in the design phase of any slot club rewards program. Improving cash back rewards over your competitors by recognizing this fact may provide a casino with a competitive advantage. Or, in some cases, it may result in a switch from a gift redemption to cash back when the opportunity exists to gain a lower ‘real’ cost structure.”
However, as a further example of why you have to understand the numbers, I asked Tse to use his analysis to compare cash back
versus cash rewards in two completely different gaming jurisdictions, where one slot tax rate was eight percent and the other slot tax rate was 25 percent. For this analysis we used the following criteria:
Player hold %(H) = 10%
Tax rate % (T) = 8%
Percentage of hold to return to the player % (X) = 2%
Cash rewards to offer player % = ???
Now let’s plug the variables into the equation:
C5 = 10% x 2%/(8% + 2%)
C% = 2%
This means that we should be willing to offer the players two percent of the drop/turnover, if we are willing to reinvest two percent of the hold back to the player.
Therefore, for a player with a drop of $1,000, the hold should be $100 ($1,000 x 10%). Tse then suggests that if the casino is willing to reinvest two percent of the hold or $2 ($100 x 2%) back to players, assuming they will play to exhaustion, then the casino can reasonably budget and offer the slot customer two percent of the drop, or $20 for that reward ($1,000 x 2%).
I have seen many strange slot marketing programs that just do not make good business.
I know this may seem confusing to some people, but this will hopefully shed some additional light on why it is so critical you understand the math. We now use the exact same formula, but change the tax rate from 8 percent to 25 percent, which is quite common with many Native American casinos, as well as international casinos.
The only variable that changes in the formula is the tax rate. The formula is now, C% = 10% x 2% / (25%=2%). Therefore, the maximum amount of cash reward offered to the slot patron, in this situation, would be $7.40.
As you can see a $20 cash reward has much more appeal than a $7.40 cash reward. The next big question for the casino operator is what is the real cost of customer loyalty?
If any reader would like to receive free copies of both MacDonald’s and Tse’s analyses along with their respective analyzers, please e-mail me your name, position, and contact information. Good luck.
Steve Karoul is President and CEO of Euro-Asia Consulting. He can be reached at (860) 536-1828 or skaroul[at]comeast.net.
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