Breakage of loyalty points has been a matter of contention among loyalty practioners and its administrators. While breakage offers temptation to the people manning the finance department, it has been a matter of concern for the marketers. The main bone of contention is the determination of the percentage of breakage that should be recognized as revenue in the periodical financial statements. Finance managers argue that a higher breakage rate will contribute to increase the net income and profitability, the marketer contends that higher breakage means less value attributed to the loyalty program by its members.  

Loyalty programs with their proven ability to retain customers have been the object of cynosure for new-age marketers. They have tangible impact on customer retention and allow companies to identify the most profitable customers, identify purchase patterns and help in rewarding loyal behavior, and therefore help to develop attitudinal and behavioral loyalty to the company. Many studies have concluded that members of loyalty programs tend to exhibit greater behavioral loyalty to organizations versus non participants. With millions of loyalty transactions taking place daily, loyalty points have become one of the largest traded currencies in the world.

The basic expectation, while issuing points, is that the loyalty program member would redeem these points for rewards of choice and thus feel exhilarated. Perhaps of all the processes involved in loyalty program management, it is redemption which is the most critical. Redemption is the revelation point when the loyalty member realizes the value of his business with an organization.  In a loyalty utopia, all accrued points would be redeemed, but in the real world, it is just a portion of points that are redeemed. The unredeemed points remain in the account of the member until they expire.  There are various reasons why a member does not use the points they accrued, these include:

  1. Lack     of knowledge about available rewards
  2. Uninteresting     items on current rewards catalogue
  3. Cumbersome     redemption process
  4. Desire     to accumulate points for an aspiration reward in the future
  5. Lack     of information on points expiry
  6. Irregular     communications regarding redemption opportunities
  7. Irregular     purchases form the program provider resulting in lower accrual rates
  8. Highly     priced rewards-too many points to be exchanged for small value items
  9. Purchase     activity in spurts with long inactive periods thus membership cancelled by     the company
  10. Filled-up     enrolment form and then never bothered checking progress of balance     resulting in accrual of orphan points

Breakage may also occur due to forfeiture from cancelled memberships. The value of these points thus end-up having zero value for members. However, these unredeemed & expired points constitute breakage for the company that sponsors the loyalty program. Technically, breakage can be booked as profit by the company, and high levels of breakage are one of the biggest drivers of a loyalty program.

 Accrued Points-Expired Points=Breakage

Points issued against purchase transactions have a monetary value that is maintained in the books of the issuer. One of the popular terms for this is CPP or Cost Per Point. While there is minimal actual expense at the time of issuance, it is imperative that the issuing company make provisions for honoring the points when they come back for redemption. Thus, the costs of actual points issued become a liability for the issuing company.  For large organizations that see millions of transactions per annum, the liability runs into billions of dollars. Wherever there are regular redemptions, this liability remains at a reasonable level. But, in cases where redemptions are not regular, the liability of points can be scary. Rewards liability is perhaps the biggest line item in the overall budget of a company that manages a large loyalty program.

Outstanding loyalty points represent a potential liability on the balance sheet and present a dilemma as:

  1. Over-provisioning     can lead to tying-up of funds that could be invested elsewhere     productively
  2. Under-provisioning     can lead to deficits in future years

By definition, breakage points can be considered as revenue by the issuing company. Breakage has diametrically opposite effects-

  1. Breakage     is good news for few companies who are glad that they did not actually     have to pay for points issued and reduction in liability.
  2. If a large     percentage of issued points are not being used, then it goes against the original     purpose of issuing points for the member-to redeem for a reward of choice.

It is rare that a member is able to empty their points balance, and redemption offers will often leave an available balance in a members account. For example, a member has a balance of 50,000 points in an FFP. He wants to exit the program and join another. He can get an economy ticket for 42,000 points, which is the minimum reward, and is thus forced to forfeit 8,000 points. 

 Some companies encourage breakage by creating stumbling blocks to redemption by:

  1. Creating     minimum accrual before a member become eligible to redeem
  2. Putting     rules that points can be redeemed only in blocks
  3. Offering     promotional points that have shorter expiry periods etc.

While proactively managing breakage it is important to focus on its effect on revenue. Despite adding to profits, high breakage levels are the prime problem of organizations that offer a loyalty program.

In the above mentioned example, where the member forfeits or loses points, the issuing company gains money. However, it defeats the fundamental purpose of issuing points.

It is important that one understands the phenomenon of breakage and its effects on one’s loyalty program.  The biggest question is ‘How much breakage is optimal? If the breakage is low, does it mean that the program is a success, and if it is high, is it because members do not care about the program? This is not always easy to answer, as a certain percentage of points do naturally break and form a part of expected revenues. Studies have indicated that breakage in the retail loyalty programs hover around 25%. Some large airlines indicate a breakage between 13-25%.

The issue of breakage is important because, it is the act of redemption that forms the basis of a loyal relationship, answering the fundamental query of ‘what’s in it for me?’ Simply stated, the answer lies in the fact that ‘redeemers churn 8-20% less than non-redeemers’.  In the contemporary world, where speed and variety dictates the success of any business, new-gen loyalty platforms, like Oracle’s Siebel loyalty, attempt to solve some of the fundamental issues including that of breakage. Such platforms enable:

  1. Quick configuration and deployment of loyalty programs across industry verticals
  2. Customization of industry requirements
  3. Faster creation and deployment of a large variety of promotions & campaigns
  4. Integration of multiple types of partners
  5. Cost effective and customized communication
  6. Configure the value of points given (CPP)
  7. Reach out to members who have stopped transacting with the company
  8. Create and deliver a large variety of rewards-both tangible and intangible
  9. Campaign Management
  10. Creation of tiers, upgrade & down grades

The features that new-gen loyalty solutions are endowed with make it possible to regularly reach out to loyalty members with ‘relevant’ and ‘interesting’ offers, and to ensure optimal engagement in all outgoing communications. While loyalty promotions are of various types, arguably it is the accrual and redemption promotions that can make or break loyalty programs. Regularity of customized promotions do play a vital role in ensuring faster and regular accrual of points in a members account as well as their regular redemption. Redemption of points is meant to recreate the desire to accrue more points and triggers the loyalty cycle all over again!

You don’t earn loyalty in a day. You earn loyalty day-by-day: Jeffrey Gitomer.

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