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All-in-one Guide to Loyalty Points Liability Management

  • Posted on October 27, 2022 by Robert
  • Reading time about 6 minutes
Customer points system

We know that almost every consumer loyalty program is designed based on currency, which means they inherently house a financial liability and have a material impact on the brand’s balance sheet. When the loyalty program issues the program’s currency to program members (i.e. points, miles, credits, cash rewards, stars, etc.), the brand incurs liability for the future program reward.

Once the currency is issued to the program member, there is a reduction in revenue from an income statement perspective. However, the brand cannot account for the full sale as some percentage will need to be remunerated in the form of a reward given back to program members upon redemption. That is why having a well-planned rewards management software is needed with the right balance of freebies and finance.

Customer Points System- Evolution of New Loyalty Currency

Loyalty programs gave birth to new currency i.e. points! Though customer points system has been around for quite a long time, they have been always treated as liabilities as they are capable of promising better future service. Many brands consider these programs normally and how they work until Delta Airlines announced its loyalty points liability which was around $3.9 billion, i.e. 10% of its total liabilities.

Today, the accounting rules have changed making it compulsory for firms to stick to the basic and inherent liable nature of the loyalty reward points. Every firm is now required to treat every point rewarded in connection with a cash sale as a separate component of the sale, as stated by the International Financial Reporting Standard (IFRS) 15, which has become mandatory in the U.S in 2018.

As it’s somewhat similar to postponed revenue, these programs are bound to decrease the firm’s profits upon the initial sale. But, the firms can recognize a corresponding amount from their deferred revenue liabilities after the points have been redeemed or expired to help them increase their profit. According to the IFRS 15 guidelines, the loyalty points‘ value should be reflected in revenue amounts.

If you are wondering how we can define the actual value of a firm’s loyalty program’s deferred revenue, we can find it by adding the total number of outstanding points, the value of a point, and the probability that the point will be redeemed. It is now clear that loyalty points liability management is one of the most important aspects to be considered for better revenue and program success.

Tips to Balance Loyalty Points Liability between Finance & Free Rewards

The finance team would like to minimize the loyalty points liability while marketing teams would like to maximize the use of loyalty points to increase customer engagement, boost repeat purchases and increase average order value through redemption.

The higher the redemption rate, the better the customer satisfaction and engagement rate. The loyalty report in 2016 says that members that frequently redeemed for rewards have 2.5 times higher program satisfaction levels as compared to members that have never done any redemption. This shows the strong support that brands must encourage redemption but it can also open up the worms of the finance department.

Additionally, it is important to note that rewards-based costs are incurred when points are issued not during redemption. This means the costs associated with the “potentially redeemable” reward points are incurred immediately & also sets up the reserve account to cover redemptions in the future. It is going to affect the loyalty program costs as the liability reserve only gets converted into cash after the actual redemption takes place.

As we can see, redemptions are done using the previously expensed reward points that has been issued months/years ago. Though redemptions can convert reserve liabilities into cash, it can make the finance team frown as they would want to retain cash as much as possible & not have to pay off the liability. This is clear that a higher redemption rate doesn’t help CFO in reducing liabilities, which is why an effective plan must be formulated by maintaining proper collaboration between finance and marketing teams for the proper management of loyalty points liability.

Factors That Help in Lowering Loyalty Points Liability

To reduce points liabilities, CMO advised the CFO to reduce the impact of these two factors stated below.

– Accrual rate, which can be defined as the percentage of points issued that are expected to be redeemed during program members’ lifetime. Lowering the accrual rate means an increase in breakage rate(percentage of points that are expected to never be redeemed by members)

Undoubtedly, CMO hates the idea of increasing breakage rate as this means lower engagement & lower program value. Though this can help in reducing liability for a while it will not do well in the future as it will increase the percentage of points that will go to liability reserve.

– Cost per point is another factor that can help in reducing your loyalty points liability. Though CMO might think to reduce cost per point, the efficacy of this option depends on the cost of the lower-end rewards if they want to go on with their redemption campaign

Another scenario is that it will enable the CMO to lower the cost per point temporarily. But if it is lowered permanently, they must re-think about rewards realignment and communication of rewards options.

Closing Statement

From above, it is quite clear that CFO and CMO struggle to come on the same page in terms of points redemption. Both teams must act smartly while finalizing the redemption strategy and keep a few points in mind like benefits it will bring like lower customer churn, and higher spending with the cost of points liability. That’s the only way to come up with the right solution beneficial for both the CFO and CMO, which is essential for proper management of the loyalty point’s liability.

Novus, being a renowned Loyalty Program Platform can transform small to well-established businesses with custom loyalty solutions that helps in bringing the right balance between the marketing and finance team for the best outcomes. Book a demo of Novus to see how we can add value to your business with services aligned with the best technology and frameworks.

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