Starbucks Breakage: Discover How Unused Gift Cards Are Pushing Profits Forward
Not everything is about coffee for Starbucks. The company has expanded its empire on a complex revenue generation strategy—and Starbucks My Rewards is just the icing on the cake. Read on and discover one of the secrets behind Starbucks’ success.
Starbucks is definitely a love brand. But have you ever wondered where the coffee chain got its brand loyalty from?
If you say it’s from their excellent customer service, quality products and exceptional branding, you’d be right. In fact, we have already written here about how the coffee chain has successfully positioned itself as a third place throughout its history.
But today we want to show you another side of the story – one that you don’t often see exposed. But there’s no negative connotation here, what we are going to talk about only makes the company’s business model even more brilliant.
This is a thoroughbred business article – and it involves a loyalty program, gift cards and a recurring revenue model. Follow this story.
Customer Loyalty = Custom in Profits: What’s behind Starbucks’ Loyalty Program Strategy?
Starbucks’ gift card program is predicated on a deviously simple strategy: gamification. As a matter of fact, gamification is what lies behind most loyalty programs since they use two of the five major elements of gamification: progress and pressure.
Thus, superficially, Starbucks’ gift card program, called Starbucks Rewards, is no different from any other loyalty program. In a nutshell, all customers need to do is download and register on the My Reward app. Afterward each time a customer interacts with the app or makes a purchase, they will gain a Star—that is, a point in Starbucks-speak.
The more loyal to the brand they are (i.e., the more they use the app or make a purchase at Starbucks), the more Stars they will have. Really faithful clients who visit Starbucks stores more often will rise to an upgraded tier in the program, reaping such rewards as free cups of coffee, birthday gifts, and personalized merchandise.
Research indicates that Starbucks Rewards is a resounding success. Though existing in some form or other since 2001, it debuted in its current incarnation in April 2008, fifteen years ago, and it’s going strong as ever. Actually, it’s so strong that it can endure not-so-subtle changes in its rules and customers still want to be a part of it.
As a means of example, in April 2016 Starbucks partnered with JP Morgan Chase and introduced its own credit card—Starbucks Visa. Up to that time, your Stars score would go up whenever you checked in at the store. Now with the new card, customers would earn stars according to the money they’d spend at the store.
More than one commenter called the move a “PR fiasco.” But here they are. The results speak for themselves: according to recent research, Starbucks’ customer retention rate is 44% – significantly higher than the industry average of 25%. And credit card or no credit card, an average Starbucks customer visits the store 6 times per month, whereas a Starbucks Rewards member visits 16 times per month.
Yet that’s not the whole story. In actuality, even though My Rewards drive more customers to buy from Starbucks than it’s usual in other companies, it’s much more profitable to the company when clients don’t use it.
Confused? Let’s get down to business then.
Make or Break: The Gift Card Breakage
Let’s imagine the following scenario:
| THE LIFECYCLE OF A GIFT CARD |
|---|
| It’s the birthday week of Bill, your friend at the office. You decide to buy a $25 gift card for Bill; |
| But since you’re already at Starbucks to buy the card you decide to grab something for yourself. Now the $25 buy is a $35 one; |
| To use the card Bill needs to register and log in to his My Rewards account. He spends the credit on the gift card and some more. He earned two Stars in his loyalty account |
| But Bill is not someone who usually buys at Starbucks because the coffee at the office is so good, so he never redeems his two stars! Now Starbucks has liable money in Bill’s account that will become profit when the Stars expire |
As said previously, even though Starbucks’ have an extraordinarily successful loyalty plan, having their clients use it is not the main source of income for the company. On the contrary, Starbucks makes even more money when they don’t use it.
A striking example of that is the fact that in 2021, Starbucks made $155 million in non-taxable profit from unused loyalty and gift card money. It’s non-taxable because until Starbucks’ accountants pencil that down as profit at the end of the fiscal year, it was in actual fact debt for the company—it was money that you, the customer, lent to the business.
As author J. P. Koenig explains, “Starbucks doesn’t pay any interest on balances held in the Starbucks app or gift cards. You, the loyal customer, are providing the company with free debt.”
Starbucks even has a name for the money lent interest-free—the points and whatnot they don’t redeem from gift cards or My Rewards— to them. They call it breakage.
Every company is “turning to a bank”
Though Starbucks’ success with its loyalty program strategy is one of a kind, having companies become banks is not a one-off. In fact, as we’ve discussed elsewhere, this is the destiny of most successful companies today. It is a case of Banking as a Service, or BaaS.
Research by Finastra revealed that 85% of businesses already use or intend to use some form of BaaS in the next twelve to eighteen months. It is a market that is worth $7 trillion and will grow 70% over the next three years.
There’s a lot of money to be made in the BaaS business, and this is why the Starbucks case is so important. It is symptomatic of an era in which, on the one hand, clients feel left behind or uncared for by legacy banking institutions, and, on the other hand, companies have more data and know their customers better than ever before.
To give an example of the disparity (and the opportunity smart companies have at hand), 75 percent of the IT budget of a legacy bank goes to maintenance (consider that Bank of America’s IT spend gravitates in the order of $10 billion), whereas a lean company can have a complete IT sector paying AWS about $1,500 per month.
Thus the advantages of becoming a BaaS company is then almost a no-brainer. Those who wish to venture into this world have myriad advantages over legacy banking institutions:
- They can develop personalized solutions to users’ needs and pain points;
- Can develop a spending and payment ecosystem that keeps the client’s money within their businesses’ reach;
- Can create a flux of buying experience that improves customer experience;
- Can design a customer journey that places your company at the center of your client’s life.
Breaking Down the Breakage: How Companies Induce Breakage
It’s important to stress that it’s not necessary to have a loyalty program to have a BaaS-type of business with breakage like in the case of Starbucks. On the contrary, many companies induce breakage by using alternative strategies with huge profits.
Amazon Prime—and let’s not forget that Amazon is today a BaaS-like business—is a good example. They use automatic recurring purchases for perpetual use as a means of having a consumer invest in their platform. This means that they have customers that monthly renew their investment in the platform regardless of how many of the products offered there they use.
There are even simpler strategies that allow your company to induce breakage, such as membership programs. This is what your local gym does. They know that 50 percent of new members stop going to the gym after six months—but they still pay their membership bill. And it’s better for the gym if they miss their workouts since it means fewer costs for the gym, less depreciation of the machines, among other things.
In Conclusion
In conclusion, Starbucks’ loyalty program showcases a clever use of gamification and breakage to drive customer engagement and profits. This approach exemplifies a broader trend where companies, through Banking as a Service (BaaS), leverage customer insights to create personalized financial solutions. As businesses evolve into multifaceted entities, loyalty programs and BaaS-type business solutions demonstrate the potential for innovative strategies to reshape industries and deepen customer connections.
