Everything you need to know about managing points liability
Editor’s Note: Brian Almeida has managed many loyalty programs over the past two decades. In his capacity as Founder and CEO Strategic Caravan, he has vast experience in managing loyalty program operating budgets and the financial liability generated by Loyalty Programs. Witnessing the devaluation of point values and overall value propositions by several brands over the past six months, Brian shares a comprehensive overview here of what it takes to keep your loyalty program effective and profitable (we call that sustainable) over the longer term.
Over the last few years, the pandemic brought to the surface an important aspect of Customer loyalty programs – the management of points liability, was it a liability or a tool to create value and loyalty.
The elephant in the room was finally being discussed – how does one manage the points liability of a loyalty program?
To understand the issue better, lets get back to core principles:
Loyalty points are issued to customers for purchases of goods by the brand as an incentive, and to keep the customer coming back to collect more and create stickiness with the brand.
These loyalty points are funded from various buckets (MDR, Commissions, Promotions, sponsors, marketing, among others) and then moved to the liability side on issuance to the Member, in other words they are accounted for in the P&L by taking it out from the respective budget and added to points liability, while not being actually spent as an outflow until redeemed, and therefore reducing the cashflow impact. As logic flows, this liability is going to mount and increase exponentially year after year as business grows and your objectives are achieved – which is hopefully a good thing.
While doing this you have also created customer loyalty, increased their value to the brand, and increased their aspirations and desire for their point redemption i.e., a flight ticket, a hotel room night, a family holiday, an iPhone, a HD TV, and much more.)
This implies a few things:
- Customer Lifetime Value to the brand has increased
- The costs of points have been accounted for
- Increasing value of existing customers outpaces the costs of Customer acquisition
Given this backdrop there are a few practices, both good and not so good, that many brands are now adopting to manage this points balance liability that reflects on their Balance Sheets. Let’s start with the not so good, since these make more of a news story as we have seen in the recent past:
1. Reduce the value of the points
This is the laziest and most destructive solution, simply because it does not seem to understand the backdrop and long-term implications of this decision. It is marketing myopia at its best. Why? Because the points were an incentive at an agreed value between the customer and the brand and, if the value is unilaterally reduced overnight, its impact on trust, customer loyalty and Customer lifetime value is huge. The bond of trust can be destroyed, likely forever.
A bigger danger is the impact of creating doubt and mistrust in Customer loyalty programs and marketers in general. Customers may respond to point devaluation by choosing immediate cash discounts, redeeming their points early, and the very purpose of loyalty program can be weakened. This is similar to when governments fall when their currency loses value, or a run on the bank that occurs during times of financial uncertainty.
2. Capping the earnings of points
Capping the earnings on points is becoming an increasingly popular method to limit the liability of loyalty points. Without realising that it is actually a disincentive (anti-loyalty) for Members to increase their transaction value with your brand when their earnings are not commensurate with the spend?
Take a moment to reflect on the message being sent to your most loyal and high value customers - "We cannot reward you for your purchase, please do not buy more than what is required as you will not earn points !!" or "If you are buying more than the stipulated amount, please use our competitors product"
3. Reduce the earning value of points
This seems to be the more fair and transparent way of managing the points, it informs the Member of a prospective earning equation without damaging the past points earnings balance and manages the future points liability build-up.
This is indicative of management responding to cope with their financial position and of the budgets that fund the loyalty points bucket. It reflects the reducing ability to fund points from current product margins and is good financial management for sustainability of the loyalty program. Because it is prospective in nature customers accept it as being transparent, clear, and fair.
How then does one manage the points liability of a Customer Loyalty program?
The secret sauce to running successful loyalty program point currencies is to keep the value of the points as high as possible and not reduce the value. It is important to remember that inflation impacts the purchasing power of loyalty points too.
To ensure the high perceived value of the loyalty currency one needs to work on the perceived value of redemption. Good revenue management in airlines and hotels and other perishable commodities help achieve a high value through redemption opportunities on unsold seats, room nights, unused bandwidth etc. Retail players achieve this through end-of-season sales.
An even better practice is to offer redemption opportunities with priceless products and services, privilege sales, and limited editions that help create an above average perception of points value for the customer. How can you price a dinner with a celebrity, an invite to a limited-edition sale, special Member only microsites, NFTs, or box seats at the game? Mastercard had it right…they are all “priceless.”
You can supplement this approach with tactics including special auctions and lottery draws, which help reduce liability while protecting the perceived value of the points.
Remember from a financial perspective that inflation will also have an impact on the value of points. It’s important to budget and plan for this with a balanced combination of redemption and pricing.
Points values increase and programs become more sustainable through added liquidity and ubiquity
When reward options are well-managed, programs become more sustainable. The perceived value of points increases with increased liquidity options, i.e., allowing Members to redeem/burn points through pay with points, offer points + cash combinations.
The value of points can also rise with increased ubiquity, which means the more options to redeem points across other products and services, the higher the perceived value of the points. Offering Members to redeem across products and services at lower real value often increases the perceived value of the overall program and the point currency.
Social Causes and donation of points, Gaming and NFT’s are increasingly popular redemption options that increase liquidity and ubiquity.
All of these options to increase liquidity and ubiquity will delight your customers and improve the sustainability of your program.
Why do loyalty programs take the suicidal decision to devalue the points?
In most cases these are knee jerk reactions to reduce the liabilities being carried on the books and a quick way to present a healthy situation. In many cases this happens when targets are missed, and the financial position needs to be improved in the quickest available way. It also reflects the inability of the marketing and leadership teams to convince the finance team about the implications of the decision.
Programs can avoid this awkward state through regular reviews of the program and currency performance. Encouraging continuous redemptions and Member communication helps create highly engaged customers with increased customer value, while realizing income via point redemptions.
Going forward, what is the solution to managing points liability?
Loyalty programs are successful if they create increased incremental sales and Member lifetime value. The Loyalty program’s objective should be this and nothing else. Members become loyal and increase sales through the stickiness of points, payment convenience, frictionless processes, etc. Engagement with the program increases through response to campaigns and stimulus, encouraging high redemption rates and creating highly active Members.
Keeping sharp attention on the perceived value of rewards and striving for lower breakage rates are keys to managing a successful program. When you practice these disciplines, the chance of facing a points devaluation is lower. From a budgeting perspective, you must ensure accurate financial accounting is in place to account for the actual cost and value of points and ensure the liability reflects the near true value.
Detailed financial modelling and budgeting of loyalty points liability can prevent the destruction of your loyalty program and help create loyal and valuable customers instead of driving them away.