Liability is a term that comes up often in loyalty program discussions. In the narrowest sense, dictionary.com defines liability as:
Noun, plural li•a•bil•i•ties.
- Monies owed; debts or pecuniary obligations (opposed to assets).
- Accounting liabilities as detailed on a balance sheet, especially in relation to assets and capital.
- Something disadvantageous: His lack of education is his biggest liability.
- Also li•a•ble•ness, the state or quality of being liable: liability to disease
Those descriptions all sound like bad things, right? Well, not so fast.
Essentially, liability is a debt, something that needs to be paid in the future. When used in the context of a loyalty program, liability means the money a company needs to set aside today to pay for rewards that will be redeemed/used in the future. Like any debt, liability can become a bad thing if it gets too large relative to income, but it can also be a tool for optimizing financial performance. Here’s what you need to know to stay on the good side of liability.
1) Why liability is important for marketers
The short reason: because it affects a company’s financial reporting, and is therefore important to the CFO and CEO. But here’s some background…
When a customer earns points in a loyalty program, the company typically takes on some degree of obligation to provide a reward at a future point in time. Accounting rules require companies to include this obligation in their financial reporting so investors have a clear view of the company’s financial situation. The obligation is reported in the form of liability – an entry on the balance sheet, similar to debt, which indicates the amount being reserved to pay for future rewards. The greater the liability, the weaker the financials look – at least on the surface (see #2).
Marketers generally don’t need to know the intricacies of calculating liability – it can be complex, and should be done with guidance from accountants. But marketers do need to know that program liability can affect the perceived value of a company, and can therefore become a focal point of discussions with Finance and Accounting stakeholders about a program’s financial performance. Understanding how to manage and optimize program liability is part of the marketer’s job.
2) Liability can be your friend
Our clients often ask us to help them reduce liability resulting from their loyalty programs. At first blush, reducing liability – that future obligation – is a fine objective, and one that is very important for the purposes of financial measurement and reporting.
But, as in so many things in life, there is a caveat:
a major strength of a loyalty program is its ability to drive customer behavior based on the incentive/promise of a reward in the future. Without the promise of that future reward waiting, a customer may not take that extra shopping trip or stick around for an extra three months.
Setting aside funds for future rewards – liability – can be a good thing as long as you are getting sufficient incremental revenue, which leads us to our next point.
3) Optimizing liability requires solid analytics
Does your good liability outweigh your bad liability? The cold, hard reality of loyalty program economics is that the majority of your members will take the money and run – they will happily redeem rewards without doing anything extra to earn them. You will have to carry that liability on the books as a cost of doing business. There is a portion of your member base, however, who will do something extra – either to stretch for a reward or because they have a reward in their pocket – they’ll spend more than they would have. You will also have to carry liability for these folks but you will get something in return.
You can’t just fire the customers who take the money and run (though some companies have tried).
The key to running a financially sound program is to ensure that those who stretch to earn a reward, or while redeeming a reward, outweigh those who take the
money and run.
The only way to know if the balance of revenue and cost is in your favor is to do analytical work using control groups and statistical methods. Analytical tools can separate out the ‘self-selection’ factor – programs tend to attract those who already have an affinity for your products/services – and determine whether your liability is driving the right behaviors. Analytics can identify customers who are likely to respond positively to incentives, as well as those who are not worth targeting. You can also do analytical work to improve the accuracy of your liability forecast based on your history of point redemption and expiration.
4) You can have a successful program without liability – but there are tradeoffs
There are two primary ways to set up a program with no liability:
a) Set a short time period for earn and redemption. Accounting rules do not require a company to book liability if points and/or rewards expire quickly. Some programs therefore rely on offers, benefits and rewards that are short-term in nature. An example is supermarket programs where one earns fuel discounts – the discounts are only available for a short time after they are earned, therefore no liability needs to be booked. For products and services with short purchase cycles, that structure may be appropriate, potentially accelerating the purchase cycle. However, short-term rewards may not be enough to keep customers shopping over the medium and long term. It is best to test and learn to determine if short-term rewards are really doing their job.
b) Build your program based on Surprise and Delight. Surprise and Delight programs make no promise for a specific reward in the future and therefore do not typically require booking of liability. That’s good for the balance sheet but may or may not be a good investment.
No-liability programs often fail to sustain engagement, because members don’t know what they need to do to receive benefits over time or if any one incremental purchase will make a difference in their experience of the brand.
For example, one well-known quick-service restaurant chain started out as purely Surprise and Delight. Their promise: “Swipe your card every time you visit and we’ll do our best to reward you with more surprises based on what you love.” This approach seemed to be financially sound up front, but customers didn’t respond that well – the company found that the program needed to be somewhat more concrete to maintain engagement, and ended up adding more tangible elements to it.
5) Optimizing liability has to start with program design
In many ways, reward structures are a zero-sum game. On one side are customers who want to be rewarded for what they would do anyway (which simply erodes margin). On the other side are companies that only want to reward behavior that is incremental and profitable. Successful reward structures find the right balancing point between those two extremes. There are a few techniques to consider:
a) Set up your structure so that the value of rewards escalates along with the profitability of the customer behavior.
b) Don’t over-pay with your base value proposition – use bonuses and offers over and above the base payout to target your reward expense toward those who are giving you more.
c) Look for rewards that have a high perceived value to customers but low cost to you – the valuable reward drives customer behavior but results in very little obligation to the company. The classic example is an unused airline seat, but unique events and experiences can also be a cost-effective way to provide member value at a low cost.
d) Use partners, or other promotional elements such as sweepstakes, to burn off points.
Managing liability isn’t the most glamorous part of a loyalty marketer’s job, but it is important, and mastering the topic will markedly improve your program’s performance. Kobie offers a wide range of capabilities to guide you, with expertise in Program Design, Financial Modeling, Program Optimization and Analytics. Let’s talk about how we can help you – to learn more, email us at firstname.lastname@example.org.