Rewards programmes are increasingly the most important feature of payment cards, with most becoming the foundation of card issuers' differentiation. But the maturing rewards market is set to alter card issuers' loyalty programme value and structures, according to Scott Henry, engagement manager for US-based management consultancy Fischer Jordan.
A robust loyalty operation represents a barrier to entry and produces a competitive advantage with a longer shelf-life than offers related to payment terms, which are easy for competitors to copy.
Loyalty becomes commoditised
Industry loyalty programmes have grown to cater to vastly diverse card member needs in an attempt to broaden their appeal beyond the airline miles segment. As a result, the majority of large issuer programmes share many of the same qualities and offer similar card member value. While some aspects of large rewards programmes are unique, for example Bank of America's new experiential redemptions, there is little doubt that the basic rewards offering is becoming a market necessity - no longer a competitive advantage, but instead a commodity.
As a result, a heightened focus on cost has the potential to spark a dramatic change in the structure of the rewards industry, potentially enabling coalition programmes, white labelling of existing programmes, and issuer-association partnerships.
The real purpose of the reward
Rewards are designed to drive profitable customer behaviour, including greater account acquisition, spend and fee revenue, and reduced attrition. The current prevalence of rewards programmes is a testament to the success of the mechanism. Rewards cards accounted for 40% of credit card spend in 2001, and by 2005 the figure had grown to 77%. While the trend is necessarily slowing as rewards penetration asymptotically closes in on 100%, consumers are increasingly cognizant of loyalty programme value.
Figure 1: Reward/Non-reward credit card spending
Source: The Future of Credit Card Rewards - Fischer Jordan
On an individual issuer basis, and for the credit card industry as a whole, rewards cards have established their value. In fact, some research has shown that rewards card spend is three times that of a traditional card, which could indicate a greater share of wallet concentration. Additionally, when rewards cards first entered the market, acquisition rates were substantially higher than for traditional cards.
Shift in motivation
On an industry level, rewards have motivated a shift from traditional forms of payment to credit cards. In 2005, cards accounted for 38% of consumer spend, up from 30% in 2001, a period when rewards spend more than doubled. The growth has been most pronounced in small payments, what some financial services firms have dubbed "everyday spend". This includes supermarket, drug store and gas station charges, among others.
Several issuers have provided additional rewards incentives (e.g., bonus points) to use cards for relatively small purchases, and have rolled out additional time saving technology (e.g., RFID) to expedite the card use process. Judging from recent issuer statements, these measures have successfully improved credit card penetration within this category.
Reward programme economics
The terms "earn" and "burn" are the basis of card member loyalty value, where "earn" refers to acquiring points and "burn" refers to how those points can be used. While numerous bonus schemes are employed, most loyalty credits are earned at a 1:1, point to dollar, ratio. Redemption value varies by card product, but cards within the same rewards product classes (i.e. fee/free and high-end/low-end) offer similar values.
Most card issuers are members of the three largest card associations: Visa, MasterCard and American Express. The interchange rate, which translates into the rate at which issuers receive spend revenue, is set by the associations. Therefore, while some economics are dictated by the issuer, including interest rate and fees, a large portion is common across all issuers within the association. The market has established a risk adjusted pricing band, even where there are differences,. Since card economics are similar across issuers, there is a convergence of issuer loyalty value offers.
The problem of commoditisation
While card products within categories provide similar value, large issuer programmes also offer similar redemption options. Citi, Chase, American Express, and Diners each offer retail, cash and air options, while additional categories may also be available. The primary programme differentiator is no longer redemption option and value, but has instead moved to marketing. While marketing can and will set programmes apart, particularly in the short term, the relative equity of programmes will eventually lead to an overarching cost focus.
With similar value propositions, rewards cards struggle to differentiate themselves and consumers see little value to switching programmes. Rewards programmes, once an issuer advantage, are becoming a market necessity. As developed rewards programmes become ubiquitous and commoditized, competition will move away from a rewards focus. However, with the necessity of rewards within a narrow value band, issuers will attempt to minimize programme expense.
Addressing programme costs
As rewards programmes turn increased attention to cost, the largest players have substantial scale advantages. Scale provides a cost advantage in administration and redemption expense, as larger issuers have greater economics of scale and purchasing power. While cost inequality is a current reality, cost competition will magnify the significance of this gap.
Even among large players, however, there is an increasing need to scale rewards programmes. Traditional reengineering provides a foundation of programme cost effectiveness, but scaling options including coalition programmes and white labelling may provide a longer term solution.
It is clear, Henry concludes, that programme cost containment coupled with commoditisation is likely to bring about a change in programme substance and management. Reengineering will give way to a revision of traditional programme economics, including a change in programme structure and management.
At the same time, coalition programmes, white labelling, and association rewards will provide the models of industry externalisation. The external result of these changes will be that the largest loyalty programmes will emerge bigger, permeating multiple industries; while internally, programme value will be unlocked turning a cost centre into a profit generating activity.
The full white paper, which goes on to discuss reengineering, coalition programmes, white labelling, association rewards, and ways of unlocking the value of rewards programmes, is available for download (free of charge) from The Wise Marketer - click here (PDF document, 244Kb).
Fischer Jordan is a management consulting firm that helps Fortune 100 financial services companies with analytics-driven marketing strategy, rewards/loyalty strategy, and strategy reengineering.