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Your Loyalty Program Doesn’t Have to Weigh Down Your Balance Sheet: How to Limit Liability Wisely

Blog- Loyalty Program Liability May 2016The Holy Grail for loyalty marketers is the program that engages members and produces incremental profitable purchases, without needing to carry any liability on the books for points and future reward redemption. But like the Holy Grail of legend, such programs are elusive; those who promise that they’ve found the real thing can prove to be, at best, self-deluded.

No-Liability Programs: There are precious few successful programs that carry no liability – they rely entirely on Surprise and Delight and short-expiration offers. No-Liability programs often fail to sustain engagement, because members don’t know what they need to do to receive benefits over time or if any one incremental purchase will make a difference in their experience of the brand. For example, one well known quick-service restaurant chain started out as purely Surprise and Delight. Their promise: “Swipe your card every time you visit and we’ll do our best to reward you with more surprises based on what you love.” Unfortunately, they found that they needed to be a little more concrete to maintain engagement and so they added progress indicators to show that you need four visits to earn a free item.

Driving incremental behavior and increasing emotional loyalty typically requires some investment. The key is to direct that investment where it is most effective and avoid investing where there is no upside opportunity.

Good liability and bad liability: Carrying a financial/accounting liability for future rewards and benefits is not necessarily a bad thing – the key is to ensure that the program is focused on good liability rather than bad liability.

Good liability = future rewards and benefits that have sufficient value to the customer to cause him/her to change behavior in a positive way, e.g., incremental sales.

Bad liability = future rewards and benefits that are pure cost because they do not drive incremental sales or profitability.

Therefore, the first and most important technique for limiting liability is not just to look at the cost of the rewards – important though that is – but to look at what behaviors earn a reward.

Managing liability through differentiation: In many ways, reward structures are a zero sum game. On one side are customers who always want to be rewarded for what they would do anyway (which simply erodes margin).  On the other side are companies which only want to reward behavior that is incremental and profitable. Successful reward structures find the right balancing point between those two extremes. The goal is to escalate the rewards as the profitability of the behavior increases. The trick is recognizing that what is incremental for one customer is business-as-usual for another customer. A one-size fits all program does not do this – there is no way to separate good liability from bad liability since everyone gets the same rewards. The solution is to set a low base payout rate for everyone, and increase the rewards for targeted best prospects with bonuses on top of the base payout. Note that the best prospects may not be the same as your best customers – you are looking for people who have the most new business to bring you. Your best customers may already be giving you all of their business, while those in the middle of the pack may be splitting their activity between you and your competition.

Liability and reward costs: The biggest factor in actually calculating program liability is clearly the cost of rewards. The most financially successful programs offer rewards that members find very valuable – but that do not cost the program sponsor a great deal. This is most easily achieved where variable costs are low and inventory is highly perishable so that the seller has a strong incentive to unload it before it becomes a write-off. The classic example is an airline seat which would otherwise go empty – putting a member in that seat costs the airline far less than the value the member places on a free airline ticket. However, about-to-expire perishable products seldom have such a high perceived value outside of airlines and hotels. There have been entertainment companies who have offered members a “reward catalog” that consists of older titles or retailers who offered less desirable overstock items as “free rewards”; these programs have mixed results, at best, because customers instantly recognize what is distressed inventory.

There are many ways to minimize reward costs, including:

  • Create rewards that are events and experiences, e.g., behind-the-scenes tours, meet-and-greets with company executives and representatives, etc. These rewards cost relatively little but mean a great deal to participants (who then tend to tell people about the event, bringing great word-of-mouth and social media exposure to the brand). These work best for brands that are already strong or have celebrity CEOs and tend to be difficult to scale beyond the top percentiles of membership.
  • Create partner rewards where the costs are shared between you and your partners. The challenge is that after a straight cash back reward, what members most often want from you is your product rather than a partner’s product. The exception to that rule is when the partner is more popular than your brand, which means that your brand may not be getting the focus it deserves with members or that your partner can replace you at will. Far too many programs fall into opportunistic relationships, rather than seeking and structuring a symbiotic partnership.
  • Use ‘hidden assets’ as rewards – things you already have or are doing that can be re-purposed and re-positioned as member benefits. This is the brilliance of the beauty products program that negotiates free samples from manufacturers for use as rewards or Surprise and Delight gifts. Similarly effective are entertainment firms that offer exclusive content to members. Customers positively recognize quality limited editions as quickly as they negatively recognize distressed inventory.

Measuring and booking liability: You will need to talk to your accountants and auditors for specific counsel on how to book and value program liability.  However, there are some general guidelines to follow:

  • In general, a liability is incurred when a customer is promised a reward or benefit in a future financial period in return for an activity during the current financial period. This has led several programs to set earning and reward periods that are as short as a quarter to avoid having to report any liability. The problem: such programs tend to cash out members regularly, so members have no incentive to ignore conversion offers from your competition.
  • The revenue recognized from the current activity is typically reduced in the current period by the value of the future liability – you cannot take credit for the full sale if you will have to pay some of it back later in the form of rewards.
  • For an established program, there is a track record of points expiring, or breakage. With this track record, accountants have a reasonable, fact-based way to estimate what percentage of rewards earned will be used so they can reduce the liability that is booked. For a new program there is no track record – so accountants will be conservative and likely require that the full value of future rewards be booked as liability.

Key takeaway: First you need to make the distinction between good and bad liability, identifying exactly what behavior should earn rewards in a program and when the incentives need to be targeted. Then focus on how to structure the rewards themselves to minimize hard costs. Using these techniques, we have reduced liability for our clients by as much as 40%. We can help you, too. Drop us a line at info@kobie.com to learn more.

Author: Laura Siegfried

Laura has over 20 years of consulting and client-side experience in loyalty programs, spanning a range of industries including travel, retail, and hospitality. She is responsible for program strategy and design, with particular emphasis on the financial impact of various program options. Laura is also responsible for developing implementation plans and measuring program results after implementation. Prior to Kobie, Laura was a partner at Metzner Schneider Associates, where she did program design and financial modeling for a wide range of clients. She also held a leadership role on the AAdvantage program at American Airlines and was Vice President of Strategy at Brierley + Partners.

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