By The Book: Understand and Manage Your Loyalty Points Liability
Loyalty continues to be the number one strategy used by brands for retaining customers and lifting behavior. Aimia’s own clients see on average a 7x+ ROI and increased engagement among members, making their investment in loyalty worth it. When considering starting or revamping your loyalty, however, you need to determine if your program will be currency based (think points or miles) or not. If you decide a currency is imperative to your strategy, be prepared to partner with your C-suite, financial and legal teams on an ongoing basis. Today, regulation around points liability is becoming stricter, as governments want to protect the financial interests of consumers.
The real challenge to points-based loyalty is the outstanding liability. While marketers are used to setting a finite budget for media and tech spend, accounting for points redeemed later is a different animal. Typically, your financial team can help you calculate your budget around your loyalty program, and many brands follow a formula consisting of the expected value proposition of the program, anticipated earned points, and predicted redemption cycle. These data points are derived from your expectations of the program. How many members, how will they spend, how long will they wait until they redeem and what will they most likely redeem? With tenured programs, these points become routine and fairly easy to predict and manage. However, with new programs, there could be significant risk to your budget. When talking points loyalty, constant liability management is a necessary commitment.
Structuring Your Program to Avoid Liability
One way of limiting liability is by allowing for point breakage. Breakage is points that are never redeemed, either because of expiry imposed by the brand, or forfeiture by the customer who never redeems points for rewards.
While some financial folks might think breakage is a good thing – the company takes in money but doesn’t have to pay out for redemption – marketers need to balance breakage with redemption. Although today’s financial rules require us to keep all point liability on the books until the breakage occurs, it’s a best practice to understand where and when that breakage will occur. Using your benchmarked data, develop a breakage prediction model, based on its drivers:
Earn Drivers: How members earn points – from transactions, brand interactions or other means.
Burn Drivers: How members burn points. Marketers have a significant amount of control over this driver and can modify aspects such as the value proposition of the rewards, rewards liquidity – including a members’ ability to pool or transfer points, reward availability or even the mechanics of redemption.
Compound Drivers: Some breakage factors are a combination of both earn and burn influencers. The most important factor in this category is the membership mix. Loyalty programs typically combine a larger high-breakage population of low-earn, low- engagement members with a smaller low-breakage population of high-earn, high-engagement members.
Expiry: Expiry can take two forms. It can be a simple expiration date, in which case, marketers need to be fair in the timing to earn points for higher ticket items, and the policy must be clearly communicated to members. Brands decide on expiration dates in a couple of ways. Some use an annual expiration, often wiping the slate clean on December 31st. Another is time-stamped or forfeiture-based after a certain period of inactivity. Brands can also force expiration through varying methods of auto-redeem. We see brands automatically knock the reward off at the POS once the customer reaches the threshold or send out a certificate that does have an expiration date. This pushes the liability off the books once the reward expires.
Cost Per Point (CPP)
Marketers determine CPP – or the calculation of each point issued and accrued – by deciding how many points a member earns for items, and how much that reward costs the company. For instance, if it takes 1,000 points to earn a $100 item, each point is worth 10 cents. This represents the perceived value of the point to a customer, but not necessarily the actual cost to the company. Here is one critical area in which regulation is changing – while internationally, brands account for the perceived value of the points, the US must accrue for the actual costs of the point.
With your financial team, you should determine the true CPP to manage your program to, such as 1% or 100 basis points. Then, be sure all your redemptions average to the 1% or less cost. Your travel rewards will come in higher, your merch awards likely lower, but you can manage your overall point liability by having items in the program that have lower cost than the cost you’re budgeting for with a high perceived value to ensure you come in below budget.
How to Limit Liability
There are several program constructs or mechanisms that can help you manage liability. We’ve worked with brands who are using loyalty strategy without points, while still collecting attributable data to build out valuable customer experiences. Companies have also had success with paid tiers or paid membership programs, in which customers benefit from better experiences, and brands benefit from covering costs ahead of the game, while simultaneously adding a line of recurring revenue. Gamification encourages members to spend points through methods such as sweepstakes, or double points redemption sales. Graduated tiering encourages point burn by unlocking varying levels of rewards and preferred treatment for members, while auto-redemption takes the guessing out of when points will be redeemed by redeeming them automatically for members.
Managing Your Liability
Issuance: At the point when points are issued, a brand’s team needs to monitor the accruing points liability to ensure it doesn’t get too large to impede business.
Redemption: Redemption is not only an indicator of how engaged your member base is with your program, but it’s also key to reducing outstanding liability. Make redemption enticing and easy for your members with a range of redeemable items and a simple redemption process. Price the items that cost you the least to look most attractive, while higher-cost items for the company should require higher point values.
Push for redemption through mechanisms such as sweepstakes, or featuring low-cost, high-perceived value items to reduce overall redemption costs. And always use timely messaging to remind and encourage rewards redemption, such as the motivating forces behind real-time loyalty trackers.
Right now, there is a great deal of buzz around points liability, largely due to stricter regulation. These new rules are becoming tighter to ensure brands can fulfill their commitment to customers, and that if there’s a run on points, businesses can still keep their promises to members. Marketers should use liability management also to be sure to come in under budget.
With the rollout of new revenue recognition guidelines, the process for accounting for points has changed. Whereas brands have historically used one of two methods that emerged over time, new account standards will change the process. Programs affected by the new accounting measure include programs that allow consumers to earn points via purchase, or if points can be redeemed for goods or services (points redeemed from goods/service not usually sold by the company will not meet this characteristic). Programs that don’t award points from purchase will likely stay the same, but consult with your financial team and auditor to be sure.
Current Accounting Methods
Accounting Method 1: Deferred Revenue
A portion of the revenue from the purchase transaction is deferred until the points are redeeemed
Deferred revenue liability for the deferred portion is recognized at the purchase date
Deferred revenue liability is relieved when the points are redeemed or expire
Accounting Method 2: Incremental Cost
All of the revenue from the purchase transaction is recognized at the time of purchase
At the purchase date, the entity recognizes expense for the points and a corresponding liability
Liability is relieved when the points are redeemed or expire
Additional revenue could be generated by the redemption, e.g., if the points are used to purchase additional product at
A retailer has a loyalty program that awards customers one point for $1 spent
Points are redeemable for $1 off future purchases (but not redeemable for cash)
A customer purchases $10,000 of product at the normal selling price and earns 1,000 points redeemable for future purchases of goods or services
The retailer expects a 95% redemption rate (950 points)
The retailer would allocate the transaction price between the product and points the following way:
Product $9,132 ($10,000 x [$10,000/$10,950])
Points $868 ($10,000 x [$950/$10,950])
Revenue = $9,132
At Redemption / Expiration
Deferred Revenue (Contract Liability) = $868
Again, adopting these new accounting methods and fully determining point liability is up to your accounting team and auditors, but loyalty managers and CMOs should keep in mind how points liability can affect a program’s infrastructure. Gain insights and buy-in from your internal stakeholders, and design the program that meets the needs of your customer while still hitting business objectives.
This piece is opinion and should not be taken as financial advice. If you’re concerned about points liability, please be sure to check in with your legal, accounting and financial teams to ensure best practices. AIMIA IS NOT PROVIDING FINANCIAL OR ACCOUNTING GUIDANCE, information provided in this article is based on third-party summary data of accounting standards. Aimia cannot be held responsible should the accounting decisions determined for your particular program differ.