Are Loyalty Programs Too Rewarding?

Written by: Naftali Marlon Tanyongana

Loyalty programs have become par for the course across industries — from retail to airline to hospitality — popularized by their ability to create a loyal customer base. But, companies can quickly lose themselves in the number of return customers and purchases, forgetting about the costs associated with these loyalty programs. Focusing on the International Financial Reporting Standard (IFRS) 15 change to finance that affects these costs, consider this to be a brief and simplified outline of recent changes in finance to keep in mind for 2019. First, a quick recap:

The Refresher

A loyalty program is a system whereby a company incentivizes repeat business from customers through features, reward schemes and offerings accessible by a point system available at the company.

The Change

IFRS 15 covers “Revenue contracts with customers” (REM Loyalty, 2018). It states in simple terms that sales with a promise of future rewards must account for those future rewards, and that reward points should be categorized as deferred revenue. To quote IFRS (2018), “IFRS 15 specifies when and how much revenue a company should recognize, and the information about revenue that the company should disclose in its financial statements. It is relevant for all companies.” Similar standards have been enforced by US GAAP.

The Result+

In 2019 it may be more fitting to consider loyalty programs a liability. With the changes to IFRS 15, companies will at least in the short term be reporting less profit, significantly impacting the company’s financial standing in the eyes of investors, as in the short term they will be perceived as experiencing significant drops in their profitability, a major turn-off for potential investors that will also affect the market valuation of the company. For larger companies, these revenue drops in their reports can cost billions in deferred revenues, with examples like American Express in 2017 losing $7.751 billion. This is already in addition to the fact that the company is essentially losing money when it provides the offerings promised, a feature called loyalty program liability — so where is the benefit?

Well, this does not consider the potential future profitability of the programs. Loyalty programs, therefore, come with a great deal of risk if mismanaged; however, if managed properly they have the potential to create a loyal customer base that is willing to spend increasing amounts on the company. This means that focusing solely on the costs could be to the future detriment of the company as customer engagement is reduced and potential future revenue is lost. According to suggestions given by Llaguno (2018) companies “should focus not just on liability, but more holistically on customer lifetime value (CLV)”.

Ultimately, IFRS 15 solidifies a view of loyalty programs as investments.e Risks are succeeded primarily through creating CLV over potential investment and positive valuation of the company. With how pervasive loyalty programs have become, it is unlikely that the decision to drop them will be considered by most companies; however, finance professionals should constantly be weighing the liability of these programs to see how well they may reap their rewards.

To read further on the topics of reward program financial reporting, please feel free to access the references below.

References

Naftali Marlon Tanyongana is a student at the Emirates Academy of Hospitality Management (EAHM) and editor of the EAHM Student Newsletter.

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