The breakage business model is a form of revenue generation based on a consumer not using a product or service they have purchased.
In addition to gift cards, the breakage business model is commonly seen in hotel loyalty clubs, credit card fees, gym memberships, frequent flyer miles, and prepaid travel credits.
Breakage itself occurs by itself and does not require business intervention. But since it is a lucrative source of revenue, many companies encourage it via various techniques. These include blocking, minimum redemption limits, expiration dates, and usage restrictions.
The breakage business model is a form of revenue generation based on a consumer not using a product or service they have purchased.
The breakage business model is based on the notion of breakage, an accounting term that describes revenue from products or services that are paid for but not used.
One of the oft-cited examples of the breakage business model is the sale of gift cards. Almost every retailer sells these cards because they know a certain proportion of them will never be redeemed by the customer. The reasons for this are varied. Some cards will be misplaced, while others will be thrown in the trash. In other situations, the consumer may simply neglect to spend the full balance of the card.
Whatever the reason, however, it’s important to note that an unused gift card results in a profit for the retailer. In essence, it has sold products or services to the customer without having to provide those products and services in return.
In addition to gift cards, the breakage business model can be used by any company that offers various forms of stored value.
These forms include:
Hotel loyalty points.
Transferable and flexible points – such as those offered by credit card reward schemes.
Frequent flyer miles and airline vouchers.
Prepaid travel credits.
Gym memberships – where consumers pay for monthly access to gym facilities irrespective of whether they attend.
Credit card fees – here, the breakage occurs when a credit card customer pays an annual account fee without using the card to make purchases.
How is breakage encouraged?
While breakage occurs naturally on its own, many businesses nevertheless encourage it by utilizing a range of strategies:
Expiration dates – even if a card is not lost or damaged, it will be void after a certain period of time.
Minimum redemptions – where a certain number of points is required to redeem a voucher or some other reward.
Restrictions – where usage is restricted. Some gift cards can only be used at participating retailers, while airline points are only available on certain airlines, routes, or seasons. Many customers purchase a card from a store they seldom frequent and may have difficulty finding a suitable product.
Blocking – this is a requirement that the entire balance of the gift card is used in one purchase.
Activity requirements – where any points or rewards accrued are void unless the customer has used their account over a set period.
Case Studies
Example 1: Online Courses and E-learning Platforms
Breakage Mechanism: Many e-learning platforms sell courses with lifetime access. However, a significant number of users never start the course or only finish a few modules.
Encouraging Breakage: Platforms might send a few reminder emails initially but reduce the frequency over time. Additionally, they might have limited-time access to course bonuses or additional resources, incentivizing early participation but not necessarily completion.
Example 2: Subscription Boxes
Breakage Mechanism: Subscription boxes (like beauty products, snacks, or books) might include a certain amount of credit for subscribers to spend in an online store. Often, subscribers don’t use all the credits.
Encouraging Breakage: The online store might have higher prices than anticipated, limited product choices, or the credits may expire after a certain period.
Example 3: Software Licenses
Breakage Mechanism: Users might purchase multi-device software licenses but only use the software on one or two devices.
Encouraging Breakage: Companies might make the multi-device license the default purchase option or offer it as a limited-time deal, enticing users to buy more licenses than needed.
Example 4: Prepaid Printing Services
Breakage Mechanism: Some businesses offer prepaid printing cards or credits for use in public printing locations. Users might not use up all the credits, especially if they only needed the service for a one-time project.
Encouraging Breakage: The service might offer “bulk buy” discounts, pushing users to buy more credits upfront. Additionally, these credits might have an expiration date.
Example 5: Event Tickets
Breakage Mechanism: Events might sell “flex tickets” which allow entry to multiple events or sessions, but many attendees might not go to all the available sessions.
Encouraging Breakage: Organizers might schedule popular events simultaneously, making it impossible for attendees to utilize all their tickets.
Example 6: Mobile Data Plans
Breakage Mechanism: Mobile carriers might offer data plans with a certain amount of GBs per month. Many users don’t consume all their data, especially if they are often connected to Wi-Fi.
Encouraging Breakage: Carriers might promote higher data plans as a “peace of mind” strategy, enticing users to over-purchase. Additionally, unused data might not roll over to the next month.
Example 7: Bulk Purchase Retailers
Breakage Mechanism: Some stores offer bulk purchase discounts. Consumers might not use all items in the bulk package before they expire or become obsolete.
Encouraging Breakage: Retailers might not offer smaller package options or might significantly discount bulk purchases, pushing consumers to buy more than they need.
Key Highlights
The Breakage Business Model: The breakage business model involves generating revenue from products or services that customers have paid for but ultimately do not fully utilize or redeem. It is based on the concept of “breakage,” which refers to the revenue earned from unused products or services.
Gift Cards as Breakage Example: Gift cards are a common illustration of the breakage business model. Retailers sell gift cards with the understanding that a portion of them will remain unredeemed. Customers may lose the cards, forget about them, or not use the full balance, resulting in profit for the retailer without providing the associated products or services.
Encouraging Breakage: Businesses actively encourage breakage to increase their revenue. Strategies include setting expiration dates on gift cards, establishing minimum redemption limits for rewards, applying usage restrictions (e.g., limited participating retailers for gift cards), and requiring customers to use the entire gift card balance in one purchase (blocking).
Other Breakage Examples: Besides gift cards, the breakage business model is observed in various industries. Examples include hotel loyalty points, credit card reward schemes (transferable and flexible points), frequent flyer miles and airline vouchers, prepaid travel credits, gym memberships (where customers pay regardless of attendance), and credit card fees (annual account fees without regular card usage).
Lucrative Revenue Source: Breakage can be a lucrative source of revenue for businesses. For instance, Starbucks reported significant breakage revenue of $140 million, with up to $4 billion in unused gift card value per year in the United States. Other industries also benefit from breakage as unredeemed points, miles, or prepaid credits translate into profit.
Customer Impact and Frustration: While the breakage business model may be profitable for businesses, it can lead to customer frustration. Customers may feel disappointed if they are unable to fully utilize their purchased products or services due to expiry dates, restrictions, or minimum redemption requirements. Striking a balance is crucial to maintaining customer satisfaction and loyalty.
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A digital business model might be defined as a model that leverages digital technologies to improve several aspects of an organization. From how the company acquires customers, to what product/service it provides. A digital business model is such when digital technology helps enhance its value proposition.
A tech business model is made of four main components: value model (value propositions, mission, vision), technological model (R&D management), distribution model (sales and marketingorganizational structure), and financial model (revenue modeling, cost structure, profitability and cash generation/management). Those elements coming together can serve as the basis to build a solid tech business model.
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Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
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