More Than Just a Gift

  In their search for value-added products they can sell to merchants, processors and acquirers insist they have found a winner in gift cards. Large merchants agree, but small and mid-sized merchants are still a tough sell. How can the market grow?
  Make no mistake about it, merchants want the lowest possible price when it comes to credit and debit card acceptance. Some will not hesitate to switch processors to save 10 or 20 basis points per transaction. Merchants' fixation on price has squeezed margins for processors and acquirers and forced them to offer commodity pricing in order to buy client loyalty.
  To help compensate, merchant acquirers and processors have begun searching for new products and services they can pitch for which they can charge a premium. Topping the list are gift cards. While nothing more than a spruced up version of the time-tested paper gift certificate merchants have marketed for decades, the popularity of gift cards among merchants has made them a hot and lucrative offering for processors and acquirers.
  Requiring little more than adding a software applet to a point-of-sale terminal, processors and acquirers can earn up to 50 cents per gift card transaction. Revenues earned on gift cards can add up quickly as 55% of all gift card holders use their card an average of three times before exhausting its value, according to Standard Register, a Dayton, Ohio-based information-services company.
  "Gift cards are an outsourcing proposition for merchants," says C. Marc Abbey, principal and merchant-acquiring specialist at Linthicum, Md.-based First Annapolis Consulting Inc. "Merchants of all sizes definitely want them and prefer them to paper gift certificates."
  What makes gift cards so attractive to merchants is that they can deliver incremental sales, attract new customers and engender loyalty. Gift card holders spend, on average, 20% above the face value of the card, according to Frequency Marketing Inc., a Milford, Ohio-based consulting firm. The average value for gift cards is $50, up from $44 in 2002.
  To enhance consumer loyalty, a growing number of merchants are deploying gift card programs onto which value can be reloaded. Seattle-based Starbucks Corp., which has issued 16.6 million gift cards, says 20% of all cardholders have reloaded value on their cards since the program's inception.
  The retail coffee king has racked up sales of $363 million since launching its program in November 2001. Starbucks has grossed $229 million in sales redemption during the first three quarters of fiscal 2003, which ends Oct. 30. Starbucks records gift card volume as it is redeemed.
  "Gift cards are more than just a gift," explains Kelvin Taylor, president of Frequency Marketing. "They are a way for merchants to reach a new customer base, engender loyalty and gain a lift in sales. This market represents a huge opportunity for merchants."
  That is especially true for specialty merchants that lack the advertising budgets of the mammoth discount stores and national retail chains. For this segment of the market, gift cards also serve as a marketing tool. Many specialty retailers prefer to offer gift cards with customized graphics that will stand out in the cardholder's wallet to keep their brand top of mind.
  "Gift cards are a way for merchants to turn their store into a destination for the cardholder," says Chris Haury, operations manager for Akron, Ohio-based FirstMerit Corp. "They are an effective marketing tool that can help smaller merchants compete with the big guys."
  FirstMerit, which sells gift card programs primarily to small merchants, compares the cost of, and sales lift from, traditional marketing methods to those of gifts cards when making its sales pitch. As of July, the bank operated gift card programs for 35 merchants.
  Other points promoters are making to strengthen the business case for the cards include reduced fraud from counterfeit gift certificates, lower handling costs compared to gift certificates, and the ability to gather demographic and sales information from the cards.
  The kicker for most merchants, however, is that proceeds from gifts card are received in advance of the actual sale of merchandise, which means they get float. About 23% of gift card holders redeem their cards one or more months after the date of purchase, according to Atlanta-based merchant acquirer Global Payments Inc. Another 10% do not redeem their cards at all and the remaining 67% redeem their cards within a month.
  "Cash merchants get ahead of redemption is money they can use for marketing or other purposes sooner," says Jeffery C. McWey, executive vice president and chief marketing officer for Global Payments. "That's a tangible advantage for a merchant."
  Equally tangible is that gift cards can be used as an alternative to issuing a cash refund. More often than not, consumers will spend a cash refund elsewhere. When refunds are put on a gift card for personal use the cardholder is more likely to spend more than the value loaded onto the card.
  Faun Evans, a suburban Chicago resident who recently undertook a home-improvement project, says she spent more than anticipated after receiving a gift card for returned merchandise at Home Depot.
  "I had overbought materials to start the project and when I returned them I got the card," she says. "If I had a gotten a cash refund, chances are I would have spent it on something else so the additional cost of my next purchase was nominal, because the card paid for most of the items I bought."
  Issuing gift cards for personal use is a trend rapidly gaining momentum. Hence, the growing interest in cards on which value can be reloaded. FirstMerit's Haury says one of her firm's merchants sends gift cards containing a nominal amount, such as $5, as a welcome gift to new residents in its operating area. The idea is to draw the consumer into the store and encourage her to reload the card with value to engender return visits.
  "We have one merchant that is working to position its gift card as a loyalty card," adds Haury. "When the customer makes a predetermined number of purchases with the card, the merchant will load value on it."
  For all the anecdotal evidence about sales lift and loyalty, merchants still want to see hard numbers when it comes to making the business case for gift cards. Transaction fees are 25 cents to 50 cents, and most processors require the merchant to order a minimum number of cards to launch a program. That amount can be as few as 500 cards that simply feature the merchant's logo on the card face. Merchants who want customized graphics on their cards must order more than 1,000. Merchants can expect to spend anywhere from several hundred dollars to launch a tiny gift card program, and up to tens of thousands for bigger ones.
  The cost of accepting gift cards is comparable to acceptance costs for personal identification number-based debit cards, which merchants consider more economical to accept than credit cards and signature-based debit cards. There is also the reduction in administrative costs. The cost of handling and processing a paper gift certificate is comparable to that of a check, which is about $1.22, according to estimates from various payments experts.
  As good as the economics for gift cards look on paper, processors are still struggling to make the business case for them with small merchants.
  "This is still a developmental business for all but the processors that handle the largest merchants," says First Annapolis' Abbey. "The big question in pushing gift cards down to the middle and lower tier of the merchant community is whether processors can generate enough volume to make these programs meaningful for their business."
  First Data Corp., which owns ValueLink, the largest gift card processor, is betting yes. In June, the Greenwood Village, Colo.-based processor launched its Mid-Market Gift Card program, aimed at mid-sized and small merchants. Merchants will have the ability to sell gift cards in any denomination.
  Initial Targets
  First Data, which has signed about 100 merchants, initially is targeting specialty retailers, restaurants and beauty-product sellers. FDC has also signed a hospital, which uses gift cards as part of an employee-recognition program. Cards can be redeemed at the hospital cafeteria or gift shop.
  "The cost of gift card programs is coming down substantially," says Doug Dwyer, vice president and general manager for First Data Gift Cards. "Five years ago, it was a five-figure investment for the merchant, now it's a three-figure investment."
  Downward pressure on the cost of acceptance is expected to continue. One solution being floated as a way to make the plastic more attractive to small merchants is for processors to charge a monthly fee for administering the program.
  Still, some processors remain skeptical about the viability of gift card programs for merchants that generate a high percentage of small-ticket sales.
  "The key in this segment is to show the merchant that the gift card is an easy-to-administer, cost-effective solution that creates a real value proposition," says Global Payment's McWey. "There looks to be a good opportunity in this segment, but so far we have not seen much activity in it."
  That is expected to change as more consumers purchase gift cards throughout the year, as opposed to the traditional Christmas selling season. Anecdotal evidence points to an increase in cards being given as birthday presents and gifts for other holidays, such as Easter and Valentine's Day. This trend is due in large part to the cachet gift cards hold with pre-teens and teens who are too young to own a credit or debit card. Gift cards also make it possible for them to shop online, since many of the cards have an account number.
  In addition, consumers over age 40 are also building an affinity for gift cards as they are given away by employers and merchants and sold through eBay Inc.'s online auction site, which has a page for gift cards. While some cards listed on eBay were received as gifts but are unwanted by the recipients, retailers have begun using the site to sell them.
  The reasons why merchants are exploring this channel vary. Some merchants are using eBay to test the waters for online gift card sales and others are using eBay as an additional marketing outlet for the cards, says an eBay spokesperson. EBay had more than 11,000 gift cards listed as of July 30.
  Ultimately, processors envision the day when gift cards are directly linked to loyalty programs. The idea is to create some type of reward for cardholders who reload value onto the card after receiving it and tracking data gathered from the card's magnetic stripe at the point of sale. Merchants can use that data to send marketing messages to the cardholder based on purchasing behavior, as well as to consumers who buy the cards as gifts. Personal data on cardholders usually are gathered when value is reloaded. Data on card buyers are gathered at the time of the sale.
  "Gift cards represent a great opportunity for retailers, specialty retailers in particular, to create brand affinity," says Frequency Marketing's Taylor. "They are a much lower cost loyalty vehicle than cobranded cards."
  With gift cards bringing so much tangible value to merchants, they are certain to provide processors with an opportunity to ease the drag on their margins in a business fraught with commodity pricing. But full market penetration will take some time.