Rewards Breakage—Boon or Bane?

Marketers design and execute loyalty programs to retain customers, strengthen long-term competitive position, and, of course, reap tangible financial rewards. Loyalty programs have the power to alter regular purchase blueprints, making them a vital marketing tool across industries. With the help of loyalty programs, marketers can identify profitable customers and their purchase patterns, and reward desirable behavior accordingly. Armed with this information, marketers can truly understand attitudinal and behavioral loyalty toward a particular organization. Several studies have proven that loyalty program members exhibit greater behavioral loyalty to organizations when compared to nonparticipants. This makes loyalty points one of the most valuable commodities for marketing managers and CRM experts.

At the same time, loyalty programs are expensive and involve considerable set-up and maintenance, as well as running costs involving accrual and redemption of points. That is why companies need to ensure that there are sizeable sales gains to recover these costs.

Points: The Loyalty Currency

The rewards offered by an organization in exchange for points should be attractive enough to keep members coming back to the brand. Otherwise, a loyalty program might run the risk of having a large member base that doesn't really care to accrue points, resulting in sales that don't meet expectations.

Which brings us to one of the biggest challenges faced by loyalty programs: breakage. Unredeemed or expired points constitute "breakage" for the operator of a loyalty program. In a successful loyalty program, members regularly redeem points for rewards of their choice. What's important to note is that redemption is the "single point of realization" that leaves members happy and excited about their relationship with the brand. In a loyalty utopia, all accrued points would be redeemed. But in the real world, just a portion of points are burned. Even though, from a financial perspective, breakage constitutes profit, "redemption rate/velocity" is the acid test of the efficacy of a loyalty program. This presents a paradox for loyalty program managers. Is breakage a boon or a bane for loyalty programs?

Outstanding loyalty points represent a potential liability on the balance sheet and present a dilemma for two reasons:

1. Overprovisioning can lead to tying up of funds that could be more productively invested elsewhere.

2. Underprovisioning can lead to deficits in future years.

Many operators swear by breakage models when it comes to managing the profitability of a program. They create breakage models by setting high redemption thresholds or create unnecessary barriers to redemption, like setting early expiration periods. While some breakage is good for the bottom line, too much would eliminate the very reason members would interact with the brand. The effects of high breakage can be so devastating that labeling it as "carcinogenic" for a loyalty program would not be an exaggeration.

What operators don't realize is that breakage models create a vicious cycle of ever-decreasing value for both the consumer and brand. High breakage levels indicate waning member interest and are symptomatic of the program's frailty. High breakage levels will not only reduce switching costs but also make alternate brands more attractive.

It is not easy to identify what the optimal breakage is because a certain percentage of points will break naturally and form a part of expected revenues. Natural breakage rates vary among industries. There are studies that show the breakage in retail loyalty programs at around 25 percent. Some large airlines indicate a breakage in the range of higher than 40 percent. The necessity for reducing breakage lies in the fact that redeemers churn 8 to 20 percent less than nonredeemers, according to CRMTrends.com and ITC Infotech's strategic loyalty consultancy studies with multiple airlines.

If you are the manager of a loyalty program, you should note that while most loyalty programs present multiple and accelerated opportunities to accrue points, they also may fail to create unique and compelling rewards in exchange. Keep in mind that the decisions to repurchase may be inertial, but the opportunity to earn "redeemable" points is an accelerant.

Also behind a successful loyalty program is the ability to identify and understand the factors that trigger and cause high breakage rates. These are:

A communication gap. A lack of regular two-way communication between the brand and the members will have a negative impact on your program. When a gap exists, the member is unlikely to know the balance points and what rewards can be redeemed using the existing balance. Members are unaware of expiration rules and aren't receiving accrual and redemption promotions that will engage their attention and increase their propensity to transact.

Flawed program design. Some programs are deliberately designed as or end up becoming breakage models. They have low exchange value of accrued points, uninteresting rewards on catalogue, highly priced rewards, a cumbersome redemption process, inflexible membership cancellation policies, complicated partner rules, a shorter points expiration period, lack of opportunity to accrue points as a household resulting in fragmented points balances, and midterm points devaluation.

Branding ambiguity. Some programs communicate membership benefits ambiguously. Without clarity in expiration of rules, members accrue for a longer time for an aspirational reward. No point of purchase (POP) material at participating outlets, untrained retail staff, and no proactive prompting for loyalty membership by retail staff all contribute to such ambiguity.

The good news in all of this is that modern technology provides some very innovative and effective ways to deal with high levels of breakage. For example, Oracle's Siebel loyalty platform attempts to solve some of the fundamental issues including that of breakage. Platforms like Oracle Siebel and others attempt to help organizations offer:

  • Quick and easy deployment of feature-rich loyalty programs across industry verticals;
  • Effective communications management that includes automatic notifications for predefined events like tier change, points expiration, etc.;
  • Efficient rewards, promotions, and member management including accelerated creation and deployment of a large variety of promotions;
  • On-boarding multiple partners with a variety of rules;
  • Prebuilt analytics, dashboards, and reports for analyzing campaigns, programs, and advanced member segmentation based on user-defined attributes; and
  • Theme-based clubs and programs for better engagement.

    New-generation loyalty solutions have several rich features and enable regular engagement with members. By understanding members' needs, it is possible to offer a relevant, timely, and interesting loyalty program which ensures maximum participation—the key to its success.

    LN Balaji is the president of ITC Infotech (USA) Inc., a global IT services and business solutions company, and head of the company’s operations in North America.

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