The Hidden Complexity of Loyalty Coalitions
Loyalty coalitions, or rewards schemes, are common tools that banks use to increase customer loyalty. However, they can be more complex than they appear and can pose significant risks if not properly structured and monitored, according to Cagatay Zor, of Trumore.
Despite their appearance, loyalty coalitions are not merely growth features. Instead, they operate as exchange networks, with multiple issuers, sponsors, and redeemers. This complexity can lead to incompatible mechanics and risks, including over-issuance and over-redemption, which can place the operator in the difficult position of mediating disputes and absorbing friction.
The Crucial Elements of a Successful Loyalty Coalition
The success or failure of a loyalty coalition largely hinges on three structural decisions: settlement timing, breakage modeling, and arbitrage prevention.
Settlement timing is akin to the primary incentive engine of the system. Settling at redemption may seem simpler initially, but it can load credit risk onto redeemers, while settling at issuance can force cost awareness but demands more complex reversal logic for refunds. Successful models often employ a hybrid approach, combining partial prefunding or reserves with periodic netting. However, this requires clear rules and transparent allocation of responsibilities.
Breakage, the portion of points that will never be redeemed, is another critical factor. A coalition that treats breakage as a profit center can cause structural harm. It is better to treat breakage as an estimate, not a target, and to use estimation discipline rather than wishful thinking.
Finally, it’s important to anticipate that not all participants will act in good faith. Coalition systems can attract edge cases that exploit differences in timing and pricing across multiple parties. Effective mitigations often include event-level audit trails, unique transaction identifiers, and tagging transactions to the specific rule set in force at the time.
The Need for Robust Operating Systems
To run effectively, a coalition needs a robust operating system that can explain every settlement line from day one, provide dispute workflows with standardized evidence requirements and service-level commitments, and track reversal rates and dispute propensity. This is not meant as punishment, but as an early warning system.
Ultimately, loyalty coalitions are not primarily a marketing construct. They are multiparty liability systems with adversarial edge cases. Successful programs treat settlement as an incentive design, breakage as an accountable estimate, and arbitrage as an expected cost of operating an exchange. Clarity is cheap before the coalition becomes large, and trust compounds over time.
By understanding and addressing these complexities, financial institutions can better manage the risks of loyalty coalitions and maximize their potential benefits.
Source: Here
