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Can loyalty programs finally overcome the engagement versus breakage conundrum?

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By: Wise Marketer Staff |

Posted on May 29, 2018

Ever since loyalty programs evolved from a means to retain customers to a means to generate cash for their operators, there is an inherent tension between reaping profits from expiring points and engaging members through rewards. New redemption options may offer a way out of this conundrum.

By Oli Dervey

In the beginning, it was simple. The first loyalty programs of the modern age came about in the early 1980's, when US airlines started incentivizing their frequent flyers to stay loyal to the company. After a number of paid flights, program members got another flight for free. So far, so good.

These programs quickly became so successful that they grew in leaps and bounds, and it did not take long for airlines to realize that there was more upside to be had by also selling this new currency of theirs, frequent flyer miles, to third parties equally keen on these high flyers’ business. Hotel chains and car rentals were the first ones to start buying miles from the airlines, but they were soon eclipsed by banks, which started offering credit cards earning miles for each transaction.

Today, loyalty programs have proliferated across many sectors and demographics, with mature airline and coalition loyalty programs typically seeing well above 50% of miles earned through partners, which pay the program operator cash for each mile issued.

Simultaneously, accounting standards have caught up with the “funny money” of such programs: Rules such as IFRIC 13 and 15 require programs to defer recognition of revenue from selling miles until these miles are redeemed – or are expected to expire. Financially, the latter is particularly attractive for the program: Miles that expire (or “break” in the industry lingo) are essentially redeemed at no cost, allowing the program to recognize the entire amount they were sold for as profit.

Breakage, however, is bad for the program member. It embodies a broken promise: Miles that were at some point earned with a view on a reward are taken away with nothing in return. In setting their expiry policies, programs therefore need to walk a tightrope. Set the policy too strict, and you push out members that may yet want to re-engage and give you more of their business. Set the policy too loose, and you eliminate the profit stream of breakage while your outstanding liability grows untrammelled. Not for nothing breakage management is also called “The Sweet Science”.

But what if there was a way to provide engaging rewards to members threatened by expiry, all while maintaining a “near zero” redemption cost comparable to breakage?

Leading programs across industries have started waking up to the potential of alternate, low-cost redemption offers from the emerging realm of digital commerce. For instance, online deals platforms such as Groupon often provide “2 for 1”, “50% off” or similar deals at little cost. Similarly, members with small account balances threatened by expiry could use them for buying virtual goods in online games and apps – items that have no physical cost at all. Collectively, members will redeem significant amounts of miles for such products, producing a very low effective unit cost.

And speaking of virtual money: What about allowing members to convert their miles into crypto currencies such as Bitcoin or Ethereum? Given their wildly swinging valuations, such a redemption – again at an attractive unit cost to the program – may yet pay off nicely to the member. But even if it doesn’t, redeeming for a chance to make it big is certainly more engaging than simply seeing miles expire.

In all of this, precise targeting remains paramount. Planning when to promote which redemption option to what member segment is crucial to achieving a sustainable balance between redemption expenses and member value.

Thanks to such very low cost redemption options though, nudging certain members towards expiry is no longer the best way to control unit cost and outstanding liability. Instead, programs can actively promote redemptions, thereby proving the value of the loyalty program to members and creating an opportunity to re-engage with them. The most sophisticated providers of low cost redemption solutions even allow members to earn some new miles on any cash co-payments, thus ensuring that account balances do not fall to zero and members stay vested in the program.

Using this new toolkit of low-cost redemption options, forward-thinking loyalty marketers should seize the opportunity to re-define their rewards portfolio now.

35 years after the modern age of loyalty began, it is time to shake off the yoke of breakage and unleash the full potential of member re-engagement.

Oli Dervey is Head of Strategy at Loylogic.  Loylogic is a partner with The Wise Marketer and is sponsor of this article.

Loylogic is the world’s leading innovator and creator of points experiences, insights, commerce and engagement. By tantalizing members with more choices and arming programs with insights on behavior – anticipating both present and future needs – we deliver powerful solutions that amplify engagement and build loyalty.  For more information please visit Loylogic.