What is Channel Incentive Breakage?
You’ve probably heard the term “breakage” before, but what does it mean in the world of incentives and how does it impact the overall design and effectiveness of your incentive programs? Is channel incentive breakage a good thing or does it create false practices that ultimately diminishes your brand and lowers return on investment?
Channel incentive breakage is the amount of an incentive earned, but not redeemed or paid prior to an expiration date. Breakage occurs frequently in loyalty points programs when participants earn points and don’t redeem them.
With loyalty programs, breakage often occurs because a percentage of the participants don’t earn enough points to redeem them for the minimum reward. Sometimes this occurs because the program doesn’t offer low-end rewards, or it makes redeeming points administratively cumbersome.
Incentive breakage is not unique to points programs however, debit/gift card programs also have breakage. Breakage occurs in these programs when cards expire with all, or a portion of the reward unused. In this case, a portion of a card has been redeemed and only a small portion remains. Participants either forget about the balance or don’t have an easy way to split transactions so they don’t use it.
If It’s Broke, Why Not Fix It?
The term “breakage” infers something is broke, so if it’s broke why not fix it? For years, some companies have made the case that incentive breakage is a good thing. There are only two cases made to rationalize the benefits of incentive breakage.
First, in most programs your highest achievers get the most points or money on cards. These incentive program participants usually pay close attention to their balances and frequently use the entire reward. It’s the little guy that doesn’t use it. Even the reward options are skewed toward the high achievers with an intent to make it difficult for the less active participants. The rationale is that the money the little guy isn’t redeeming creates more money to reward high achievers.
Incentive breakage also occurs in rebate programs. In this case, a merchant sells something with a promise from a brand the consumer will get cash back. This also happens between brands and distributors when the brand promises they’ll get cash back when they buy inventory. On the backend, the brand makes it so difficult to redeem the rebate it never gets paid out. The brand feels this is a win because they get an uptick in sales without incurring the cost of the incentive.
In both cases, one could see these examples as a win and think incentive breakage is a good thing, but reality is, breakage is not a win, no matter how you look at it.
Incentive Breakage Rationalization is Irrational
Let’s start with the words unfair, unethical, deceptive and misleading. Are these words you want associated with your brand? Do they scream LOYALTY to you? How do unfulfilled promises motivate or build an affinity to a brand?
A recent study showed that brand name is a key buying influence for consumers. How do you think consumers will see your brand if you use rebate tactics that lead to breakage, making the redemption process too difficult?
Take that a step further and think about brand loyalty. Consumer loyalty programs are built to encourage small repeated purchases over an extended period. If the consumer doesn’t believe they’ll ever redeem the points for a meaningful reward, will they be encouraged to participate? Aren’t you just rewarding those that are already loyal? How is this building loyalty?
Every time an award is earned and not redeemed it diminishes the value of the award. Once the award loses value in the minds of participants, they’ll also lose the motivation to achieve it.
Sales channels usually have an 80/20 rule where 80% of revenue comes from 20% of the channel. If only 20% of the sales channel is benefiting from incentive programs are you really achieving your program goals? Aren’t you just giving more money to the part of the sales channel already performing?
What happens the next time you run a channel program? Will 80% of your sales channel tune it out because they’ve learned you don’t intend to reward them anyway? The same can be said for consumers who find the rebate process too difficult. If this is what you’ve taught them, will they be motivated to buy the next time your run a rebate program?
Assume your incentive programs produce a tangible ROI, why not spend the money? Wouldn’t your CEO want you to spend as much as possible if every dollar spent achieves a 30% return on investment? Why would he/she want the money back?
The Incentive Breakage Fallacy
This brings us to the breakage fallacy, which is that you can use that money for something beyond what you told the world it was intended. I hate to break (no pun intended) it to you, but for compliance reasons you can’t promise more money than the program funding. The funds also can only be used for their intended purpose. Incentive breakage doesn’t come back to the sales/marketing team to use at their whim, it creates a reversal in accounting.
You can’t assume people will not redeem rewards. What if they do? If they earned them and filed a claim you have to assume they will eventually collect and use the reward. A reasonable finance team wouldn’t assume claims will go unredeemed even if the redemption process is known to be cumbersome. They will accrue for the unredeemed funds on the balance sheet.
When points or money expire there will be a reversal on the balance sheet for the breakage. Some sales/marketing people think this is a good thing, because it improves earnings. The reality is that it is a financial anomaly that occurs below the line and paints CEOs and CFOs in a bad light. It effectively makes them look like they don’t know their business. Worse yet, the larger the number, the more it stands out.
There Are No Winners in the Incentive Breakage Game
Don’t get caught up in the incentive breakage game. It diminishes your brand and incentive programs. I often tell my children for every bad thing you do it takes ten good things to overcome it. With breakage you’re creating a lot of hard work, and in the end, you’re really getting nothing in return.
You should be trying to spend every incentive dollar. If you’ve got strong programs, you’re getting a good return on each dollar. Don’t try to get them back; this is not a win. Worse yet, even if they come back it doesn’t give you more money; it simply creates an accounting problem.
Breakage isn’t a win, no matter how you look at it.
Editorial Correction: This article has been updated from its original version. The original version of the article mistakenly led a reader to believe that not accounting for all potential claims could be considered fraud. This was an inaccurate statement and we apologize for any confusion it might have caused.