What is the business model of discounted gift cards?

Question

Context:
I have an account on a third-party website that sells discounted (first hand) gift cards — because my employer is part of the scheme.

For example, you pay ¤95 for a ¤100 gift-card, in the case of a mainstream supermarkets. There is also this top-up system, so basically, you can add as much money on your gift-card — it then become like a pre-paid card (except it's shop-specific).

Issue:
For supermarkets, discount varies from 4% to up to 8%. This seems to be higher than the margin of this industry.

Question:

I have come with a few explanations, but I'm not sure which/whether they are correct:

• The discount is covered by my employer, because it sponsors the scheme,
• The gift-card company makes money by investing the moneys in the time between when I buy the card, and when I pay with it,
• The supermarket offers the discount to the gift-card company, because:
  • it enables to write earnings earlier than the actual sell (but does this works with accrual accounting?),
  • it generates cash before the sell, so there is no need to borrow money to buy stock,
  • it will receive ¤95 anyway, and expect people to lose/forget about their card, so the claimed gift-card amount is lower than ¤95,
  • it offsets the cost of "acquiring a customer"…

My question is then:

What is the business model behind such gift cards?

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_{Note: In this question, I am not talking about second-hand gift card platform, where people sell ¤80 a ¤100 gift-card of a specific shop, because they have no intention to ever buy in that shop, so prefer cash instead.}

Answer 1

1. Generates cash before any expense is taken on COGS (negative leadtime is heaven, and cash is, as we know, king)
2. It is a way of segmentation of customers - you appear as a good choice both for non-price sensitive customers AND price sensitive customers. Your access to goods is high enough to sell with differentiated margins to both customer groups. A sale to one customer is not a lost sale to a different customer. If your access to goods is not high enough, having "sales" are not worth it.
3. People tend to lose, forget, or for any reason misplace or let cards time out.
4. And, agreeing with DJClayworth, I add: [I]t locks customers in to your store. They might have spent much of the gift card's value at other stores if you hadn't offered the discount.

I'd say most of your own suggestions are valid, but to my opinion the three I have mentioned are most important.

Answer 2

In economics, any prepaid amount is a loan. In fact, a gift card is arguably a cash advanced loan derivative but it's not regulated. Many issuers are gaming the system to take advantage of this interest-free cash-advanced loan.

• Advance cash for the issuer. A bank loan may cost them 8% interest, but now the gift card buyer just helps to fund the unsecured loan.
• Many issuers don't reserve gift card sales into a trust account. If the issuer goes bankrupt, the gift card value will turn zero. The consumer must always aware whether the gift card issuer is going out of business.
• Issuers set an expiration date on the gift card, which means free cash for them.

• Some issuers charge a fee on dormant gift card usage, which is free cash for them.

• Some gift cards come in a voucher/coupon form, which creates inconvenience to carry around and the customer might misplace it.

• It locks the customer into a particular brand. Since it doesn't allow a customer to exchange it back to cash.
• Gift cards can be used as money laundering tools.

Currently, there are efforts to regulate gift cards. But it depends on where you live, the mileage varies.

Answer 3

Speaking to a restaurant owner I learned that, for his business, only about 80% of the amount sold in gift cards ever gets redeemed (your point #3). This means that he makes a much larger margin on gift cards than on his main products (food). It also explains why he could discount them for more than his profit margin on other products and still come out profitable.

Also, discounted cards which are bought as gifts during the holidays are often used to buy items worth more than the card's value. This makes them great for shops who sell high-priced items. E.g. Carol buys a $100 Best Buy card for $95, gifts it to Marc, who uses it to get $100 off the $500 TV he buys. The 5% discount on the card becomes effectively a 1% discount on the TV.

Answer 4

In addition to the many valid points made in other answers, there is another important point: A store-issued gift card gives the merchant control over more of the payment processing cycle. This factors into their decision to discount the cards because they can still come out ahead in the end.

When you swipe a card at a point of sale machine, the transaction changes hands a number of times between the merchant, their bank, a processing network, and an issuing bank (i.e. the bank that issued the card). There may be even more entities, if either bank is outsourcing their card processing operation (which is fairly common). Essentially, all of those entities take a slice of the transaction. The consumer may have bought $100 of goods, and may see $100 against the card's account, but the merchant may only receive $97 after everyone else has taken their fee.

Between the various entities involved in processing your transaction, contracts will dictate who gets what part of that $3 fee.

In the case of a personal debit or credit card, which you hold against your own bank, the merchant themselves can only influence a small portion of those contract negotiations (essentially, between them and their own bank). But - if you use a store-branded gift card, the merchant can work directly with a gift card issuer who controls the whole process and is more likely to give them a better deal, in terms of who gets what. Going back to the example where the merchant got $97 for a $100 purchase made on a private card, if the same purchase was made on a store-branded gift card, the merchant might get to keep $98.50 instead of only $97. Essentially, that makes the apparent discount the consumer sees (by paying $95 for a $100 card) smaller than it looks.

Answer 5

Another reason that shops (especially restaurants) like gift cards is that many people don't think of a gift card as real money, and so will often spend more when using them. Say a customer has a $50 gift card, they may mentally subtract that amount and buy $60 worth of goods thinking it only cost them $10 out of pocket.

A few years ago in my town, there was a restaurant that offered an exceptional deal on gift cards, something to the tune of a 20% discount.

The only problem was that they closed their doors 3-4 months later, and the gift cards were worthless. I like to think that the gift card sale was their last-ditch effort to get enough money to stay in business. The alternative is that they knew all along they were closing and sold those gift cards with no intention at all of honoring them.

Answer 6

A key point that I think is being missed is that a supermarket's gross margin is much higher than its net margin of 4%-8%. So long as the cards are bringing in new sales rather than just substituting for sales that would have come in anyway they can be profitable.

Lets say that the shop has a 33% gross margin, gives a 5% discount on the cards and 60% of the card value is extra business and 40% would have come in anyway.

For a $100 card, they have given away $5 discount in return for $60 of incremental sales on which they make a gross margin to 33% x $60 = $20. They increase profits by $20 - $5 = $15.

A gift card may also encourage trial by new customers who may spend even more and may become repeat customers and the brand may benefit from any co-promotion by the card providers.

Anyway, this level of discount is not so different from supermarket marketing budgets as a % of sales. If card discounts are a substitute for other marketing activites there may be very little net cost.