## Loyalty and rewards programs – free??

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!

## Loyalty points, reward programs and credit cards revisited!

As a result of my last blog, I received some questions about loyalty programs and points and their true costs – including some from my nephew Derek.

Points, miles or whatever, they all have a value – so somewhere money is changing hands – and the only source is consumers – all of us – whether or not we collect points/miles or ?? we are paying something towards the prizes or awards that are claimed. In order not to offend any vendor or card company, I will use the name MERCHANT for the store/business/retailer/restaurant, POINTSPLUS as the name of the program and C-CARD for the credit card that may be used.

MERCHANT hopes to increase repeat purchasing in their business. They decide to have a business relationship with POINTSPLUS. POINTSPLUS says happy to have you on board, here are the costs. For your customers to get 100 points, you have to generate enough revenue to send to POINTSPLUS a total of \$1000 plus a handling fee of 20% – so 100 points to the customer means it will cost you \$1200.00. PP will do all administration, redemption etc. So now MERCHANT has to figure out how many points to allocate for each \$1.00 spent in their business. If MERCHANT decides to add 2% to all prices, then 2% divided by \$1200 means MERCHANT will need to add approximately 1.6 cents – call it 2 cents to every item sold and for every \$60000 in gross revenue, MERCHANT will have collected \$1200 in extra revenue. Doesn’t sound like much but they charge this extra cost to every customer – whether or not they collect POINTSPLUS – everyone pays it on every item.

Now for C-CARD costs. C-CARD has 3 kinds of cards – Bronze, Silver and Gold. Bronze is just a simple charge card – nothing extra included. Silver allows cardholders to collect flyer miles at the rate of 100 miles for each \$1200 spent and Gold gives cardholders flyer miles plus automatic rental car insurance and lost luggage insurance. C-CARD charges MERCHANT a percentage of sales charged at 3 different rates depending on which version of card a customer uses. Bronze cards result in a charge of 1.5% to MERCHANT, Silver cards are 3.7% and Gold card use results in a charge of 4.7%.

MERCHANT knows they are not allowed to charge users of the different cards a different price, and the C-CARD user agreement doesn’t allow MERCHANT to give customers a discount if they pay cash, so MERCHANT has to add another 4.7% – to cover their maximum cost – to EVERY item they sell!!

So the POINTSPLUS loyalty program adds 2 cents to everything and C-CARD adds 4.7% then the merchant needs to add at least another 1% to cover their additional costs of trying to adminsiter all of this internally on their books – so now it is 2 cents plus 5.7% – to ALL customers whether or not the use any credit card at all or they belong to POINTSPLUS. Remember in-house programs and charge cards (usually from department stores) work exactly the same way!!

Hope this clarifies things and remember, There Ain’t No Such Thing As A Free Lunch!! Cheers