Business

Delaena Kalevor – Why the “Breakage” Model is Profitable But Could Prove Unsustainable

Published

3 years ago

January 13, 2021

I would like to introduce readers to a concept called “breakage.” It’s a common business strategy in fee-based or subscription-based services, such as gym memberships, video rentals, and annual fee credit cards. It’s also common in loyalty rewards programs.

Before I discuss this concept, I want you to think of how most businesses operate. The customers want a particular product or service. They buy it. They use it and the transaction is complete.

Let’s consider a basic example:

Let’s assume that you’re hungry and you want a bacon burger.

You go to the drive-through and buy a burger. You eat the burger.

You’re happy because you’re no longer hungry.

The drive-through franchise owner is happy because they generated a sale. This is how most businesses work.

The “breakage” model works the exact opposite way. With breakage, the company makes money when you do not use the product or service you purchased.

Let’s look at the gift card business for example: Let’s assume you buy a $25 gift card from Amazon.

You give the gift card to your friend for his birthday. How does Amazon make any money doing this?

Well, it turns out that for every $100 spent on buying a gift card, only $75 is actually ever redeemed. People who receive the gift card either lose the card, forget about the card, don’t use up the entire value of the card or the card expires.

This is breakage. Gift cards have an implied breakage of 25%. Meaning on average 25% of the value of gift cards never get redeemed. According to Delaena Kalevor, breakage can be very profitable. When someone purchases a gift card, the issuer of the gift card recognizes the gift card value as a contingent liability on their balance sheet. When the gift card value expires, the contingent liability is taken off the books and recognized as revenue. This has a direct accretive impact on net income, which can make breakage in the gift card and loyalty rewards industry extremely profitable.

The cashback and loyalty programs of credit card issuers also work in the same way and breakage is a valuable part of how these banks make money. They use tools like redemption caps (for example with American Express, you can’t redeem until you have $75 worth of points), points expiration, etc to enforce breakage. Most customers never reach that $75 redemption threshold before the points expire. This is an example of breakage. That’s why Delaena Kalevor’s favorite credit card is Discover Card. They have no breakage at all – no redemption caps and no points expiration.

Another example of breakage is health clubs or gyms. The parallel to that in the credit card industry is cards that have an annual fee.

Most fitness centers work on a monthly membership fee model.

I pay $50 a month to have access to the facility.

Whether I show up every day or never show up, I still pay the health club the same $50.

In the health club business, by far the most profitable customers in the industry are people who sign up as members but don’t actually show up to the gym.

This is also breakage. Similarly, credit card customers with an annual fee credit card, generate breakage income for the issuing bank when they do not use their card.

Breakage-based business models can be very profitable. Imagine a health club with 10,000 paying members where nobody actually shows up.

The problem with breakage business models is that you’re receiving value from customers without customers actually receiving value in return. Basically, you’re betting that customers are too lazy to recognize this.

Before Netflix and video streaming of movies became popular, a company called Blockbuster used to rent DVD movies to entertainment seekers. You would rent a movie for two nights for something like $5. If you forgot to return the movie on time, they would charge you a $3/day late fee.

Imagine renting five movies for the weekend and forgetting to return the movies for an entire week. Instead of spending $25, you end up spending $100.

This is a form of breakage too. In fact, at its peak, Blockbuster was generating 70% of its net income from late fees. Their profits came from customers who were too lazy or forgetful to return the DVD sitting in their car.

The problem with breakage though is that customers DO NOT like it.

When Netflix first started, they had a subscription-based DVD rental by mail business. For a flat fee each month, you could keep the movies you rented for as long as you wanted.

According to Delaena Kalevor, Netflix targeted Blockbuster’s most profitable customers — those that pay late fees — and ultimately put Blockbuster out of business.

Personally, I prefer a business where sales and profits come from happy customers, instead of unhappy ones that wish your way of business didn’t exist.

I don’t see the gift card, loyalty rewards, and health club businesses going out of business anytime soon. I don’t even expect their breakage business model to change. But Delaena Kalevor likes the idea of customers receiving good value for what they pay. The value should be mutually beneficial, like in the burger example. It’s a good thing to profit from really happy customers that are thrilled to do business with you. Blockbuster did not expect to go bankrupt. But they did. History has a funny way of repeating itself. The breakage based businesses out there should take lessons from Blockbuster’s experience.

Business

Opportunities for Black Banx in Emerging Markets

Published

3 days ago

May 5, 2024

Matthew Wiles

A significant digital transformation is underway in the world of finance, marked by the emergence of non-bank innovators offering a diverse array of financial technology products and services. This transformation is not confined to established markets; rather, it extends its reach into emerging economies, offering a compelling digital alternative to traditional banking institutions. These alternatives are particularly vital in addressing the issue of financial exclusion, which has left substantial populations underserved by traditional banking systems.

Among these innovative digital banking entities stands Black Banx, a fintech brand dedicated to fostering financial inclusion in emerging markets by seamlessly integrating banking services into digital ecosystems. Founded in 2014 as a visionary concept by German billionaire Michael Gastauer, Black Banx swiftly evolved into a global force in the global financial market Officially launched in 2015, the institution rapidly garnered international recognition, extending its services to 180 countries and territories from its inception. Within a mere 12 months of operation, Black Banx amassed over 1 million customers, marking its initial expansions in key regions such as the United States, United Kingdom, and Hong Kong. At present, with a customer base exceeding 40 million as of February 2024, Black Banx stands as one of the fastest-growing digital banks not only in developed countries but also in emerging markets.

What Are Emerging Markets?

An emerging market mostly describes the economic landscape of a developing nation progressively engaging with global markets during its growth trajectory. These economies possess some but not all of the defining characteristics of developed markets, which typically exhibit robust economic growth, high per capita income, well-established equity and debt markets, foreign investor accessibility, and a reliable regulatory framework, according to Investopedia.

As emerging market economies evolve, they tend to integrate more deeply into the global economy. This integration fosters increased liquidity within local debt and equity markets, heightened trade volume, and augmented foreign direct investment. Moreover, these economies witness the emergence of modern financial and regulatory institutions as they transition from low-income, less developed, often pre-industrial states to modern industrial economies with elevated standards of living.

With improving standards of living, the demand for financial security and opportunities escalates, underscoring the pivotal role of banking services. However, traditional banks face challenges stemming from bureaucratic processes and sometimes limited services. Conversely, fintech firms are gaining prominence owing to their convenience, user-friendly interfaces, and expedited signup procedures. Furthermore, their accessibility anytime and anywhere with internet connectivity enhances their appeal to the public.

Strong Demand for Financial Technology

The surge in digital banking adoption, particularly conspicuous in emerging markets, owes much to innovations originating in these regions. For instance, nearly nine out of ten consumers in the Asia-Pacific region, encompassing both emerging and developed markets, actively utilize digital banking services, with a significant portion expressing openness to expanding their usage through digital channels.

Enthusiastic adoption of fintech tools and e-wallets among consumers in emerging markets has propelled the market penetration of these innovative solutions beyond levels observed in developed markets. In the emerging Asia-Pacific region, the penetration of fintech apps and e-wallets surged to 54 percent in 2021, compared to 43 percent in the developed segment. This is indicative of the accelerating shift towards fintech transactions and services, as per McKinsey & Company.

A portmanteau of finance and technology, fintech refers to the burgeoning industry of companies utilizing computer programs and other technologies to provide support or enable banking and other financial services. In developed nations, there’s been a rapid expansion and adoption of fintech technologies ever since businesses and even governments started accepting digital financial transactions as a standard mode of payment. But even in emerging markets, the demand for fintech has also skyrocketed as more people report a diminishing reliance on cash for weekly expenditures.

Identifying Opportunities in Emerging Markets

Launching a successful digital bank entails navigating a myriad of challenges, irrespective of the market’s maturity. However, digital banking in emerging markets presents its own unique set of hurdles, particularly in securing widespread adoption among mass-market consumers. To thrive in any market landscape, a digital bank must first establish meaningful access to its target customers. While the initial interaction may appear straightforward in the digital realm, the reality proves more nuanced.

The proliferation of digital advertising notwithstanding, capturing customer attention remains a formidable task, compounded by the intricacies of onboarding procedures, even for digitally savvy clients. Moreover, the reliance on app downloads as a precursor to engagement further heightens the barriers to entry as first-time users may find them intimidating.

Building a solid trust relationship with customers is important for digital banks to maximize their opportunities in emerging markets. Trust, arguably the linchpin of sustained usage, demands meticulous investment in creating positive onboarding experiences and fostering comprehension of banking channels and products. However, achieving this trust quotient is not easy, especially in emerging markets with lower access to financial services and digital literacy.

Black Banx’s Success in Emerging Markets

Black Banx is a digital bank focused on empowering financial inclusion in emerging markets by integrating banking into digital ecosystems. It was founded by German billionaire Michael Gastauer who always believed that well-designed financial services have the potential to uplift even the most marginalized segments of society, providing them with enhanced economic opportunities.

Consequently, Black Banx is steadfast in its mission to promote financial inclusion while harnessing the advancements within the fintech landscape. Today’s digital technologies offer unprecedented tools to reconstruct banking paradigms, especially for those underserved by traditional financial institutions, with smartphones and laptops serving as gateways to financial empowerment. But while Black Banx makes use of the most advanced fintech technologies, including blockchain and artificial intelligence, it delivers an intuitive and easy-to-navigate user experience through its website and mobile app so even the inexperienced or less tech-savvy consumers won’t have a hard time using its platform to carry out financial transactions.

With his expertise and decades of experience in the financial industry, Gastauer has a keen eye for trends and what works in different markets. So instead of delivering different experiences for developed and emerging markets, the renowned fintech mogul opted to roll out the same suite of services to both because of his motivation to realize financial inclusion and offer only the best banking experience to all. As such, Black Banx facilitates seamless transitions between physical and digital currencies and even cryptocurrencies. The digital bank also tailors its channels to accommodate customers at various stages of their digital journey, ensuring that they feel guided every step of the way until they achieve their financial goals. All of these contribute to Black Banx’s success in emerging markets.