News

Gift cards are big business

February 22, 2006

Using stored-value cards instead of cash is a growing trend among U.S. consumers. The Federal Reserve estimates about 20 million consumers will spend $72 billion through stored-value cards this year. The number of users is expected to more than double by 2008.

According to a 2004 Celent LLC report, the prepaid option is flexible for both issuers and cardholders. The report, "Finding the Value in Stored Value Cards," finds cards are becoming a replacement for money, and are the answer to the desire of many companies to move to a cashless payment system.

Card rewards

The stored-value system features two types of cards: open-loop and closed-loop. Both can be reloaded with cash through magnetic-stripe or radio frequency identification (RFID) technology. Open-loop cards are typically issued by banks or credit card companies and can be used anywhere. Closed-loop cards can be used only at the issuing retailer.

Before partnering with Visa USA to create the Starbucks Card Duetto Visa (an open-loop stored-value and credit card), the original Starbucks Card had $1 billion loaded onto more than 58 million cards from November 2001 to July 2005.

"The Starbucks Card is so successful because they have people going there five times a week," said John Gould, a partner at the New Hampshire-based Prepaid Advisory Services. "Not many places are going to have that kind of success."

Most restaurants invest in the closed-loop version, said Gould. "It makes most sense for a restaurant to issue a card that can only be used in its chain."

Amanda Barnes, marketing director for ZT of Louisville, said her Qdoba Mexican Grill restaurants switched from paper gift certificates to gift cards a year ago. As a result, the chain has experienced a significant increase in gift-card sales.

"They've been really good for us," Barnes said. "If money runs out in a card, the patron can just add more."

She said the entire process is easier for customers, and people prefer paying with plastic over paper money. Joe Hurley, vice president of Discover Financial Services, said consumers tend to purchase more with gift cards.

"They (consumers) consider their meal to be free," Hurley said. "When offering gift cards, restaurants will see an increase of average ticket spending and more incremental sales."

With paper gift certificates, Hurley added, "They were folded in a wad and forgotten. Today, the gift card becomes a billboard for some of these restaurants."

Setting up a card

Gift card specialist Ernie Toth, vice president of Global Card Services, said creating a successful gift card takes work. The first priority is selecting a processor or manufacturer. Toth said most merchants go directly through the payment processor or work with customized gift card manufacturers like Global Card, CPI Card Group or Stored Value Systems.

The next step is choosing a design. Some restaurants simply place their logos on the cards while others illustrate popular menu items. And this is where a gift card program can become expensive, Hurley said.

"If you have a single-outlet store producing 20 to 30 cards a year, the price is drastically different than that of a large-scale chain," he said. "It could cost anywhere from 12 to 15 cents per card to $1.25 and higher, depending on colors and textures. All these different types of things go into how much a card costs to produce."

Then the question becomes: Where are the cards placed?

"Retailers have it easy in this regard. The consumer goes to the counter and there is a rack of cards," Toth said. "Restaurants hardly sell anything that's not prepared and served, so they're not as used to selling over-the-counter. But I think as long as they have a nice presentation, there is a lot of sales potential with gift cards in the restaurant marketplace."

The legislation and concerns

For the most part, states treat gift cards as unclaimed property. If a card is not used by its expiration, the retailer must report the unused funds to the state and follow the state's unclaimed property laws. In some states, unused funds default to the state. For example, gift cards of more than $100 issued in New Hampshire default to the state if not used before expiration.

But restaurant lobbyists are working to change gift card laws.

In 2004, 33 states introduced 100 bills that touched the stored-value market. Last year, Illinois passed a ruling that allowed all gift cards issued without an expiration date or dormancy fees to never default to the state. According to the National Restaurant Association (NRA), the Illinois legislation protects the customer by allowing the card to be redeemed at any time and allows the restaurant to hold the unclaimed property and use it for other purposes until it is claimed by the customer. The Nebraska Restaurant Association is seeking a similar law.

"We would like legislation that acknowledges if a gift card doesn't have an expiration date, it can be honored and used in the merchant's store and should never revert to the state," said Joe Partingon, executive director for the Nebraska association. "If it does have an expiration date on it, we believe it should have some unclaimed property law."

Other states like Massachusetts prohibit dormancy fees and apply an expiration window of seven years. Arizona statutes passed last year allow for fees and expiration dates, but force retailers to be up front.

"From our perspective, we don't mind if a restaurant charges a fee for their gift cards, but they must disclose fees or expiration dates," said Andrea Esquer, spokesperson for the Arizona Attorney General's office. "We don't want consumers trying to use a worthless card six months after purchase."

One federal lawsuit could override all state laws on open-loop cards.

Three New England states allege Simon Property Group's gift cards include fees and an expiration date that violate state consumer laws. Simon Property Group, however, contends its open-loop Simon Visa Giftcard is not subject to state law because it was issued by Bank of America. According to the company's argument, the card falls under federal banking laws.

NRA said the case's ruling could have significant consequences for national chains that issue gift cards from an independent company based in another state.

"This lawsuit really does not pertain to restaurant gift cards, but because gift cards fall under such vague laws, the ruling could have a blanket effect on how restaurants set dormancy fees or expiration dates," said Tom Foulkes, vice president for NRA state relations. "What that effect will be, we won't know until the case is decided."