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IFRS valuations for Customer Loyalty Programs

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Title: IFRS valuations for Customer Loyalty Programs


1
IFRS valuations for Customer Loyalty Programs
  • 18 June 2009

Gautam Kakar Business Leader - Retirement, Risk
and Finance Consulting Email gautam.kakar_at_mercer
.com Phone 91 22 4342 4520
2
Agenda
  • What is Customer Loyalty Program?
  • IFRIC 13
  • Implication on Companies
  • Results of Analysis
  • How Mercer can help?
  • Q A

3
What is a Customer Loyalty Program ?
  • Customer Loyalty programs are structured
    marketing efforts that reward, and therefore
    encourage, loyal buying behaviour behaviour
    which is potentially of benefit to the firm
  • Tool for rewarding customers who have repeat
    purchases
  • The program usually specifies a minimum
    requirement to receive the incentive
  • e.g. purchase 10 coffees and receive the 11th
    coffee free
  • Award credits commonly known as miles or points
  • Common examples supermarkets, airlines, hotels,
    credit card providers, petroleum distribution
    companies

4
Issues ?
  • Commercial use of the personal data collected as
    part of the programmes has the potential for use
    /misuse
  • Loyalty program discount goods to people that are
    buying their goods anyway, and that the expense
    of doing these programs may not pay
  • Additional implied employee benefit - An employee
    who needs to buy something (such as a hotel room
    or an airline flight) for a business trip but who
    has discretion to decide which airline or hotel
    chain to use has a powerful incentive to choose
    the payment method that provides the most credit
    card rewards or loyalty points instead of
    minimizing cost for the organization.

5
International Accounting StandardsIFRIC 13
6
International Financial Reporting Interpretation
Committee Interpretation 13 (IFRIC 13)
  • Aims to standardise how Customer Loyalty Programs
    recognise, measure and disclose in financial
    statements obligations that arise from providing
    customers with free or discounted goods or
    services.
  • Applies to award credits, from a Customer Loyalty
    Program, that are part of a sales transaction and
    require other qualifying conditions.
  • Revenue from the sale of award credits is
    deferred until the obligation to provide awards
    is met.

7
IFRIC 13
  • IFRIC 13 has mandated that paragraph 13 of IAS 18
    applies
  • ..in certain circumstances, it is necessary to
    apply the recognition criteria to the separately
    identifiable components of a single transaction
    in order to reflect the substance of the
    transaction. For example, when the selling price
    of a product includes an identifiable amount for
    servicing, that amount is deferred and recognised
    as revenue over the period during which the
    service is performed.

8
Application
  • What is the revenue to be deferred?
  • Fair Value of the points issued
  • What is Fair Value?
  • The price payable if the award credits could be
    sold separately
  • Weighted average of the fair value of awards
    allowing for award credits expected not be
    redeemed

9
IFRIC 13 in Asia Pacific
  • Australia, New Zealand, Singapore, Hong Kong
  • Accounting Years beginning 1 July 2008
  • India 1 April 2011
  • Japan No later than 1 July 2011
  • Korea in draft stage implementation expected 1
    January 2011
  • Thailand Currently moving towards IFRS
  • Malaysia currently in draft, for period
    beginning 1 Jan 2010
  • Indonesia unclear but moving towards IFRS
  • Taiwan unclear but moving towards IFRS
  • Philippines unclear but moving towards IFRS

10
Implication on Companies
11
Implications on Companies having Customer Loyalty
Programmes
  • Need to estimate how long a member holds their
    points/miles before they are redeemed for an
    award, the probability of redemption or expiry
    for the balance (or current outstanding points)
    at a point in time for example the accounting
    date
  • Need to estimate the probability that a point
    issued tomorrow will be redeemed, this can help
    in pricing when selling points to other retailers
    etc.
  • Require help of Actuaries to do the valuation or
    review the valuation they have performed. Audit
    companies recommend that an actuary should
    calculate the probability of a point expiry.
    Actuaries let the data tell members behavior and
    also look at future plans of the program while
    setting assumptions

12
Implications on Companies having Customer Loyalty
Programmes
  • IFRIC 13 may change the design of the Customer
    Loyalty Programme, for e.g.
  • If the company does not want to hold liability
    for long in their books, it would have strict
    rules for expiry of the points, awards available
    in small denominations of points
  • If a company like for e.g. a credit card company
    wishes the customers to have multiple
    transactions instead of single transaction, it
    might put upper cap on the numbers of points one
    can earn is a single transaction

13
Results of Analysis
14
Analysis
15
Analysis
16
Case Studies
17
Case Study 1.Awards supplied by the Entity
  • A grocery retailer operates a customer loyalty
    program. It grants program members loyalty points
    when they spend a specified amount on groceries.
    Program members can redeem the points for further
    groceries. The points have no expiry date. In one
    period, the entity grants 100 points. Management
    expects 80 of these points to be redeemed.
    Management estimates the fair value of each
    loyalty point to be one currency unit (CU1), and
    defers revenue of CU100.

18
Case Study 1.Year 1
  • At the end of the first year, 40 of the points
    have been redeemed in exchange for groceries,
    i.e. half of those expected to be redeemed.
  • The entity recognizes revenue of
  • (40 points / 80 points)CU100 CU50.

19
Case Study 1.Year 2
  • In the second year, management revises its
    expectations. It now expects 90 points to be
    redeemed altogether.
  • During the second year, 41 points are redeemed,
    bringing the total number redeemed to 4041 81
    points. The cumulative revenue that the entity
    recognises is (81 points / 90 points)CU100
    CU90.
  • The entity has recognised revenue of CU50 in the
    first year, so it recognises CU40 in the second
    year.

20
Case Study 1.Year 3
  • In the third year, a further nine points are
    redeemed, taking the total number of points
    redeemed to 81 9 90.
  • Management continues to expect that only 90
    points will ever be redeemed, i.e. that no more
    points will be redeemed after the third year. So
    the cumulative revenue to date is
  • (90 points / 90 points)CU100 CU100.
  • The entity has already recognised CU90 of
    revenue (CU50 in the first year and CU40 in the
    second year). So it recognises the remaining CU10
    in the third year.
  • All of the revenue initially deferred has now
    been recognised.

21
Case Study 2.Getting the most out of your
loyalty program
  • Client situation
  • A retailer was looking to fundamentally re-launch
    its customer loyalty program by introducing a
    number of changes to invigorate the program to
    increase customer loyalty and grow their customer
    base. These changes were expected to have a
    material dollar impact on profit, especially in
    the long term. Quantification of the impact was
    beyond the modelling capabilities of the customer
    loyalty program manager.
  • Client needs
  • The client needed a series of what if scenarios
    to determine the dollar cost impact and the
    change to customer redemption rates. Having this
    information was vital to help shape the new
    look program.

22
Case Study 2.Mercer action
  • Mercer worked with the client to acquire a
    detailed understanding of the program and was
    able to build a robust, refined and accurate
    valuation model. Through use of this model,
    Mercer was able to test
  • The impact of various levels of increased
    customer points accrual over a number of years
  • The introduction of non-expiry of points for
    those who accrue more than a specified number in
    a month
  • The impact of targeted rewards for low point
    balance members
  • The impact of introducing annual limits on the
    number of points earned

23
Case Study 2.Results
  • Mercers actuarial modelling and analysis in
    partnership with the client resulted in a number
    of benefits to the client
  • A greater understanding of the financial outcomes
    from the timing of expiration of points, customer
    spending patterns and impact from the various
    what if scenarios due to the increased accuracy
    and management of data
  • Ability to assess possible strategies based on
    the model outcomes and choose the optimal option
  • Ability to relaunch their customer loyalty
    program with confidence understanding the long
    term financial impact on the program.

24
Case Study 3.
  • Client situation
  • An airline client was seeking to adopt the new
    international accounting interpretations for the
    valuation of their frequent flyer program in
    their financial statements. One key statistic,
    mile expiry (known as breakage) had been
    previously derived internally based on historical
    program experience for miles at the balance date.
    Under the new accounting interpretation, the
    client needed to change the methodology for
    measuring breakage to be based at the time of
    issue. Quantification of breakage on this basis
    for audit purposes was beyond the modelling
    capabilities of the clients internal resources.
  • Client needs
  • The client needed ratification of current and
    previous breakage statistics, and an estimate of
    the breakage statistics into the future.

25
Case Study 3.Mercer action
  • Mercer worked in tandem with the clients
    internal team to acquire a detailed understanding
    of the operation of the frequent flyer program.
    Based on this knowledge, Mercer then aggregated
    very large volumes of data to create summaries
    based on an accurate representative sample that
    enabled appropriate analysis of redemption and
    expiry experience.
  • Through the analysis of the redemption and expiry
    experience Mercer was able to build a robust
    forecasting model.
  • This model was able to reconcile the historic
    breakage statistics with the forecast breakage.

26
Case Study 3.Results
  • Mercers modelling and analysis in partnership
    with the client resulted in a number of benefits
    for the client
  • Flexible tools that allow prompt assessment of
    the impact of potential changes aimed at
    invigorating the program and promoting membership
    engagement
  • External verification of key statistics that
    formed part of the clients published financial
    statements
  • Transition to the new accounting interpretation
    occurred with confidence that later adjustments
    were not required
  • Better understanding of the drivers of breakage
    and redemption, therefore assisting in
    quantifying the impact of decisions regarding
    program development
  • Ability to consider program refinements to manage
    costs as well as customer appeal.

27
How Mercer can help?
28
MercerThe big picture Marsh and McLennan
Companies (MMC)
  • MARSH
  • Risk and Insurance Services

MERCERConsulting, Outsourcing and Investments
  • KROLL
  • Risk Intelligence
  • GUY CARPENTER
  • Reinsurance Services
  • OLIVER WYMAN
  • Management Consulting and Advisory Services

29
Our core capabilities globally
  • Retirement
  • Health and benefits
  • Human capital
  • Mercer College
  • Surveys and products
  • Communication
  • Investment consulting
  • Investment management
  • Outsourcing
  • Mergers and acquisitions

30
More than 25,000 clients worldwide
Serving all regions, industries and sizes and
the worlds leading companies
Americas
Asia/Pac
Europe
31
Valuing customer loyalty programs
  • Mercer is one of the leading global providers of
    customer loyalty program valuations with over a
    decade of loyalty program valuation experience.
    We have developed actuarial and financial
    techniques to help you quickly and efficiently
    assess the impact on your loyalty program.
  • Mercer is currently working with some of the
    largest customer loyalty program providers to
    assist them in dealing with the new IFRIC 13
    accounting changes. These changes require
    businesses to value customer loyalty programs in
    a consistent, precise and transparent manner.
  • Our analysis covers the key requirements of IFRIC
    13 and includes
  • The probability of redemption or expiry of a
    point/mile.
  • The market value of each point/mile.
  • Disclosure information to allow the client to
    meet its IFRIC 13 obligations (i.e. quantity of
    revenue to defer and to release).

32
Other Mercer loyalty program services
  • Mercer can also provide
  • Sensitivity analysis Quantifying the immediate
    and future financial impacts associated with
    changing a programs terms and conditions. This
    enables providers to make informed decisions
    regarding marketing strategies and optimizing the
    impact of any changes to their customer loyalty
    program in their financial accounts quickly.
  • Analysis of financial drivers to a program
  • Financial governance and risk management

33
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