Gift Cards

Am I in danger of becoming obsessed with plastic cards? It’s possible. But there is one type of card I have somehow managed to avoid discussing in 21 months of blogging.

That type is gift cards, the anonymous chits that are as good as money in one particular store. In their current form they are a relatively recent innovation. When I was your age (20+ years ago) stores sometimes sold paper gift certificates for specified amounts, but they were a one-use item. If you bought a $50 sweater with a $100 gift certificate you generally got $50 in actual cash as change.

It wasn’t until we entered the digital age that modern gift cards, each a miniature debit account, were born. Spend $50 with a $100 gift card and your “change” is the same old card, only now it is worth just $50.

Retailers love gift cards for several reasons, the most obvious of which is that they are an easy sale. If somebody shells out $100 for a gift card, it is, quite literally, money in the bank. And yet, the retailer does not, for the time being, need to deliver any goods other than a festively designed plastic card. If nothing else, that is an interest-free loan.

The psychology of gift card use is also beneficial for the store. Since a gift card cannot be used as cash by the holder, except in that one place, consumers think of it as being worth less than the face value. So they are much more likely to spend it on something they would not pay for with real money. That means they are less likely to wait for sales and might even be induced into spending more than just the card balance, for example buying that $125 jacket with the $100 card and $25 in cash.

The reason retailer’s love of gift cards that is most often cited by us cynics is that a meaningful percentage of them are never redeemed. In retail lingo this is called either “breakage” or “spillage,” neither of which make any sense to me. (I think retailers just like speaking in code. Stolen inventory is called “shrinkage” and nobody seems to have a convincing explanation of why it is called Black Friday.)

The average level of breakage has been pegged at 6%, which seems to be from consulting firm the TowerGroup. That sounds like free money for retailers, and to a certain extent it is, but it is not that simple. In many states unused gift card balances are considered abandoned property and must be handed over to the government.

And in the rest of the country, the accounting is tricky. When a retailer sells a card it does not book a profit. It gets cash in the bank but must also enter on its books a countervailing liability for the value of the card. Deciding when to extinguish that liability even though the card has not been used, on the theory that it will never be, is a bit of a controversial topic in the accounting world. Investors tend to think of that source of profit to be suspect, since it involves so much management discretion.

Also, the level of breakage may be shrinking. The TowerGroup seems to think it has been down recently. And consumers may be getting better at harvesting their unused gift cards. There are several websites that act as used gift card dealers, e.g. CardWoo and CardPool. As of this morning, eBay had 1,779 listings for gift cards.

Somewhat to my surprise, the secondary market for gift cards is fairly efficient. Discounts off face value are modest and the bid-ask spread from dealers, the difference between what they will pay for a card and what they then will sell it for, are pretty small. CardPool will pay $90 for a $100 Target card and offers it at $97.

In general, it seems the broader the selection that the store offers, the higher the gift card’s value relative to face. Again based on CardPool’s prices, Target has a discount of 3%, Barney’s 10%, Brookstone 20%, and 1-800-Flowers 30%.

There are some people trying to peddle Blockbuster cards at 20% off on eBay. That seems like a dangerous purchase to me. Just ask the folks left holding more than $100 million worth of Sharper Image and Linens ‘N Things cards. A gift card is basically a loan to the retailer, and if the store goes belly up all you can get for the card is a place on the long line of creditors.

CardPool has iTunes at a 6% discount, which is interesting to me because some time ago I noticed that they actually go at a premium to face on eBay. It took me several weeks to work out the reason. Songs are cheaper in the US than they are in other places, in particular the Eurozone. To open a US account you need either a credit card with a US billing address or a US iTunes gift card.

Using a gift card to masquerade as an American might seem a little sleazy (does Homeland Security know about this?) but that is only the beginning of their darker side.

They are a de facto shadow banking system. The cars are easily transportable and concealable and completely anonymous. $10,000 in cash in your wallet might raise suspicions. A Macy’s gift card will not, even with $10,000 stored on it. At many stores you can buy other store’s gift cards with your gift cards and if you need actual cash there is that efficient secondary market I just discussed.

The Treasury recently announced new rules to “to keep gift cards out of the hands of terrorists.” Seriously.

Also, apparently, the thing to do if you have stolen a credit card is to buy gift cards with it before it gets cancelled. This seems unlikely to me. Gift cards, by definition, are uniquely identifiable and therefore pretty easy to trace. So unless you can quickly sell the card on a street corner for cash it seems to me that jewelry and electronics are a better choice. But then again, this is not my field.

For a round-up of other gift card related fraud see this Snopes entry.

One trick not mentioned there is a bit of household embezzlement I recently heard about. Non-working stay-at-home spouse buys a $25 Nordstrom’s/Home Depot card each time she/he goes to the supermarket. After a few weeks, she/he can buy those sexy shoes/power tools that she/he wants without it showing up on the credit card bill. To the other spouse, groceries are just a little more expensive.

[Photo – That is Then-Governor Sarah Palin giving a Wal-Mart gift card to a deserving child.]

Credit Cards, Government | Frank Curmudgeon | October 27, 2010 1:59 pm

12 Comments

By zach, October 27, 2010 @ 4:22 pm

Black Friday is an accounting term, from what I was told. It used to be, and may still, that small businesses would run in the red all year. When the holidays started, they would make enough sales to put them in the black. Black Friday.

I too love gift cards, because I quickly realized I could use them to my advantage. My most recent encounter with them would have been about 8 months ago (not a frequent user). I was looking for new bed sheets/comforter at Bed Bath and Beyond. I found what I wanted for about $95. I had cleverly registered with two dump email accounts to receive 20% per purchase. (I would break up my purchases to two transactions at the counter). That is another story.

After I had searched for the products I wanted, I took the internet once again. This time I used craigslist to find someone looking to ditch their $125 Bed Bath Gift Card for a discount of $100 cash (An amount I intended to spend anyway). With the extra cash I acquired some nice candle holders that hang on a while, to accent my room.
By zach, October 27, 2010 @ 4:26 pm

clearly I should learn to review my posts.

Edit: I took *to* the internet and the candle holders hang on a wall not *while*
By Holly, October 28, 2010 @ 7:52 am

That’s okay, Zach. Frank had a few misplaced apostrophes…
By CT, October 28, 2010 @ 10:42 am

Frank,

The article about the Treasury you linked to seems to really be focusing on those pre-paid Visa or MasterCard cards one can buy. They’re touted as gift cards because unlike cash, the recipient can’t simply bank it, but has to spend it. However, the article also suggests that they’re used by people who don’t have bank accounts, ie the poor and terrorists. Anyone who has a regular bank account would be crazy to buy one of these, as the fee is something outrageous, like $9.95. It also says the value of what you’d need to buy would be at least a thousand dollars. I have seen very few single merchant cards, with the possible exception of high-end department stores and jewelers, who offer cards with that kind of value. Even Best Buy limits the denomination offered online to $500. (I’d also wager that anyone who has $1000 to prepay steak dinners isn’t going to be dining at the Outback, but the Internet is chock full of people able to prove me wrong on such matters.)
By Frankie, October 28, 2010 @ 3:49 pm

Anyone who has a regular bank account would be crazy to buy one of these, as the fee is something outrageous, like $9.95.

Not only that, they charge you sales tax on the purchase price on the card and again when you buy something.*

* This may vary by state.
By Investor Junkie, October 28, 2010 @ 10:20 pm

Zach At least in my household BB & B sends out those $15 or 20% in the mail it seems at least once a month. If anything IMHO they are discounting too much. So no need to register multiple email addresses with them.
By Steve, October 29, 2010 @ 2:42 pm

Also our BB&B accepts expired coupons.
By mwarden, October 29, 2010 @ 5:23 pm

The “gift card” market wouldn’t work without breakage. Breakage is what allows the issuer (e.g. subway, starbucks, etc.) to sell the card at places like Walmart, to which the issuer must pay a commission. That commission, not coincidentally, is right around the mean breakage. If breakage were to fall below commission, then the issuers would stop selling in those stores.

(In reality I have simplified a bit. There is generally another party in between the company that will eventually redeem the card, like subway or starbucks, and the retail store. That party manufactures the card and manages the accounting, which can get extremely complicated when you start thinking about how a subway card can be purchased in one franchisee-owned store and used in a store owned by a different franchisee 2 years later.)

Also, while you are right that companies can take off the liability after some period without claim, it is no longer the case that the balance can be fully reclaimed. If in 10 years I try to use my subway card with 5 cents on it, they must honor it, even though they probably wrote off that 5 cents liability many years before.
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