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    October 2013
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    Loyalty and rewards programs – free??

    Ian Whiting

    A conversation with one of my grand-daughters

    I always enjoy chatting with Jeannette – 23, very smart – we starting talking about “free flights” from a well-known loyalty program used by many retailers. I asked her if she really thought they were free – and she said yes. She had never been charged any extra money when she handed the retailer this card so she figured the rewards were free.

    So we discussed that and finally it dawned on her that since the flights did in fact cost money (if she wanted to take the trip on her own without the loyalty “points”) someone was paying for them. So now she had to figure out who was paying and how much they were paying.

    I explained that the retailer who accepts such cards (including credit cards that have loyalty programs attached to them), is paying a percentage of the sale amount to a loyalty provider and in turn the loyalty provider (after deducting expenses and of course some profit), uses the net amount as electronic cash (actually an early concept version of Bitcoin) and pays the airline or cruise line or hotel or resort accordingly at some pre-negotiated discount rate.

    Time for some numbers – and I will EXCLUDE the fees charged by credit cards just for the sake of simplicity.

    A typical loyalty program works their calculation backwards starting with how many “points” they want people to accumulate before they can have a “reward”. So let’s assume the program provider decides to track process in multiples of 100 “points”. By going to various vacation-type providers and after some negotiations with them, the provider figures that 100 “points” needs to have a nominal “cash” value of $150. So 1 point = $1.50. Next, the provider has costs to administer the program and they estimate it costs them $15 to do the administration behind the $150 nominal value. Next, they decide that a reasonable profit is $5.00 per $150 of nominal value. So where are we now?

    We need $150 plus $15 plus $5 = $170. So how much does the loyalty provider charge the retailer or merchant? The retailer decides that a customer will need to spend $50 to get 1 “point”. So 100 points means the customer has to spend at least $5000. Time to calculate a product markup to cover this added expense.

    170/5000 = 3.4% markup on all products to cover the cost to the retailer of this loyalty program. This is a mark up on EVERY product they sell. It is a markup to EVERY customer or client WHETHER OR NOT they belong to the rewards program.

    You are paying for the program whether or not you use it. So you may as well get it and use it since you pay for it regardless! Oh, by the way, PST and GST are added on TOP of this cost too since it is embedded in the item cost – so increase that by 12% in BC!

    My next blog will compound the cost of markups when credit cards are involved!

    The MONEY® Network