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March 14, 2007
Gift Card | Technology
Michael L. Kasavana, Ph.D., NCE, CHTP - kasavana@msu.edu

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Gift cards were the most popular present this past holiday season with more than half of all Americans receiving at least one gift card. In fact, gift cards, which sustained better than 20 percent growth in each of the past three years, are expected to remain in high demand in the future.

For many years, prepaid arrangements have been commonplace in many sectors of the hospitality industry, with hotels and restaurants prominently positioned in the multibillion dollar gift card marketplace. In 2004, for example, Starbucks reported selling 21 million gift cards representing $312 million in revenues–not bad for an industry that not long ago relied on manually produced paper certificates. The implementation of sophisticated technologies enable hospitality firms to create customizable gift cards presented through multiple distribution channels, in amounts ranging from $1 (Wendy’s Restaurants) to $100,000 (Four Season Hotels). Gift cards differ from traditional gift certificates in that they are distributed as electronic stored value cards, not loosely controlled paper documents. Now when a consumer spends $25 from a $50 gift card, the account can be automatically updated and the balance displayed online. This process is obviously more efficient than the operator reissuing a second gift certificate in the amount of the remaining balance. The goal of an effective gift card program is to distribute a branded prepaid card through multiple channels (POS, kiosk, retail display or online) in any denomination, that is instantly redeemable. The emergence of gift card in-store kiosks, off-premises display racks, assorted activation technologies and Web-based application service providers combine to extend the reach and capabilities of product offerings.

Creation and validation of a paper certificate is time consuming and requires bookkeeping entry, manual authorization and comprehensive tracking to ensure validity. In the past decade, point-of-sale (POS) terminals became capable of supporting electronic gift cards through magnetic stripe and/or bar coding authorization and monitoring. The POS system took on the responsibility to activate, administer and process credit transactions against gift card accounts. Recently, Web-based application service providers (ASPs) entered the marketplace offering highly secure, customizable and reloadable gift cards, capable of being marketed through multiple distribution channels, including on-premises, third-party premises, and virtual premises. Most gift card management companies offer business card-sized plastic cards that can feature customizable artwork and/or personalized embossing.

Card Types
Gift cards fall into two general categories: cards issued by banks (open loop network) and cards sold by retail establishments (closed loop network). Open loop cards have a wide degree of negotiability (brands like Visa, MasterCard and American Express) and are akin to a debit card. As the name implies, open loop cards can be used at any establishment that accepts a debit card or ATM transaction. This is not true for a closed loop card that can be redeemed only at participating outlets or groups of retailers. Consumers have slightly more protection with open loop cards, which can be customized or personalized, since they are governed by the Office of the Comptroller of the Currency (OCC) which oversees banks. Closed loop cards are governed by state laws, which vary widely. Some states, for example, do not allow gift cards to expire, while others place limits on non-use and administrative fees imposed if the card is not used in a specified period of time.
First Data Corporation claims open loop cards are rapidly gaining usage and popularity as consumers increasingly demand more flexible payment options and retailers seek a complementary product to private stored value cards. For example, the STAR Gift Card, really a PIN-based debit card, is accepted at several million retail and ATM locations nationwide and holds special appeal for hospitality operators without a proprietary gift card program. In 2005, the fastest growing open loop gift cards in ranked order were American Express gift cards, Visa gift cards, MasterCard gift cards, Discover gift cards and AAA gift cards.

Closed loop cards are as the name implies, limited in scope and negotiability. Closed loop gift cards rely on a proprietary network provided by a business entity or fulfillment agency. From a hospitality industry perspective, a closed loop card provides a means to build customer loyalty while also serving as an incentive for new customer attraction as the stored value of the card must be used at participating locations.

According to a 2006 pre-holiday survey conducted by BIGresearch, more than two-thirds (79.7 percent) of consumers polled said they planned to purchase at least one gift card and more than half (52.8 percent) said they would like to receive a gift card. As gift cards continue to increase in popularity, technology applications continue to expand to form end-to-end deferred payment monitoring networks.  Interestingly, gift cards, which once carried a stigma of being impersonal, have become a preferred gift item. The Mercator Advisory Group claims 2006 gift card sales grew significantly to about $80 billion. According to figures released by the National Retail Federation, during the recent holiday season alone approximately $25 billion in gift cards having an average transaction value of $116 were sold in the United States. This represented an impressive increase of $6 billion over 2005 holiday sales when the average transaction totaled $88. American Express estimates that 7 percent of gift card recipients used the gift card within the first week of receipt; 33 percent during the first month; and an additional 23 percent during the first six months.

For the hospitality industry consumers may visit company properties, third-party venues or online Web sites to create a plastic IOU; one that may never be redeemed. Gift cards, which do not require purchaser registration, have created an issue that credit and debit cards never face; how to deal with unused funds. Technological advances have changed gift certificates to sophisticated gift cards that are considered as secure as credit cards. The urban myth that gift cards are ripe for fraud has not been proven. The security methods surrounding the production, activation, distribution and use of gift cards has benefited from automation. Tamper-proof cards, encrypted online sales engines, complex accounting software, detailed transaction monitoring schemes and identification requirements for balance information are important considerations.

Gift cards are appreciated by recipients since they provide a range of purchasing options. From a hospitality industry practitioner perspective, gift cards have many appealing features; not the least of which is breakage and upspending. Breakage is the term used to describe the unused monies remaining on an expired gift card while upspending refers to the amount of money spent in addition to the value represented on the card. Hospitality firms considering contracting a gift card processor are wise to solicit one that also processes credit and debit card transactions and seamlessly integrates with the company’s POS system. Several firms provide gift card management (fulfillment and account tracking functions) as an application service provider (ASP). Generally an ASP takes responsibility for account creation, monitoring and reporting. The database used to manage gift card accounts is also ripe for aggregated analyses and reporting options. In addition, some ASPs also enable the purchaser to send a creative e-card greeting to the recipient.

Gift cards are known as stored value media for good reason; as their value to the hospitality business may be permanent. Boston-area consultants TowerGroup estimates that of the $80 billion spent on gift cards in 2006, 10 percent to 12 percent will never be redeemed. This represents a level of breakage of $8-9.6 billion. While this level of breakage might seem high, consider that Consumer Reports estimates that 19 percent of the gift cards received in 2005 were never spent. For example, last year BestBuy reported earning $16 million in gift-card breakage from gift cards bought but never redeemed.

With most processor-based gift card solutions, the gift card management company/processor holds the money. When the card is used, the processor credits the retailer’s account with the proper amount. That means if a card is never used or a balance remains, the unused funds go to the processor, not the retailer. Industry practitioners need to consider receiving full funding at the time of gift card creation. As a point of interest, cash from unredeemed gift cards is unrestricted and can be invested in an interest-bearing account.

Upspending describes the situation in which the consumer purchases goods and services at a higher dollar value than carried on the card. In order to complete the transaction, the consumer must apply additional funds. First Data claims that 56 percent of all gift card holders spend more than the initial value on a gift card. Datamark Technologies claims that when a gift card is used, the average transaction value is 31 percent higher than the retailer’s normal check average. Dan Horne, professor of marketing at Providence College, claims gift card holders tend to spend 1.4 times the value of the card. These two statistics represent a significant rate of upselling.

Gift cards can be processed using existing credit card readers, and therefore eliminates the need for separate gift card processing hardware and/or communication software while maintaining control over the ability to activate new cards, increase the value of existing cards, perform balance inquiries, and redeem purchases.

Several hospitality industry gift card programs are stand-alone, processor-based solutions in which the processor, not the hotel or restaurant company, manages account data, transaction posting, account reconciliation and system reporting. In order to have an effective linkage, the processor needs to seamlessly interface with the hospitality company’s in-house POS system since that technology will be used to create, activate, post and process gift card-related transactions. The processor must program the system to conform to the expiration date, administrative fee and other requirements of the state in which a transaction is likely to occur. The location of the gift card bank will also influence the technology configuration.

The gift card processor, in addition to tracking account balances, can also provide Web services to cardholders through a special Web site. While the primary role of the fulfillment provider is to support an effective means for tracking gift card redemption, it also gains insight into purchase behavior and product trends. Account creation also leads to the establishment of a pipeline (e-mail connection) with the cardholder. Part of the role of the card processor is to handle card security, production, packaging, transaction processing, database management, reporting and help desk support.  Web-based reporting of real time account activity, balances and aggregate transactions as well as gift card accounting and financial tracking should be available.

Due to improved technology, some hospitality companies are able to reissue a lost gift card if consumers have kept the original purchase receipt. Some retailers also encourage gift card recipients to register the card through the company’s Web site, which enables online balance review and replacement card issuance for lost or misplaced cards.

There are several channels used to sell hospitality gift cards. The most direct format involves purchasing on the premises of a hotel or restaurant property. With an on-premise sale, the gift card is activated either at the POS terminal or a connected free-standing kiosk payment device. Alternatively, off-premises POS equipment and online card processor (ASP) activation services are also available.

ASP Online
Some hospitality companies offer gift card sales from a Web site where the payment processing firm handles the transaction record, completes card fulfillment and forwards details of the transaction to the host firm.

Gift cards for hotels and restaurants are also being marketed in supermarkets, drug stores and other non-competing venues. In these circumstances the cards are pre-designed and pre-denominated, and at  the point of purchase can be POS activated. Remote card sales normally are linked to an online card processor that in turn reports activity directly to the hospitality company and fulfills the purchase. For example, Outback Steakhouse uses Paymentech as its fulfillment and gift card monitoring agent.

In December 2006, 100 restaurant executives in North America were surveyed relative to the implementation of self-service solutions. The online survey was conducted by Channel Media & Market Research using Nation’s Restaurant News’ customer database. The survey revealed that nearly two-thirds of the firms plan to test or implement self-service applications in 2007. The top three self-service areas cited were kiosk-based customer data capture, gift card dispensing and product mail ordering. Several firms planning kiosk applications do not necessarily plan installation on the premises. Busy traffic areas like airports, convention centers and shopping mall locations have special appeal to operators interested in increased exposure and innovative revenue opportunities. This is not unlike the current practice of third-party display racks for gift card sales through POS activation at select supermarkets, pharmacies and other off-premise locations. Also, in its 2007 forecast, the National Restaurant Association identified self-service technology among its ‘hottest’ full-service restaurant trends. Gift card dispensing kiosks can be placed in a secured area and accessible even when the outlet it serves is closed. Sales through this device will represent an increase in same-store sales without related expenses.

Custom Cards
Customized and personalized plastic gift cards, often called signature cards, can be used to boost card sales. Similar to hotel room key cards, changes in the artwork on the card face can be rapidly produced. Embossing the recipient’s name as well as the giver’s name or using digital ink jet application, can be additional design features intended to further promote card sales. The variety of templates, artwork, fonts and card formats is extensive as magnetic stripe cards, contactless cards, embossed cards, bar coded cards, scratch-off surprise panel cards, and the like are used in coordination with a broadcast mailing or e-mailing list.  Personalized cards are a growing trend. Wal-Mart for example, allows consumers to upload a photo to create a unique appearance and American Express offers personalized gift cards with the recipient’s name embossed on the card. Electronic gift cards, purchased online, may be restricted to use online for Web site merchandise or catalog selections, but not in stores.

Multiple Channels
Another convenience factor is that many non-hospitality industry venues are able to offer hospitality-related gift cards either on display racks throughout the store or at a checkout counter since the cards are not valid until scanned and activated. Retailers such as grocery stores and pharmacies often carry a variety of gift cards for restaurants, hotels, movie theaters, coffee shops and clothing stores.

A recent innovation for the hospitality industry is a flexible product gift card that enables the retailer (or buyer) to limit the card’s acceptability to select locations and/or restrict validity to specific calendar dates, day parts, meal periods, menu items, concierge services or packages of services. In addition, the price of each or all products on the card can be hidden from the recipient. The technology to accomplish this feature is built into the fulfillment algorithm.

Consistent with this trend is a strategy in which the retailer specifies that gift cards can't be used until after a certain date. By doing so, retailers were attempting to drive sales into hotels and restaurants during a time when business was forecasted to be down.
In simplest terms, the issuance of a gift card is a currency exchange and not a sale. The sale is deferred and does not occur until the guest redeems the card as a form of payment. From an accounting perspective, the sale of a gift card represents a current liability to the business as payment is collected at the point of sale for a promise of future provisions. Standard accounting practices suggest that until redeemed, the amount received in payment for goods or services not be recognized as revenue. As gift cards are used, revenue represented by the rendered goods and services is recognized through gift card bank withdrawal and the liability reduced accordingly. In order to account for monies derived from gift card sales, a separate entry and fund deposit is normally created to chart redemption activity and to hold the funds securely for some period of time–may be up to five years–per state governed liability limitations. If a credit or debit card is used to purchase a gift card, some gift card management companies create a separate bank account and deposit cash in the amount of the transaction to the bank. As a result, monies collected for gift cards in one accounting period likely will not appear as revenue until a future period; whenever the gift card is used. Despite the fact that a gift card is sold for cash, the retailer is obligated to hold the money from the sale until the consumer uses its stored value.  Historically, a common practice for non-redeemed gift cards was to charge a holding or dormancy fee ($2-3 per month for non-use) as a cost of deferred redemption.

There are no national laws regulating gift cards; state laws regulate usage. Many states have enacted laws that allow the state to collect abandoned property, which means that gift cards that go unused or unredeemed for more than some period of inactivity may become the property of the state. Retailers would be required to turn over unused gift card dollars to the state government under the guise of returning abandoned money to the gift card purchaser. It is for this reason that consumers are encouraged to spend their gift cards within the first year of purchase so that they receive the full value.

Several states have adopted legislation to restrict the use of gift card expiration dates or dormancy fees, or both. Regulations governing gift cards are in part driven by consumer advocates who believe gift cards should be as fluid as cash. In California, Connecticut and Maine it is illegal for gift cards to have an expiration date, and in Massachusetts cards can be redeemed for up to seven years from date of issuance. Most states also have restrictions on dormancy and service fees. Some gift cards expire over a certain period of time (usually 12 months or more) and some cards depreciate month-by-month once the card has been inactive for a certain period of time. Most retailers are moving away from expiration dates and dormancy fees. Under current conditions, service fees and expiration dates are more common with bank-issued gift cards than retailer-issued cards. Dormancy fees, also referred to as a monthly service fee, can be charged against the outstanding balance on the gift card. Starbucks, for example, which used to charge an inactivity fee of $2 per month after 12 months of non-use, no longer levies a dormancy fee.

Regulations related to unclaimed property, called escheat laws, are current in nearly all states and dictate that a retailer transfer the outstanding value of a gift card to the state treasurer if the value isn’t redeemed within a certain amount of time. While rules vary among states, most escheat laws take effect between three and five years.

Lost or unused gift cards, sometimes referred to as drift cards, may not be found until after they expire. Once that happens, redemption may be problematic as the cardholder realizes the card’s value has slowly dwindled as the retailer may apply a service (or dormancy) fee as high as $2.50 per month. As a consumer protection benefit, many states have adopted laws governing gift card issuance, redemption and non-use. Inconsistent state regulations, designed to clarify consumer’s rights relative to inactivity and value preservation, are found in a set of regulations termed escheat laws.
It is interesting to note, that there are no specific requirements for disclosing unredeemed gift card amounts under the Generally Accepted Accounting Procedures or the Uniform System of Accounts. The Securities and Exchange Commission, however, requires a company disclose its specific non-use data if the amount is more than 10 percent of current liabilities.

Escheat Laws
Gift cards that are not redeemed for the full value on the card result in breakage that becomes subject to state escheat (unclaimed property) laws. Until recently, most states permitted retailers to sell gift cards with expiration dates, inactivity fees (also known as dormancy or administrative fees), and/or other fees designed to reduce unspent balances to protect unclaimed funds from escheatment. This no longer is the case as many states have changed laws to protect consumers. Since 2004, some states have considered or adopted legislation to exempt gift certificates from escheat laws. Part of the reasoning for legislative relief stems from the fact many businesses struggle to reconcile revenues with sales over a lengthy horizon. Since gift certificate values can range from $1, tracking a large volume of small dollar transactions often becomes tedious and unreasonable. Even when aided by a comprehensive software application, many hospitality practitioners find monitoring outstanding balances to be challenging. There are basically three models of escheat laws:
  1. No Expiration Date Model – A consumer friendly approach in which funds never transfer to the state as a gift card remains valid until used. This model requires the retailer maintain a reserve fund for unanticipated redemptions. Used in several states including California, Washington and Massachusetts, money never escheats to the state.
  2. Sixty-Forty (60/40) Model – Allows gift cards to carry an expiration date and at expiration (between three and five years) retailers are responsible for 60 percent of the value of the card escheat to the state. Retailers are allowed to keep the other 40 percent to cover reasonable costs (Indiana and Iowa use this model).
  3. Imposed Expiration Date Model – Under this model, the state eliminates gift card expiration dates but imposes its own end date for redemption (usually three years). Despite the fact consumers will not find expiration dates on the gift cards, the cards are expected to be used in a specific time period. Non-use during the prescribed timeframe results in funds escheating to the state. (Connecticut uses this model.)

Of note: In 13 states expiration dates have been banned and although the laws apply only to local retailers, some national issuers have voluntarily eliminated or loosened card expiration policies. This is consistent with the increased number of retailers that allow online gift card sales and purchases as well as reloadable cards. Hospitality industry-related state escheat law summaries can be found at www.restaurant.org/government/state/giftcards/giftcards_statelaws.doc; and a summary of state gift card consumer protection laws can be found at http://www.consumersunion.org/pub/core_financial_services/003889.html.

While technology has been a major force in advancing the popularity and security of gift cards, cards often remain somewhat vulnerable to fraud. The two most popular gift card frauds involve purchasing a gift card with a stolen credit card and stealing data from unsold cards.

Under the stolen credit card scenario, the thief steals a credit card and immediately uses it to purchase a stored-value gift card. Given the efficiencies of the credit card network, stolen credit cards are usually cancelled shortly after being discovered missing. This provides a limited opportunity for the thief to purchase as many gift cards as possible. Since the transactions of the cards remains anonymous, this fraudulent behavior often goes undetected. In turn the thief can sell the cards, apply them to online sales, use them to make in-store purchases, or redeem for cash refund. In the case of data theft, the perpetrator copies information (account number, bar code or magnetic stripe data) from unsold cards and then regularly checks account balances (800-phone number, online or store-direct) to note when the card is sold and its current value. The thief then proceeds to spend the value on the card before the actual cardholder can conduct a legitimate transaction.

Scratch-off security codes and protective packaging are among the various technologies being applied to safeguard the vulnerability of gift cards. Applying a security code to the card and coating it with a special scratch-off material will provide a level of protection only known to the cardholder. If the gift card area has been tampered with, detection will be obvious. The security code would then be required for all account inquires. Another technology being used involves capturing unique personal data at the time of gift card activation (password, recipient’s name, birthday or other data) and placing this data in the network’s database. This data could then be checked at POS terminals equipped with database access so that cardholder validity would be correlated with stored identification data. Automated scrutiny presents additional consumer protection that might be applied when a gift card transaction or account balance check is initiated. Also important is having a complex back-end property management system to prevent criminals from obtaining access to proprietary gift card information.

According to financial experts, gift cards sold through online auction sites are more likely to be counterfeit or obtained through fraudulent means. Additionally, consumers should keep the original receipt showing the initial value of a purchased card in case of redemption problems.

Gift cards can be branded, personalized and customized and offer the benefits of comprehensive usage tracking and a variety of redemption options.

Gift cards can be used to recruit, recognize and motivate consumers. Breakage is an important dimension of gift cards, and under many state laws, unredeemed card balances are considered unclaimed property and subject to escheat laws. Upselling is an interesting phenomenon that can significantly contribute to revenues beyond the original value on the card. Similarly, reloadable cards enjoy an extended life as additional funds can be added to its value. Many industry observers predict continued growth in hospitality industry gift card sales; projecting record sales again in 2007.

Michael Kasavana, Ph.D., NCE, CHTP, is a NAMA Professor in Hospitality Business for the School of Hospitality Business at Michigan State University. He can be reached at kasavana@msu.edu.

Nothing is considered potentially more pampering than an electronic gift card to a hotel or spa. While most consumers are aware that a majority of table service and several quick service operations offer gift cards, many do not know that hotels have also expanded offerings into this marketplace. Consider the following examples of hotel gift cards available in 2006:
  1. Four Seasons Hotels– gift cards valued up to $100,000 are available at hotel properties while cards in denominations of $100 to $5,000 are available online.  Fourseasons.com/giftcard
  2. Sheraton Hotels – gift cards in denominations of $25 to $1,000 are available at hotels and restaurants for use within a calendar year; can also be applied to purchases at Starwood and Four Points Hotels in the United States.
  3. Hyatt Hotels – gift cards can be purchased online and at select third-party retail locations (Kroger supermarkets and Staples office supply stores) and are accepted at Hyatt Hotel and Resort properties.
  4. Marriott Hotels – gift card programs exclude groups, some corporate categories and commissionable travel agents; gift cards accepted at 2,700 Marriott locations worldwide and/or rentals at Marriott Vacation Clubs.


Gift Card Trends

  • The maximum amount on cards has increased.
  • State laws prohibiting expiration dates have had some effect. Thirteen states have banned expiration dates and some national issuers have voluntarily done away or loosened card expiration policies.
  • More companies are allowing gift cards to be purchased or used online.
  • A significant number of gift cards are now reloadable.
  • Personalized cards have emerged as a new trend (embossing recipient’s name and/or photo) to create a custom card.
  • Gift card sales in non-competitor venues such as supermarkets.
  • Some card providers are charging a fee ($2.50-$5) for specialty packaging and delivery.

- 2006 Study Bankrate.com


Case Study
B.R. Guest Restaurants

A highly successful gift card seller is B.R. Guest Restaurants headquartered in New York City. B.R. Guest uses advanced technology that enables gift cards to be sold without the need to create an account at the point of sale. Instead the account is created when the recipient registers his/her gift card online. Registration requires the recipient enter the card number and security code, and add a user name and password. Once the account is activated, its balance can be checked online. Gift cards can be used at all B.R. Guest locations and the consumer can purchase up to 25 gift cards at one time. Gift card values range from a minimum of $25 to a maximum of $300 per card. All gift cards are bought using a major credit card. B.R. Guest also offers a unique corporate giving opportunity that accepts in-kind donations. Each month B.R. Guest donates gift cards to various organizations for use as auction items and door prizes. B.R. Guest gift cards do not have an expiration date but there is a $3.00 per month service fee deducted from the remaining account balance after 12-months of non-use (except in states that prohibit such practices). For online shopping, B.R. Guest provides a shopping cart metaphor and allows gift card funds to be applied against shopping cart purchases.
Source: shopbrguest.com/faq.php


Gift Card Terminology

  • Breakage – card value purchased but never redeemed
  • Dormancy Fee – also referred to as non-use fee, a holding fee for unredeemed gift cards (state laws differ on the legality of fee application)
  • Gift Card – there are two types of gift cards: purchased cards and promotional cards. Policies do not apply equally to both types of gift cards. Local laws of the state in which the gift card was purchased or issued govern its legality
  • Negotiability – defines the locations and/or affiliates participating in gift card redemption
  • Reloadable Card – also referred to as value added card, consumer can have additional funds added to the original funds stored on the card; card life is extended as value is added to the card
  • Redemption Policy – clarifies whether the gift card can be used only for goods and services, redeemed for its cash value, is reloadable, and/or some combination thereof
  • Upspending – spending additional funds beyond the value of the gift card

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