Loyalty Truth

I recently shared a story in the Toronto Globe & Mail about how Canadian parents would rather talk with their children about sex, drugs or alcohol than money.

Sometimes when I talk with stakeholders responsible for loyalty program operations, I get the feeling that the question draining their complexion is not far from that mark. “Who pays for Loyalty?” is a simple question that can cause discomfort and spark lengthy discussion.

My first boss (just a few rungs up) was Hugh McColl, the ex-marine who built North Carolina National Bank (NCNB)into a regional powerhouse and set it on a course to become what is now Bank of America.  Mr. McColl taught me a lot and had a famous way to simplify the evaluation of a company’s commercial credit risk. In the middle of heated debates about which ratios should be included in a financial analysis to see if some Fortune 100 customer was able to handle a loan under consideration, Mr. McColl would remind us that “all loans have to be paid back from cash, somehow, sometime.”

This pure logic should be remembered by retailers as they push harder to lower interchange rates for card transactions. As the rush to meet implementation deadlines for the Credit Card Act of 2009 dwindles, attention is turning once again to interchange. A good take on the current debate can be found in this article.

The question before many loyalty sponsors today is actually closer to “How can I pay less for Loyalty points?” The behavior of card issuing banks responsible for loyalty programs during this recession speak loudly that reducing cost is high priority. The changes to program rules to hasten forfeiture of points or miles, added fees for redemption, and additional points needed to redeem rewards have all been applied in well known rewards programs over the past several months.

Funding the cost of loyalty can be borne by one party or shared by partners.  How the breakage of those points is shared influences how each party manages program rules and drives more (or less) breakage. In some pay-for-performance models where participating merchants fund rewards to debit card holders from their banking partner, breakage is not a critical issue for either party.

• The bank, typically paying out rewards as a cash back account credit, is not too concerned about the nearly “100% redemption rate” occurring since the retailer is footing the bill.

• Fortunately, the retailer is able to offset its expense with incremental sales earned, all of which is accomplished by a lower than average give-away (10% cash back equivalent versus 40% markdown).

Some people have tried to paint this “merchant funded” model as banks taking advantage of retailers, but I disagree. Intelligent targeting that drives incremental sales and reduces the retailer’s reliance on discounting, while delivering increased card spend at lower cost to the bank is a win-win for all parties.  With retailers papering the walls with “40% off everything in store” signs just to get consumer attention, funding the equivalent of a 10% cash back in points is an attractive alternative.

In my opinion, the renewed emphasis on legislating interchange rates is the red-herring of the year. Yes, MasterCard, Visa, and American Express have a lock on the acceptance network at the retailer. But any perceived threat of monopoly can be balanced with understanding that merchant sales increase when cards are accepted. The cost is high, but at this point, the opportunity cost  is unacceptable.

It is entirely reasonable that business wants to reduce cost, and here’s the lowest hanging fruit – train front-line personnel to stop asking customers if they want “debit or credit” and encourage them to enter their PIN for debit transactions. Consumers really don’t care how they use their card as long as the purchase is completed and there are significant cost reductions to be enjoyed by a continuing shift to PIN based purchases.

If the focus remains instead on reducing credit card interchange rates, card issuers will see a key driver of the rewards business case in jeopardy and could shut down the rewards nozzle even tighter. If cash is not available from the banks, if rewards cards were to go away all together (they won’t), retailers would be left to subsidize their own loyalty marketing efforts without the prospect of shared funding from another source. Private label cards are probably not a holistic answer as consumers have spoken that they want more utility from their payment devices and are only willing to carry the cards with highest utility in their wallets.

In a world without card based loyalty, retailers would be left one tool short of a solid toolbox. Breaking the cycle of discounts and endless sales will be increasingly difficult and consumers will be further trained to wait for the greatest discounts before “footfall” occurs in store.

Here’s the best part: consumers don’t care who pays for loyalty. They want the utility of their payment card, want to earn rewards, and want the best price with good quality from the items purchased in store. I would not want to be retail executive who puts a huge dent in interchange and, while celebrating a temporary victory, watches revenues shrink as the alternatives to ever growing rounds of discounts and pure price competition are diminished.

The visual image I leave you with is Leon Lett getting the ball knocked out of his hands just before he crosses the goal line and is denied his touchdown by Don Beebe on a play that should have led to a massive celebration.

PS: That play might be the only highlight for the Buffalo Bills in Super Bowl XXVII