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The economics of unused gift cards

The Hustle | Zachary Crockett | Jan 4, 2020

most requested holiday gifts - The economics of unused gift cardsEvery year, Americans spend billions of dollars on gift cards. But what happens to the money when the cards aren’t redeemed?

The most desired item on wish lists this past holiday season wasn’t a pair of Airpods, a Nintendo Switch, or a Baby Yoda plush toy and not even the realization of the dream of every student "who could be writing my papers".

For the 13th straight year, the present of choice was the gift card.

In 2019, Americans purchased an estimated $171B worth of these plastic cash substitutes, ranging from $500 prepaid Visa cards to grandma’s annual $25 Cheesecake Factory “nibble.”

Gift cards are so popular that they account for 55% of the average shopper’s entire annual gift budget.

In an ideal world, the gift card is a win-win: For the buyer, it’s a hassle-free gifting experience; for the recipient, it’s a cash equivalent that can be used at any store or restaurant

But gift cards aren’t always ideal. Oftentimes, they go unused — whether we lose them, forget we have them, let them expire, or fail to spend the full amount that was gifted.

And when that happens, there’s only one winner: The companies that sell the cards.

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When gift cards go unused

Most people who receive a gift card are quick to put it to use: More than 70% of all gift cards are redeemed within 6 months of purchase, according to one survey.

But after that first 180 days, the rate of use tends to stagnate. At the one year mark, just under 80% of cards are redeemed — and as time passes, they are less and less likely to see the light of day.

At any given time, 10% to 19% of gift card balances remain unredeemed — and around 6% of gift cards are never even used.

These small percentage points add up to big money when you consider that, over the past 10 years, more than $1 trillion in gift cards have been sold.

Between 2005 and 2015 alone, unredeemed gift card balances amounted to an estimated $45.7B. That’s a hell of a lot of Cheesecake Factory dinners!

Why retailers love gift cards

When grandma buys a gift card to The Cheesecake Factory, she exchanges $25 in fungible cash for $25 in-store credit that can be redeemed at a later date.

Big companies like The Cheesecake Factory use what is called accrual accounting, which means that money is tallied not when it is received, but when it is earned. In other words, grandma’s $25 isn’t counted as revenue until the gift card is redeemed.

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Under a 2009 federal law, most gift cards can’t expire for 5 years (and in many states, like California, they can never expire). Companies have to plan for the possibility that gift cards may be redeemed at some point in the distant future — and until then, any unused gift card balances are earmarked as liabilities.

But after a certain amount of time (typically, 6-24 months), the law also permits companies to turn these liabilities into what’s called breakage income.

This is the amount of money from gift cards that the company estimates will never be redeemed. Another way to put it: That’s the amount of money the company is essentially getting for free.

For instance, let’s say you never spend the $25 gift card to The Cheesecake Factory that grandma gave you. Your grandma paid the chain $25 and the chain didn’t have to give you anything in return. It netted $25 at a 100% profit margin.

In 2017, 5 companies banked over $20m in breakage income, according to figures listed in annual reports.

To put this into perspective, here’s what this money could’ve bought the consumers who put their gift card funds to use:

  • Starbucks: $105m = 57m cups of coffee
  • Best Buy: $37m = 148k Smart TVs
  • Home Depot: $34m = 493k cordless drills
  • Outback Steakhouse: $26m = 1.4m 11-oz. sirloin steaks
  • Dunkin’ Donuts: $22m = 22m donuts
  • Chipotle: $4m = 615k burrito bowls

Chipotle’s annual report gives us some insight into how beneficial gift cards can be for big companies: The chain claims that, on average, 4% of its gift cards are never redeemed. That means that the company gets to pocket $1 out of every $25 gift card purchase at virtually no cost.

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Some states, like Delaware and New York, have passed laws that entitle the state to unclaimed property, including gift card money. But by and large, the corporations who issue the cards still get to keep most unused gift card funds.

Despite this, retailers claim they make more money when consumers spend their cards. Here’s why:

  • 75% of people who redeem gift cards end up spending more than the value on their cards (e.g., they’ll use a $50 gift card to make a $100 purchase).
  • On average, shoppers spend $59 more than the value of their gift cards.
  • Shoppers using gift cards are 2.5x more likely to pay full price for an item than a customer paying with cash/credit card.
  • 34% of shoppers say a gift card prompts them to visit a store they otherwise wouldn’t frequent (good for new customer adoption).
  • Gift cards often aren’t redeemed in one trip, prompting shoppers to return multiple times (good for foot traffic metrics).

None of this means that gift cards are an inherently bad gift — especially those that have more general applications (Visa, Amazon, etc.).

But in the eyes of many economists, there is a much more enticing alternative…

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