When I sat down to write about managing the financial liability generated by customer loyalty programs, I naively thought it was suitable for a post to Loyalty Truth. In terms of subject matter, it is right on target, but in terms of complexity, program liability is not something you can adequately discuss in a few hundred words.  How about if you just stay tuned for a White Paper on this subject in the very near future?

For now, let’s cover a few salient points and, in Loyalty Truth fashion, rip the cover off the soft talk that is being used to address the subject.

First and foremost, a liability can never be defined as an asset, however clever the argument. My finance professors in Charlottesville would never have let me pass if I couldn’t scribe this equation accurately: Assets = Liabilities + Owners Equity.

In financial accounting, a liability is defined as:

“an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.”

In Loyalty Marketing terms, liability represents a deferred expense and is normally satisfied by a future cash payment to a vendor for the cost of a reward redeemed by a valued program member. For loyalty program sponsors paying for points (or whatever they wish to call their promotional currency) “On Issuance”, there is a line item in the marketing budget to expense total reward cost in the current period. The flip side of the equation provides that the reward supplier (the seller of the points) holds a liability against future redemption activity. The supplier manages the point bank and accepts the associated risk, but also benefits from predictable cash flow and breakage resulting from points expired or forfeited in the future. Note: there is a potential conflict between client and supplier built-in to this business model as the breakage that creates profits for the supplier could negatively impact the client’s reward program.

For program sponsors paying for points “On Redemption”, a financial reserve is made for the value of each point issued based on a percentage rate framed by industry norms and auditor approvals.  Accounting entries are made each month for the actual cost of points redeemed in the period. The sponsor is in control of all the financial levers that dictate the financial health of the loyalty program and only parts with cash to pay supplier invoices for the actual cost of rewards redeemed on a monthly basis. The spoils of breakage belong to the sponsor.

In my experience, there are two key elements of Loyalty Program Liability that must be addressed at the Executive level of the sponsoring company:

• Setting Expectations: A fair and accurate forecast of future liability is integral to the loyalty business case. Projections should address both the magnitude and growth rate over time and be tested for sensitivity to varying levels of point cost, earn rates, and redemption levels. To understate or avoid addressing financial liability can be as damaging to the future health of a loyalty program as any other single factor while wrapping up the business case.

• Engagement Value: It is critical to establish with Executive Stakeholders that higher redemption rates correlate with higher program activity, engagement, and will lead to program ROI and corporate profitability. As an extreme example, if no one redeems, your financial staff may be chest-bumping in the short term, but working on their exit strategy within the near future. Lack of redemptions equates to customers who don’t care about your program, and are either responding to different forms of promotion or have moved on to patronize another brand.

Speaking from direct experience, I have worked with three separate banks over the past year that surprised me with one of these situations:

• An existing Loyalty program in market for several years with no reserve made to account for unredeemed points
• A mature Loyalty program with point liability being accrued based on an actuarial calculation disconnected from actual activity and redemption rates
• Newly launched program with business case in place forecasting liability and with recommended accounting entries – but no reserve being made

The root cause for each situation could be described, respectively, as lack of knowledge, inexperience with loyalty program best practices, and poor execution. In each case, it wasn’t fun being the messenger who delivered an accurate calculation of unreserved liability or pointed out that the road-map was in place but no one turned the keys in the ignition. But isn’t that what companies expect from their trusted outside advisors? The financial impact of these reserve shortcomings was more than 10X my fees charged and our recommendations spared the banks from further financial harm and management embarrassment. The message was a hard pill to swallow, but saved the patient from a potentially terminal illness!

Stories like these get around and there have been a few cases where issuers of promotional currency encounter financial hardship and can’t make good on their obligations. This combination of factors led one North American bank I met with to politely digest a complicated calculation of recommended reserve rate and then “over-reserve” at 90% of the funding rate to avoid even a sniff of risk associated with their program.

Loyalty Program Liability is the biggest line item in the overall budget and can’t be talked around or white-washed with business-speak. “A leopard never loses its spots” and loyalty program financial liability won’t just take care of itself.

The key to successfully managing the point-bank starts with setting expectations properly in the business case and reaching consensus with executive stakeholders that high redemption rates are a lagging economic indicator of loyalty program success. Program profitability can be further driven by aggressively managing reward cost, establishing partnerships to share cost, and remaining attentive to program rules to manage liability growth.

For every person who chirps that Loyalty programs don’t work, I respond by pointing out the unrealized opportunities with existing programs in the market.

Recent COLLOQUY research reported that American households belonged to an average of 14 loyalty marketing programs but were active in only 43%. Think about the implications of this simple metric.

If the average household has about 14 loyalty and rewards cards floating around between their pockets, kitchen counter, and file cabinets, only about 6 are probably IN the wallet, the glovebox, or the purse and ready to be used. Equally striking is that the other 8 cards are relegated to a place of darkness in the house and, depending on your definition of “active”, haven’t been used even once in the past 12 months.

For the cards being used on a regular basis, the program sponsor needs to understand what benefit is being created for the business, and has a fiduciary responsibility to shareholders to demonstrate profitability and return on investment (ROI).  For owners of those 8 inactive rewards programs, there is need for budget justification if the program is to continue, and key questions should be addressed, starting with:

• Should adjustments be made to program communications to create more engagement with members?
• Can the program value proposition be improved to create more spend, earning activity and redemption?
• Can costs be lowered?
• Can liability for unredeemed points be managed more proactively?

A well crafted measurement plan will provide all these answers for program sponsors. That said, it is surprising that far too many businesses minimize resources dedicated towards the discipline.  The saturation of loyalty and rewards programs in the market is not a reason for despair, but should create a sense of urgency to measure and evaluate program performance to drive continuous improvement and ensure that objectives are being met.

A Measurement Plan is defined as a tool through which a program sponsor can evaluate the success of its Loyalty program on an ongoing basis. Having a usable plan is considered a Global Best Practice across the Loyalty Marketing industry. The foundation of the plan must be tied to clearly defined financial objectives and underlying assumptions outlined in an approved Business Case.

A basic measurement plan should address these three key issues:

• Profitability – Metrics that capture incremental income derived from the program and all relevant program expenses
• Product Objectives – Measures that indicate progress versus targeted goals for individual products promoted in the program e.g. credit and debit cards
• Liability Management – Track growth and trends in the Reward Liability reserve and make adjustments as needed to the rate of reserve applied to new program earnings

For a measurement plan to deliver high utility to stakeholders and merit credibility within the business, it should be created within this construct:

• Accuracy – Models used must have consensus support among management and the model output must be perceived as accurate
• Relevancy – Users of the information must understand the relevancy of the data to their areas of responsibility within the business
• Execution – The plan stakeholders should be able to translate the information into tactical activities in order to address daily challenges and opportunities in the business

This framework is essential to build an effective measurement plan with high utility in the Executive suite. Over the next few weeks, I plan to break down key elements of Measurement plans and share insight into how to better manage the financial liability for unredeemed promotional currency (with real world examples!).

Ever since man has been on earth, we’ve been running. In the beginning, our motivation was the need for food, shelter, and survival. By the mid-twentieth century, pursuit of fitness through sweaty activities had become the domain of oddballs. Given the outlaw nature of adult fitness only 50 years ago, the origins of the 70’s running boom are remarkable.

Bill Bowerman, the one-of-a-kind University of Oregon Track & Field Coach, is most well known as the guy who shaped Steve Prefontaine’s front-running style into record breaking performances, and for having a hand in the founding of Nike. Few know that his chance trip to New Zealand in 1962 would lead to the jogging craze that swept America in the early 70’s.

Ask most people about running and they have an opinion – usually resolute and often diametrically opposed. The phenomena is so pervasive that New Balance has adopted it as the theme of its “Love and Hate” advertising campaign. Since I’ve logged about 35 years of pavement pounding, I can attest to man’s Cybill-like relationship with the sport. Some days the endorphins kick in and feet seem to float across the pavement. Other days, it just plain hurts.

In my experience, the most reliable anesthesia to dull running agony is to think. Allowing my mind to wander may have contributed to slower race times, but that’s another story. Through it all I’ve found that a good long run will clear the mind, spawn new ideas, and root out the solution for the problem of the day.

Soldiering through a 10K run the other day, I pondered the many ways in which independent retailers strive to breed loyalty and combat big box merchants. Punch cards and cash back discounts are the most common tactics used today. Listening to one merchant talk about his program recently, I realized that it was purely tactical, without strategic foundation, and absent specific objectives except for the hope that “more sales” would result.

As the ten kilometers that add up to the 6.2 mile run passed by, I assembled a list of ten questions that every retailer should ask when seeking to improve repeat purchase behavior and increase customer loyalty. The answers can be blended with a bit of “secret sauce” in order to give their Customer Strategy new meaning.

The 10 K’s of Retail Loyalty:

1. Who do you really think is your competition?
2. What does your Brand stand for?
3. How are you identifying customers today?
4. What are you doing with any data collected?
5. What are the objectives of your marketing efforts?
6. Are your offers coordinated to meet these objectives?
7. How are you communicating with customers?
8. How do you measure results?
9. Are employees trained to understand and promote the program?
10. What are you going to do next?

Marketing resources are scarce and, in a tough economy, every penny counts. Working through these ten questions will lead to a simple, yet effective strategy that any independent retailer can employ to improve their business.

It’s no sweat!

Bill Hanifin