Gift Cards: The Changing Face of Retail

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Includes: AEO, BBY, HD, M, MCD, RL, SBUX, SHLD, WMT
by: Andrew Corn

Each year, as our country becomes more gift-giving challenged, the big retail product winner is now the “generically yours” Gift Card. Many of us were brought up being taught “it is the thought that counts,” and then had the rude awakening as adults, learning to “get a gift receipt.” Today some people are lazy, others are fearful of buying the wrong thing for people after having been disappointed and had to supply too many gift receipts. Gift Cards are easily purchased from general merchandisers such as Macy’s (NYSE:M), Sears (NASDAQ:SHLD) and Walmart (NYSE:WMT), to specialty stores ranging from Starbucks (NASDAQ:SBUX) to Ralph Lauren (NYSE:RL).

Any way you look at this phenomena, the National Retail Federation anticipates gift card sales to increase this season to $26.3 billion, up from $24.8 billion last year. Last year many gift cards were never redeemed adding to the bottom line of retailers but not the top line as revenue is not recognized until merchandise walks out of the store.

This time in 2006 I posted:

Last year a lot of holiday shopping occurred as the; buy yourself what ever you want on me program, also known as gift cards. Last holiday shopping season, November 2005 and then in January 2006 I had commented for Bloomberg TV and radio about the tremendous impact of gift cards. Essentially, stores take in the cash for a gift card but most stores do not account the transaction as revenue until merchandise has been exchanged for the card. Not unlike the old travelers checks game, some cards are lost, tossed into the back of dressers and never used. There is quite the profit margin on those, yet they are not ever booked as revenue. Additionally, stores have the use of the cash, sometimes for months. Most cards are redeemed by February and redemptions slowly fade out until June. After June they are assumed to not be redeemed.

This is an accounting and revenue recognition issue. It shows up in operating margins and other places that quants like us like to dig. The issue is the numbers are skewed. Gift cards are bigger and bigger numbers each year, over $18 billion in the 2005 holiday season.

We are waiting to see how the big four accounting firms jigger the books. Of course, some of us will be watching very closely.

Today, the availability of gift card malls and other expanded uses are making gift cards even more popular and versatile. Comdata Stored Value Solutions recently conducted its fifth annual survey of gift card purchases by adults providing insights into the upcoming holiday retail season.

  • For the 2007 season the average gift card purchaser expects to spend $203 on holiday gift cards, up from $186 in 2006.
  • The average amount per card increased from $46 in 2006 to $53 in 2007.
  • 38% of those surveyed who have never purchased a gift card are very or somewhat likely to purchase gifts cards this holiday season, representing an 81% increase in new card users over last year.
  • 53% of card users often or always spend more than the amount originally loaded onto their cards. They are also most likely to redeem their cards over two visits, increasing store traffic and the potential for sales over the value of the card.
  • One in five says they pay retailers to reload their cards. On average, they reload cards with $47, up from $32 in 2006.
  • 85% purchase gift cards because they want the recipient to be able to select their own gift, while 57% don't know what to buy.
  • Department stores are still the most popular place to purchase a card, followed by clothing and book stores, then restaurants.
  • One-half of gift card purchasers are more likely to buy a gift card that comes in a box, with ribbon and tissue, or in a tin.
  • The survey shows that the convenience of gift card malls is clearly a selling point for “lazy,” or “I can’t figure out what to buy you” consumers:

  • Last year, 94% of purchasers bought cards at a specific retail location. In 2007, only 88% prefer a specific location.
  • Last year, 22% made purchases from gift card malls, and this year, that number increases to 27%.
  • The market for children's gift cards is also growing:

  • Approximately one-third of all gift cards purchased last year were purchased for children or teens.
  • 4% of cards purchased were for children under the age of five.
  • Of those who have purchased gift cards for children, 35% are the child's parents, followed by 30% who are aunts or uncles.
  • Hispanics are the demographic utilizing the most Gift Cards:

  • Hispanics received gift cards with the highest average value among all ethnic groups; $71 representing a $33 increase from last year.
  • Hispanics (69%) are most likely to spend more than the value on their cards, making up the difference with their own money.
  • 26% of Hispanic report giving gift cards to children as a budgeting tool.
  • Stores, despite the delay in revenue are going to great lengths to drive gift card sales. Customization is the latest trend for branding and differentiation. Here are a few examples:

  • Macys.com, upload your own photo onto a gift card and include a personalized greeting card for a mere $5 above the value of the card.
  • Bestbuy.com (NYSE:BBY) offers personalized picture gift cards, for $4.50.
  • Starbucks.com has introduced design-your-own gift cards, along with a $4 customization fee.
  • For no additional fee Home Depot (NYSE:HD) a card that doubles as a how-to do-it-yourselfer DVD or one that can be redeemed for a free 20-ounce Coke product.
  • American Eagle (NYSE:AEO) is selling recordable gift cards so you can record a message for the recipient.
  • McDonald's (NYSE:MCD) has teamed with Upromise to offer the chance to earn college savings with every purchase or reload of a gift card.
  • A Consumer Reports survey found the dark side of gift cards. As the travelers check industry has found, an unredeemed card has a beautiful equation. Payment for no service = near 100% profit. The rub for retailers it that they do not get to book any revenue and for quants like me that means scrutinizing efficiency statistics for answers as profitability at these firms will rise if the numbers get big. According to Consumer Reports, the numbers are headed in that very direction.

    A National Retail Federation survey found nearly 90% of shoppers plan to buy two or more gift cards this holiday season.

    The number falling straight to the bottom line is still to be determined but $8 billion (Consumer Reports) in gift cards went unredeemed last year, as nearly a third of survey respondents with unused gift cards simply forgot about them.

    Some conclusions:

  • Gift Cards are more than simply here to stay, they are growing swiftly.
  • Gift Cards delay revenue which could deflate holiday revenue numbers and smooth them out in January and February when most cards are redeemed.
  • Many shoppers will spend more than the face amount of their gift cards making them a real asset for stores and some shoppers will even add money to their cards.
  • Many shoppers never redeem their cards, causing profit without revenue, making firms appear more efficient then their operations achieve.
  • Watch more than revenue this holiday season. Ask management to report separately for gift card sales. Based on revenue alone, Black Friday and Cyber Monday may come later than anticipated, but the bottom line still may improve, and sooner than analysts anticipate.

    Disclosure: Mr. Corn holds no position in any of the securities mentioned.

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