The Key Things To Know About Managing Loyalty Program Liability

Loyalty programs have become an integral part of most marketing strategies, and for good reason. They help create lasting and profitable relationships with customers. However, while loyalty programs may seem like a straightforward marketing tool, managing the liability associated with them is an entirely different story.

Understanding your company's loyalty program liability is essential to maintaining effective cash flow and accurate financial statements. In this article, we'll share the three key things to know about managing loyalty program liabilities.

Know the Basics of Loyalty Liability
Loyalty liability is the debt a company owes to a customer when they earn rewards that can be redeemed in the future. 

A growing liability can actually be a positive thing if you have the right models in place. When your liability grows, it means that your members are actively engaged and accumulating points with the intention of redeeming them. This encourages them to spend more money on your products and services in the long run.

However, if you have unsophisticated models, your liability may grow due to members earning points they don't actually plan to redeem. This becomes problematic if your models can't recognize the low likelihood of redemption. This situation indicates two scenarios:

1. Your breakage models may be inaccurate, resulting in an overstatement of liability. This can lead to compliance and regulatory issues that can be resolved by using more sophisticated and accurate models for breakage estimation.

2. Your loyalty program members may not be interested in redeeming their points, suggesting low engagement and a program that doesn't meet its goals. Accurate breakage models can serve as an early warning sign, as increasing breakage predicts decreased engagement in the future.

To do this, you must follow specific accounting rules and hold a specific amount of money to cover the rewards that can be redeemed. The money must be set aside and accounted for separately from other financial commitments to ensure accurate financial reporting.

Separate Accounting Should Be Carried out for Every Performance Obligation

New laws require companies to carry out a separate accounting for every contractual promise made to customers regarding their transaction. This is known as a performance obligation, and it must be logged separately.

For example, if a customer earns loyalty points on multiple transactions, each transaction must be recorded and logged separately to ensure accurate calculation of loyalty liability. This means that individual performance obligations must be accounted for separately, even if they are part of a larger transaction.

Calculating Loyalty Liability

Another essential aspect of managing loyalty liability is calculating the debt owed to customers accurately. Typically, revenue from customer loyalty points is not recognized until the reward is redeemed or expires.

To calculate your loyalty liability, you need to calculate three essential factors:

Outstanding Points: This is the number of points you have issued to customers that have not been redeemed or expired.

Cost per Point: The expected cost of the points that will be redeemed.

Redemption Rate: The probability that the points will be redeemed.

Once you have computed these factors, you can calculate your outstanding loyalty liability by multiplying them.

In conclusion, managing loyalty program liability is critical to maintaining accurate financial statements and managing effective cash flow. By understanding the basics of loyalty liability accounting, carrying out separate accounting for every performance obligation, and calculating loyalty liability accurately you can ensure your program stays on track and healthy.