If you're contemplating launching a loyalty program for the first time, brace yourself: you'll be hearing a lot of daunting financial terms. Loyalty marketing has its own language. Terms like "point liability," "cost per point," and "breakage" will appear, and it's important to understand them.
The financial aspects surrounding a new loyalty program are predominately associated with point liability. It refers to a "holding" account for earned points that are outstanding and expected to be redeemed. Points reserved within the liability account are converted into a dollar amount and reside on the organization's balance sheet. Think of point liability as an obligation or a debt owed on the part of a company, because that's exactly what it is. It represents a payout, in points, that is owed to members and will be demanded at some point in the future through redemption.
Many factors affect point liability and the overall financials. Successfully managing a loyalty program requires expertise in especially juggling these five key financial realities:
1. Rewards expense is incurred when points are issued. While the actual cash flows out when the points are redeemed and you pay for a reward, your marketing budget is impacted at the time points are issued. This is different from most marketing strategies that are short term in nature and where expenses are normally incurred at the same time as cash flow.
2. In the healthiest of programs, nearly one third of all points will go unredeemed. This is "breakage," referring to points that are never expected to be redeemed, either due to expiration or member forfeitures. Expected breakage is normally estimated up front and is technically never put into your point liability -- which also means it should never hit your expense.
3. A point expiration policy helps you estimate breakage. Most marketers and program members prefer their points never expire, but there are financial advantages to having an official point expiration policy. It helps you determine a better estimate of breakage -- knowing that there is a time when points no longer exist. It lowers program expense and gives you more budget dollars for other marketing initiatives.
4. Member redemption patterns tend to follow a very predictable trend. Points are most likely to be redeemed in their second year of life and much less so in their first year. While there are exceptions to this rule (such as programs will very low-value rewards) this trend has been born out in most large, high-frequency loyalty programs. How and when members redeem points will determine if your expected breakage is on track. Monitoring redemption trends is a proactive way to ensure your expected breakage is realistic and prevent unexpected surprises to future program expenses.
5. Typically, your program's return on investment (ROI) will break-even in the second year. Experiencing a financial return on a loyalty program will not happen immediately; it usually takes about two to three years. The second year tends to be the turnaround point because of two main factors that occur in the first year: the one-time upfront program development costs and the ramp-up period of building a membership base. Understanding this timeline is critical to setting the right expectations with your management and financial teams. Commit to showing a positive return on your program sometime late in year two or during year three, and you'll be more likely to be able to deliver on your success metrics.
Finally, don't let all these financial concepts take the fun out of creating a compelling loyalty program. The marketing aspects of designing a program are exciting, and the long-term results of implementing a program provide a strong ROI. It's just important to have a working knowledge of some of the financial terms you'll come across, which in the end, will result in a successful loyalty strategy.
Barry Kirk is VP of Loyalty Strategy for Maritz Motivation Solutions. A sought-after speaker, blogger, and workshop leader, Kirk led the introduction of new disciplines like neuroscience and gamification to the loyalty space, and champions the belief that "consumers are human beings first." Follow Kirk on Twitter @barrykirk.