The practice of Loyalty Accounting has become increasingly important as programs have matured and the value of deferred financial liability on corporate balance sheets has grown.

The key offset to the balance sheet liability is breakage. It is the word used to describe the value of the accumulated points that go by the wayside and is controlled through published Terms and Conditions, the fine print that accompanies each program. The better executed programs explicitly share the rules of the game, i.e. how often you must shop, fly, or swipe to keep your points alive and available.

Every organization that operates a loyalty program should know by now that it is in the best interest of the customer and the brand to not only disclose the rules, but to provide ample warning of points reaching expiry. Explanation of the actions required to protect point value must be shared in an easy to understand manner.

Two recent personal examples illustrate the contrast in how brands handle breakage. You will see from the examples that there is also a contrasting impact on customer satisfaction and future disposition to repurchase.

I received an email from JetBlue advising me that:

“Your TrueBlue points won’t expire as long as you fly at least once a year. Unfortunately, it’s almost been a year since you’ve flown with us. To make sure you get to keep the points you’ve already earned, just fly with us again in the next 30 days.”

I knew that I had flown with JetBlue on several occasions during the year, but that I wasn’t receiving credit for my mileage due to the disconnect between the naming of my TrueBlue account and the new TSA requirements for passenger identification. I have written about this before and feel strongly that airlines have a golden opportunity to assist their valued frequent flyers in making this transition to TSA compliancy.

Knowing that the process is not easy and that the time needed to request, validate, and receive credit for past flights with reservations in different names would be a poor use of my time, I was resigned to sending an email to customer service.

To my surprise, I received a response within 24 hours informing me that past flights were being credited to me and that my expiration date was extended accordingly. In addition the email made clear how to get my account in sync with TSA requirements and to avoid future discrepancies.

This was a fantastic result and one that renewed my allegiance to the JetBlue brand.

Next, I received an email notice that my ATT wireless bill was due. Visiting the account online to pay the bill, I checked to make sure the recent changes to my wireless plan had been made and that the bill was correct. In a box shown as part of the billing statement I saw this:

Previous Rollover Balance – 10,592
Current Rollover Balance – 1,400
Bonus and Adjusted Rollover Minutes (10,157)

Translated, this was telling me that, in the process of making changes to my account, I forfeited 10,157 rollover minutes. I have been made aware of these rules in the past, but the reality of losing these minutes was never mentioned in my call to customer service to make changes to my account, nor was any gesture of value offered to me for *gasp* trying to adjust my plan to a more sensible and economical setup.

I would say that this transaction lessened my affinity for the ATT brand, but since they trade only on a contractual basis, I suppose it doesn’t matter. What ATT and the other carriers are missing is a huge opportunity to create goodwill across their customer base.

Treating the rollover balance like a rewards currency and proactively offering me something, anything, for losing this truck-load of minutes would have been a wonderful surprise.  Instead, the carrier reinforced my predisposed opinion that I am being held captive by my wireless carrier and, as a prisoner, my rights are non-existent.

Two approaches to breakage and two distinct outcomes on brand affinity, customer loyalty, and future disposition to purchase.

Can you hear me now?

Loyalty Truth has been giving a lot of thought towards the shaping of loyalty and rewards programs to engage the interest of Millennials and the broader digital consumer group we are calling Consumer 2.0.

With many merchandise offerings lacking imagination as well as value, and airline miles tough to redeem given capacity restraints on available reward seating, cash back has earned renewed popularity as a quick-to-earn and easy to understand reward.

The problem is, rational can be boring. And easy to understand sometimes means too easy to label. With Groupon offering a 50% off “deal of the day”, a 1% deferred cash reward seems to be teetering on irrelevancy.

A 2010 paper written by an esteemed group of professors from Harvard University, University of Virginia, and University of British Columbia, pointed out that, in most cases, people enjoy experiences over things. While an item purchased can bring temporary pleasure, it is an experience that leaves a lasting impression.

Music is experiential and has been described as a “time machine” by some people. Most of us can attest to the impact of hearing a favorite song on the radio. The opening notes can transport us back in time and bring us vivid memories of first dates, world events, or just plain old good times.

If you don’t believe that music is important to human beings, is pervasive in our culture today and can be used to shape purchase behavior, then at least factor in these statistics:

• MP3 players — Just under half of American adults (47%) own an MP3 player such as an iPod — a nearly five-fold increase from the 11% who owned this type of device in early 2005  – Aaron Smith, Research Specialist, Pew Internet & American Life Project October 14, 2010

• 16 percent of Americans age 13 or older are using devices other than their home computers to download software applications (apps), music, video, and other entertainment content from the Web – NPD Group, May 2010

• 75 percent of iPhone and iPod Touch users are connecting to the Web to download entertainment content and apps – NPD Group, May 2010

Rewards and Music have been linked in an interesting way so far. Several digital content providers, including iTunes, have made forays into the loyalty industry. Reward administrators were asked to pre-purchase exclusively download codes to offer music as a reward, and the redemption process was often cumbersome as it required consumers to leave the brand sponsor’s web environment to collect their music.

To my knowledge, there hasn’t been a fully integrated platform to deliver music and other digital content as a reward until PointTunes™ was announced last year. The platform makes it possible for a loyalty program participant to redeem points or miles directly for music, eBooks, software and games with a patent pending transaction process named PointRobot™.

I had the opportunity to interview the founder of PointTunes™, Bill Cunningham, who shared that PointRobot™ can be used to create a customized digital rewards offering where program administrators have complete control over their digital rewards options.

He told me that PointTunes™ has its origins through his work as a Product Manager for one of the largest employee rewards companies in North America. “During that time I was never presented with a viable digital solution by our vendors” said Cunningham, and “myself and other rewards administrators were looking to add digital reward options to help control costs and find new clients.”

If you understand the shift taking place towards customer engagement, you understand how breakage, while a tempting element of a rewards financial model, can have negative impact on customer relationships. With pressure on reward costs, digital content is attractive to brands sponsoring loyalty programs.

Something had been missing from the previous method of including music as a reward in most loyalty programs and Mr. Cunningham “believes digital rewards is a perfect fit for the loyalty market both from an incentive (do this get that) and a loyalty (points, miles et al.) angle.”

Considering that Consumer 2.0 is perfectly at home with social networks and location based marketing (Gowalla, Foursquare, Facebook, Twitter et al.), using digital rewards that are as mobile as your customers makes sense. To meet the need, Cunningham said a mobile rewards platform is planned for launch in 2011, allowing consumers to redeem for music right from their mobile handset.

Loyalty is evolving to become more social and to meet the needs of the brands that sponsor the programs. PointTunes™ is a group to watch as the “Social Loyalty” continues to unfold during 2011.

Breakage is the classic crutch of loyalty marketing financial models. As I mentioned here in a recent post, attitudes towards breakage are changing, both from perspective of the loyalty supplier community and consumers.

Brands aren’t missing the boat on breakage, in fact recent moves by Delta Airlines and Points.com over the past two weeks signal additional recognition that the accrued value in loyalty programs is not a ’shiny object” to tease consumers with, rather it is truly an alternate currency that people expect to have liquidity and be able to convert for value.

Points.com announced that it is teaming up with Paypal to allow its Aeroplan® miles, American Airlines AAdvantage Miles® and US Airways® Dividend Miles® to convert into cash in member’s PayPal accounts. It’s one thing to flush your points for questionable value in the form of magazine subscriptions. I’m sorry, but I just don’t call that a good value proposition for most people.

It’s quite another matter to be able to convert miles into cash. In concept it’s a great enhancement for Points.com and a boon for PayPal. The crucial driver of success for the tactic will be the exchange rate set between the two currencies. At this point I’m not privy to the exact exchange rate but understand it will be distinct for each airline. Some consumers are already crying about lack of value and we’ll have to keep a watchful eye here. On the surface, it’s a great idea.

Frequent Flyers didn’t fare badly this week either. Delta Airlines announced that mileage no long expires in its SkyMiles frequent flyer program. This change could be viewed in two ways. The skeptic will contend that infinitely available miles will just make a seat capacity problem that frustrates most frequent flyers even worse. Additionally, it might seem to represent another step in making FFP’s tougher for the airlines to manage from a financial standpoint.

The optimist will opine that eliminating mileage expiration will spark brand affinity for Delta in the short term and, if combined with some additional redemption options (can Delta play in the PayPal arrangement or come up with some other ideas?) will increase customer engagement over a longer term.

I’ll weigh in as an optimist. With our estimates of Consumer 2.0 at or near 150 Million US consumers, brands that shift the emphasis of their rewards programs from breakage to engagement will come out on top. Consumer 2.0 wants attainable rewards on a more liquid basis. Conversion to cash through Social Shopping, redemption at point-of-sale, and Social Giving are all options that this group finds attractive.

It’s good for the industry and for the consumer when we witness brands encouraging engagement rather than hoping for breakage.

The loyalty supplier business is full of contrasts. Go-to-market strategies, and business models cover the spectrum. Looking East to West across the range of choice for brands operating traditional points-based loyalty programs, the offerings can be categorized somewhere  between old-school and ground-breaking. One key area of difference boils down to a single word – breakage.

By definition, the value of unredeemed points has been the cherished prize of whatever party owns the points bank. For years, many vendors “sold” points as part of their service offering, and breakage became a hidden value from which the vendor accrued value.

Eyes are wide-open today, with everyone benefiting from the loyalty value chain attentive to breakage – both its magnitude and how it is shared. Breakage is an important assumption in projecting loyalty program ROI, and sharing in the pot is heartily negotiated between vendor and brand.

Increasingly, the conversation around breakage is changing, with more progressive brands and their vendors asking if breakage is (gasp) a good thing.

Managing breakage has been thrust into the spotlight as new regulations are in play mandating how unused value in rewards program are to be tracked and funded. The rules, referred to as IFRIC 13, have become frequent topics of interest in industry conferences and have gained attention from global accounting firms seeking to carve out a new area of core business.

Beyond accounting standards, brands are attentive to how breakage impacts the success of their rewards programs and the associated satisfaction levels of their customers.At the Airline Mega Event this past October, a “Liability Forum” was presented with panelists describing breakage as “an asset to be used for program improvement” rather than just a kitty from which to bolster profits at quarter-end.

During the Mega Event, United Airlines presented a new communications campaign that highlighted this new view on breakage, saying that United Mileage Plus is “The program that wants you to use your miles”.

At the Cards and Payments Loyalty Conference a month later, panelists were asked “what is the ideal level of breakage” in a loyalty program. Fabio Garcia, head of cards at Banco Popular, got the audience to lift their eyes from their smartphones when he asserted that “zero” was the ideal figure. His logic? More redemptions equates to higher customer engagement, lower credit risk, and is a precursor to longer term program satisfaction.

Here are a few take-aways on Breakage & Liability Management:

1. Have a clear strategy for ownership of the points bank and how ensuing financial benefits will be allocated. Craft a position on acceptable levels of breakage, with customer engagement & satisfaction guiding the process.

2. Run from vendor relationships where points are sold on issuance and the spoils of breakage are held exclusively by the vendor.

3. Be prepared to defend your business case against financially driven colleagues who contend that higher breakage will add value to the program (hint: higher program value is offset by lower customer values over time).

The loyalty supplier business is full of contrasts. Go-to-market strategies, and business models cover the spectrum. Looking East to West across the range of choice for brands operating traditional points-based loyalty programs, the offerings can be categorized somewhere  between old-school and ground-breaking. One key area of difference boils down to a single word – breakage.

By definition, the value of unredeemed points has been the cherished prize of whatever party owns the points bank. For years, many vendors “sold” points as part of their service offering, and breakage became a hidden value from which the vendor accrued value.

Eyes are wide-open today, with everyone benefiting from the loyalty value chain attentive to breakage – both its magnitude and how it is shared. Breakage is an important assumption in projecting loyalty program ROI, and sharing in the pot is heartily negotiated between vendor and brand.

Increasingly, the conversation around breakage is changing, with more progressive brands and their vendors asking if breakage is (gasp) a good thing.

Managing breakage has been thrust into the spotlight as new regulations are in play mandating how unused value in rewards program are to be tracked and funded. The rules, referred to as IFRIC 13, have become frequent topics of interest in industry conferences and have gained attention from global accounting firms seeking to carve out a new area of core business.

Beyond accounting standards, brands are attentive to how breakage impacts the success of their rewards programs and the associated satisfaction levels of their customers.At the Airline Mega Event this past October, a “Liability Forum” was presented with panelists describing breakage as “an asset to be used for program improvement” rather than just a kitty from which to bolster profits at quarter-end.

During the Mega Event, United Airlines presented a new communications campaign that highlighted this new view on breakage, saying that United Mileage Plus is “The program that wants you to use your miles”.

At the Cards and Payments Loyalty Conference a month later, panelists were asked “what is the ideal level of breakage” in a loyalty program. Fabio Garcia, head of cards at Banco Popular, got the audience to lift their eyes from their smartphones when he asserted that “zero” was the ideal figure. His logic? More redemptions equates to higher customer engagement, lower credit risk, and is a precursor to longer term program satisfaction.

Here are a few take-aways on Breakage & Liability Management:

1. Have a clear strategy for ownership of the points bank and how ensuing financial benefits will be allocated. Craft a position on acceptable levels of breakage, with customer engagement & satisfaction guiding the process.

2. Run from vendor relationships where points are sold on issuance and the spoils of breakage are held exclusively by the vendor.

3. Be prepared to defend your business case against financially driven colleagues who contend that higher breakage will add value to the program (hint: higher program value is offset by lower customer values over time).

I recently shared a story in the Toronto Globe & Mail about how Canadian parents would rather talk with their children about sex, drugs or alcohol than money.

Sometimes when I talk with stakeholders responsible for loyalty program operations, I get the feeling that the question draining their complexion is not far from that mark. “Who pays for Loyalty?” is a simple question that can cause discomfort and spark lengthy discussion.

My first boss (just a few rungs up) was Hugh McColl, the ex-marine who built North Carolina National Bank (NCNB)into a regional powerhouse and set it on a course to become what is now Bank of America.  Mr. McColl taught me a lot and had a famous way to simplify the evaluation of a company’s commercial credit risk. In the middle of heated debates about which ratios should be included in a financial analysis to see if some Fortune 100 customer was able to handle a loan under consideration, Mr. McColl would remind us that “all loans have to be paid back from cash, somehow, sometime.”

This pure logic should be remembered by retailers as they push harder to lower interchange rates for card transactions. As the rush to meet implementation deadlines for the Credit Card Act of 2009 dwindles, attention is turning once again to interchange. A good take on the current debate can be found in this article.

The question before many loyalty sponsors today is actually closer to “How can I pay less for Loyalty points?” The behavior of card issuing banks responsible for loyalty programs during this recession speak loudly that reducing cost is high priority. The changes to program rules to hasten forfeiture of points or miles, added fees for redemption, and additional points needed to redeem rewards have all been applied in well known rewards programs over the past several months.

Funding the cost of loyalty can be borne by one party or shared by partners.  How the breakage of those points is shared influences how each party manages program rules and drives more (or less) breakage. In some pay-for-performance models where participating merchants fund rewards to debit card holders from their banking partner, breakage is not a critical issue for either party.

• The bank, typically paying out rewards as a cash back account credit, is not too concerned about the nearly “100% redemption rate” occurring since the retailer is footing the bill.

• Fortunately, the retailer is able to offset its expense with incremental sales earned, all of which is accomplished by a lower than average give-away (10% cash back equivalent versus 40% markdown).

Some people have tried to paint this “merchant funded” model as banks taking advantage of retailers, but I disagree. Intelligent targeting that drives incremental sales and reduces the retailer’s reliance on discounting, while delivering increased card spend at lower cost to the bank is a win-win for all parties.  With retailers papering the walls with “40% off everything in store” signs just to get consumer attention, funding the equivalent of a 10% cash back in points is an attractive alternative.

In my opinion, the renewed emphasis on legislating interchange rates is the red-herring of the year. Yes, MasterCard, Visa, and American Express have a lock on the acceptance network at the retailer. But any perceived threat of monopoly can be balanced with understanding that merchant sales increase when cards are accepted. The cost is high, but at this point, the opportunity cost  is unacceptable.

It is entirely reasonable that business wants to reduce cost, and here’s the lowest hanging fruit – train front-line personnel to stop asking customers if they want “debit or credit” and encourage them to enter their PIN for debit transactions. Consumers really don’t care how they use their card as long as the purchase is completed and there are significant cost reductions to be enjoyed by a continuing shift to PIN based purchases.

If the focus remains instead on reducing credit card interchange rates, card issuers will see a key driver of the rewards business case in jeopardy and could shut down the rewards nozzle even tighter. If cash is not available from the banks, if rewards cards were to go away all together (they won’t), retailers would be left to subsidize their own loyalty marketing efforts without the prospect of shared funding from another source. Private label cards are probably not a holistic answer as consumers have spoken that they want more utility from their payment devices and are only willing to carry the cards with highest utility in their wallets.

In a world without card based loyalty, retailers would be left one tool short of a solid toolbox. Breaking the cycle of discounts and endless sales will be increasingly difficult and consumers will be further trained to wait for the greatest discounts before “footfall” occurs in store.

Here’s the best part: consumers don’t care who pays for loyalty. They want the utility of their payment card, want to earn rewards, and want the best price with good quality from the items purchased in store. I would not want to be retail executive who puts a huge dent in interchange and, while celebrating a temporary victory, watches revenues shrink as the alternatives to ever growing rounds of discounts and pure price competition are diminished.

The visual image I leave you with is Leon Lett getting the ball knocked out of his hands just before he crosses the goal line and is denied his touchdown by Don Beebe on a play that should have led to a massive celebration.

PS: That play might be the only highlight for the Buffalo Bills in Super Bowl XXVII

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.

Watching the Vice Presidential debates, there was a lot of talk from both sides about bolstering the hopes and fortunes of the middle class. This struck a chord as I reflected on my shopping experiences that same day and realized that retail marketers rely on several promotional tactics that, in our opinion, aren’t truly designed with the customer in mind.

Extended Warranty Protection Plans, Same-As-Cash deals, and Mail-in rebates are all on the suspect list but Mail-In Rebates are the focus of this post. Designed originally as a deferred discount to distract consumer eyes from the “real” price of the product, mail-in rebates came into view years ago and continue to proliferate throughout retailing. Today, they have proliferated across product and category to the point where consumers can’t just rely on reading the “price” shown in big bold type, but need to look at the fine print to see what conditions apply to enjoy the stated price.

Two quick stories will have you nodding your head as they illustrate customer experience in mainstream retailing:

• Needing to replace a mobile handset for a family member, I called the “help” line to find out what deals were available. I was given the prices of specific phones that I was eligible to acquire and was told that a $75 early upgrade fee would apply. The phone we selected totaled up to $125. This price was in my brain when I walked into the wireless store only to learn that it was net of a $50 Mail-In rebate. End of story…..I paid $175 and walked out with a new handset and a rebate form to complete.
• My 19” computer monitor was on the fritz and I had no choice but to shop for a replacement. Prices for 22” monitors ranged from $179 – 295. When my frugal Irish eyes looked more closely at the $179 model, I noticed that the price was net of a $50 rebate. Next to it was a more attractive model with bigger brand name. Since the price was $249, I struggled with the wisdom of paying a higher price and not having to take my rebate “homework” with me. End of story……I am still shopping.

The attractiveness of Mail-In rebates for marketers is summed up in one word: breakage. The burden of cashing in on the rebate falls solely to the consumer. Completing the paperwork properly, including the right documentation, mailing before the expiration date, and spending additional money for delivery confirmation stacks up in favor of the retailer. It is a game that can be played successfully by consumers, yet many of us don’t have the discipline to follow through properly. The fact that Mail-In rebates continue to be a popular pricing tactic is testimony that breakage does benefit the retailer.

From what I have learned about Millennial (Generation Y) purchasing behavior, I wonder if breakage rates will go sky-high across this 80 Million person group. Maybe the only hope for this upcoming generation is out-sourcing. I’ve seen pet-sitters and dog-waste services advertised in the local paper along with cleaning and yard services. Maybe bookkeepers need to add rebate processing to their list of services.

Responsibility lies on both sides of the transaction and consumers need to be educated and disciplined when making purchase decisions. Marketers might consider this Loyalty Truth: whether this is the type of relationship they wish to promote with their customers over the long term. As they continue to employ tactics that force consumers to be detail driven in order protect their interests, the chances of building enduring brand loyalty will be diminished with each transaction……Bill Hanifin