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Saturday, December 05, 2009

Off-topic: Gift Cards

[ Update: The New York Times wrote this column several days after I posted this entry. It's full of detailed industry data. ]

Though I never talk about it, I had a consulting contract a very long ago with a company that wanted to do something in the credit card business. I was involved for about a year, and the while the idea itself was great, it never got off the ground because of a critical "last puzzle piece" that couldn't be solved. I eventually did (and filed a patent), but it was after the company fizzled, and I had no desire to enter into the "payment" business. So, there it stays in my history pages.

But just today, I was talking with someone that said the following:

"I've heard that prepaid debit cards are really bad gift ideas..."

This prompted me to vent a long-standing issue I've had with credit card companies.

The main reason people don't like gift cards is because when the card gets down to about $10 or less, they become virtually unusable. Although you can go to a store and say, "charge the first $7.43 on this gift card and the rest on this regular credit card," it's very rare that people do this. And you certainly can't do that online. So, your $50 gift turns out to only be worth $42.67, and Visa/MC makes a handsome15% profit.

In this sense, gift cards to visa are the victim of their own success. People see the lack of value in the cards, and don't adopt them nearly as much as the card companies would like (or had expected).

The question is, what can card companies do to raise the rate of adoption while not giving up too much on the margins? Remember, the card companies *don't* want you to use up all your credit--otherwise, they give up the margins that makes them worthwhile (to the card company). And they don't suddenly gain new customers just because someone uses a gift card.

Now, one could argue that, as long as they make the same 1-3% margins on the gift cards as they do with regular cards (this 1-3% is the rate that the merchant pays on the total cost of your order), that should be good enough. Well, administration of the gift card program is a bit more expensive, and besides, there's plenty of room to optimize margins anyway. So, don't get me wrong: I don't fault the companies for using gift cards for profit motive at much higher rates. I fault them for not being more intelligent about this in ways to service both themselves and us, the consumers who could benefit from them. Their challenge is to increase overall revenue by finding the sweet spot in the increased adoption vs. the decrease in margins.

The way to do that is by making it easier to use that unused credit in high margin products or services, such as a visa-run online store where they sell products from co-marketing partners (where the co-marketing effort yields more revenue). This would be especially useful for non-physical goods, such as downloadable products, like music, games, movies, etc.

Or, allow gift card holders to apply unused dollars to their Visa Rewards program, which is pretty good, albeit under-appreciated, largely because most people opt for other programs with their visa cards, like airline miles (see below). This would do more to raise adoption rate of the program and potentially convert users to their "real" card. (That should ultimately be one of their prime motivations, yet it's not effectively promoted that way.)

Card companies should also consider developing helpful payment services that make it easier for online retailers to accept multiple card payments, or partner with paypal or google to allow users to register these cards in exchange for a portion of the margins.

Industry research shows that most "reward" programs usually yield the consumer about 1% of his money back, but getting that value is not entirely easy, nor is it immediate. It takes time. A research study I read in the NYTimes some years ago showed that the best programs are those that simply pay you cash back--even at 1%, this was best for consumers. Ironically, airline miles yield the least return, but people opt for them because having more unused miles gives other benefits like premier status that allows access to airline clubs at airports, and advanced positions when upgrading and other things -- all these require high mileage values creating a disincentive to ever "spend" your miles. This makes the "statistic" that credit card airline programs yield low rates of return a bit murky.

The point about reward programs as anyone in the consumer business knows, it garners much more revenue and profit than the 1% you give up to attract the users. Yet, gift card programs don't even attempt to tie into this. Such programs and co-marketing efforts could be more profitable if the card company was willing to make only 5-6% margins (instead of 15%) and offset that with a 10% increase in the rate of adoption, if they were only kinder to the consumer.

Ok, that's my vent. This is not a topic (or field) I will be watching at all, unless it happens to come across the mainstream press. I'm more than happy staying out of this business.

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