All About Loyalty Program Fund Rates
by Michael Greenberg | CMO
The customer’s perception of a loyalty program’s value is crucial for enrollment, ongoing engagement, and long term retention. One important component is the fund rate, both perceived and actual.
Perceived fund rate is the percentage of sales that is promised to customers in the form of rewards. Most credit card programs are at 1%, many retail programs range from 2-5%, with a few programs as high as 10%. This is how most consumers evaluate a program’s value, although other benefits influence this perception. In reality, no program ever costs this much.
Actual fund rate is the percentage of sales actually paid to consumers in the form of rewards. This is driven entirely by breakage, which is the portion of value accrued that is not redeemed and expires. A good rule of thumb is to assume 50% breakage in your program estimates (although this number can vary widely).
So Actual Fund Rate = (1 – Breakage %) * Perceived Fund Rate. Pretty simple.
Lets look at 2 examples using one customer who spends $100 and another who spends $350.
In the first program, customers receive a $5 reward for every $125 spent, a perceived 4% fund rate. Customer A will never receive a reward, so all $100 of her spending breaks. Customer B will get 2 rewards, with $100 left over that does not get a reward, which also breaks. Assuming Customer B redeems both $5 rewards, the actual fund rate is $10/$450, or 2.2%.
In the second program, customers get a 4% rebate at the end of the year, also a perceived 4% fund rate. Customer A gets a $4 rebate, Customer B gets a $14 rebate. If Customer A does not redeem her rebate and customer B does, the actual fund rate is $14/$450, or 3.1%. However, in this scenario Customer B makes a purchase in the second year (when she redeems her rebate), so while the Year 1 fund rate is 3.1%, Year 2 is actually getting the benefit of the revenue.
You can see from these two examples some of the tradeoffs that must be considered in program design. Both programs have the same perceived fund rate. But their actual fund rates differ, the timing of their redemptions differs, their impact on accounting differs, and the actual redemption rate will differ. This is why it helps to have a professional help with your program design.
Since its clear that breakage has a dramatic impact on program design and economics, we’ll look at breakage in more detail next month.
