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Looking in the Mouth of the Gift Card

Consumers love them, and so do companies. But finance departments face plenty of challenges in managing them well.
Russ Banham, CFO Magazine
September 1, 2011

Gift cards are the gift of the era. Last year, shoppers spent nearly $25 billion on cards of all kinds, from traditional stored value and promotional cards to loyalty, rebate, electronic, and e-cards. In fact, forget Zhu Zhu Pets or Tickle Me Elmo: gift cards have been the most popular holiday gift request the past four years running, according to the National Retail Foundation, which estimates that more than 75% of shoppers purchased one or more gift cards last Christmas.

In just a few years, the gift-card industry has become a rapidly expanding financial universe in which banks, credit-card companies, retailers, and makers of consumer goods continually enhance their strategies for this lucrative market. The industry has even spawned a secondary market in which recipients can sell, swap, and buy one another's cards. And it has given rise to a growing field of third-party processors to manage the cards' budding legal, regulatory, and accounting issues.

That last facet of the gift-card world is quickly becoming a concern for CFOs. Take, for example, the complex liabilities that emerge when a card expires without being redeemed by the consumer. Certain cash-strapped states say the unused balances (or "breakage," in industry parlance) are unclaimed property due them under state escheatment laws. Given that an estimated 10% to 20% of the sums spent on cards each year is breakage, it's no wonder the states are interested.

"Some states, like Arizona and Maryland, have either fully or partially exempted gift cards as a property subject to escheatment laws," says Giles Sutton, tax partner in accounting firm Grant Thornton's Dallas office. "But many others, like New York and New Jersey, are intensifying their pursuit of dormant cards to boost revenue, which is seen as less offensive than a tax increase."

Then there are the state tax consequences. For a state to tax an entity selling a gift card, the entity must have nexus — a physical or economic presence establishing jurisdiction in that state. This gets problematic when the issuer is an online business with no brick-and-mortar stores, like Amazon.com. But, says Sutton, "if a gift card is on a kiosk, does the ownership of a card on that kiosk, without any further activities by the gift-card issuer in that state, establish a physical presence for the issuer? In some states this is enough to establish nexus, making compliance intricate."

Nonetheless, issuers insist that gift cards are worth the headaches. They "are a way for us to strengthen our brand, increase interactions with consumers, drive traffic to our Website, and encourage consumers to spend beyond the limits on the cards," says Tracey Swain, director of corporate finance at TaylorMade Adidas Golf, a maker of golf clothes and equipment. Like other companies that issue gift cards, TaylorMade started out by offering paper gift certificates. Three years ago, it began to offer standard gift cards to golf retailers (that could be given away as golf-tournament prizes, for example).

Golf highlights one major appeal of gift cards — they can be personal, yet pragmatic. "You know your dad loves golf; you may even know the brand of golf club he prefers. But he's going to want to select his own clubs," says Samuel Cochrane, controller for Golf Town, a 59-store chain that offers a variety of gift-card options, including some that can be reloaded with cash.

Be Loyal to Your Burrito
Boloco, a chain of burrito restaurants, also offers a gift card that can double as a loyalty card, and which can be reloaded with cash via the company's Website. "It's not a credit card — it can be used only at our restaurants or on our Website to buy Boloco merchandise," says Patrick Renna, CFO of the company, which generates $18 million a year in revenues.

The cards have become so popular that "you almost never have to use cash here," Renna boasts. "People just keep reloading their cards with money and using them again and again." The cards also give Boloco the chance to reach out to those customers again and again, with various promotions.

That's a nice marketing edge, but Renna cites "customer frequency" as the number-one benefit of Boloco's gift cards. "Retaining customers costs a lot less than generating new customers," he explains. "People with registered Boloco cards also spend more money per visit than someone without a card, probably because they're apt to try new dishes."

What's next? "We've just begun to tap social media, so that if a customer has a complaint, the waiter can instantly add points to that person's card and tweet, 'Sorry about your last visit — come by and try us again for free,'" says Renna.

Indeed, gift-giving seems to be just a small part of what these cards can do as they morph into their own form of currency. Young America Corp., for example, works with retailers and consumer packaged-goods makers to provide rebates as branded prepaid cards. "A rebate used to be cash you received at the point of sale, but there's greater value in putting a rebate on a prepaid card with your company's logo," says Mark Lockwood, senior vice president of payment services at the company. "Even though the rebate can be spent anywhere, our research indicates that at least 10% to 15% of it will be spent back at the store or on the company's products. The logo drives purchasing behavior."


Michael Chittaro, head of Visa's corporate prepaid-products group, notes that "given that estimates of rebate promotions are about $6 billion a year, the economics of branded cards are huge."

Another variation on this theme is being played by Coinstar, provider of self-service coin-counting machines often found at supermarkets and other retail locations. Typically, consumers crack open their piggy banks and pour the contents into the machines and receive a voucher for cash or in-store credit in return, for which Coinstar charges a 9.8% fee. A few years ago, it came up with an alternative approach: give coin redeemers the option of receiving gift cards from partners like iTunes, Amazon.com, Lowe's, and Banana Republic, and pay no fee to Coinstar. "We're indifferent as to who pays us — the consumer for taking cash or the retailer for the gift card," says Scott Di Valerio, CFO of Coinstar. "Although the lion's share of consumers opt for the cash back, we are attracting the fee-avoider segment of the consumer population."

Back-End Burdens
These and other envelope-pushing gift-card strategies are evolving faster than ways to tax, regulate, and account for them. Larger companies, such as Visa, Coinstar, and Golf Town, have sophisticated legal, finance, and marketing departments that are able to issue cards, track purchases and unused balances, and cope with state and federal compliance issues. Smaller outfits like Boloco leave the workload to service firms like Paytronix, Card Compliant, and others. These companies can sift through "whether a purchase on a combined value/promo card should be treated as a discount or a tender," as Scott Walters, a Paytronix sales representative, puts it. "Restaurants that try to do this on their own often mark a sale as revenue when it is an expense [a situation where points are used to make a purchase]."

Mike Loritz, a shareholder at accounting firm Mayer Hoffman McCann, says the third-party providers serve a necessary purpose. "If I were issuing these cards, my biggest concern would be tracking the record-keeping requirements," he explains. "New federal revenue-recognition standards, determining what is and isn't tax or a liability under GAAP and tax rules, and then staying compliant with the escheatment laws require near-full-time attention. You need three sets of books — GAAP books, tax books, and what I'll call legal books."

For a card issuer that does not impose expiration dates or dormancy fees (or, in some states, is prohibited from doing so), Loritz says it now has a "liability that lives on forever. You need to derecognize this liability at some point and take it to income so it no longer appears on the GAAP books. But, there are various tax laws [that dictate] when you can and can't do this. And if someone redeems the card 10 years from now, you still need to have the cash in a restricted account or a trust account. Otherwise, you'll need operating cash available to relieve the liability."

Reputation also comes into play, say some CFOs. While many cards will never be redeemed, for those consumers who do suddenly find an old card, Boloco and others pledge to honor it, no matter the true total cost. "We're a consumer-oriented company; we'd honor them," Renna says.

The Limits of the Law
Seeking to provide some clarity to gift-card purveyors, the Federal Reserve implemented new rules in August 2010, driven by the Credit Card Accountability Responsibility and Disclosure Act of 2009. The Fed beefed up disclosure requirements and put restrictions on dormancy, inactivity, and service fees, which can kick in only after a consumer has not used a gift card for at least a year. It also generally prohibits the sale or issuance of gift cards if they have an expiration date of less than five years.

That legislation was aimed primarily at improving consumer protections, but it competes with a morass of conflicting state laws. "Because the federal act does not preempt state law unless the state law is inferior [to the federal rules] insofar as protecting the consumer, companies must still analyze on a state-by-state basis whether or not their gift-card programs are compliant," says Carol Osborne, corporate department chair for Denver-based law firm Holme Roberts & Owen. "The challenge for CFOs is that they think they have set up a program correctly, but then the marketing group tweaks it here and there. Each change might have the right business outcomes, but they need to be vetted by finance."

Osborne has two recommendations. "The biggest mistake a company can make is not setting up the program correctly," she says. "You need to have an experienced law firm or compliance consultancy help you to achieve the marketing benefits you want without any compliance issues. Then it is up to finance to maintain a line of communication with marketing, which really drives these programs, to ensure they understand that gift cards aren't just about making customers happy and driving more consumer interactions; there are substantial compliance risks as well." Osborne says the cost of designing a program with counsel can be less than $10,000.

Grant Thornton's Sutton predicts an increase in both the pros and cons: the integration of gift-card strategies will boost sales for issuers while also causing more back-office headaches. "I've heard of $25 cards that buy $50 in merchandise, and even coupons that are blended into gift cards," he says. "Just imagine the [accounting] implications."


Sutton attended the National Retail Federation trade show earlier this year and says the number of technology firms outstripped actual retailers. "Retail is now 90% technology," he says. "The future is gift cards wedded to mobile apps."

That may help the bottom line, but also seems likely to make gift cards even more complex to manage.

Russ Banham is a contributing editor of CFO.


Gift-Card Power Plays

Consumers often wish they had more control over how to use gift cards; some retailers wish consumers had less. These days, both parties have options for getting what they want.

For the consumer who wishes the cards were more like cash, there are a number of new Web-based services, including Swapopolis, Plastic Jungle, and Swapagift, that aim to do just that. "We're all looking to get across to people that they can turn their unwanted gift cards into wanted gift cards, cash, or donations to their favorite charity, while enabling them to stretch their shopping dollars and buy these gift cards at a discount," says Swapopolis founder and chief swap officer Sean Snyder.

Swapopolis offers plenty of flexibility to gift-card holders. Although it recently phased out an eBay-like auction process, it does allow consumers to swap cards by selling them on the site and using the proceeds to buy another card, or they can sell gift cards outright to another user, directly to Swapopolis, or donate cards to charity.

Meanwhile, merchants long for a little less fungibility. Enter a company called StoreFinancial, which offers shopping centers, malls, and other clients with groups of unaffiliated merchants a way to restrict gift-card redemptions to only that location. The card can be redeemed at any store in a given shopping center, for example, but not at the same store in another center. "You can use it at the Gap in one mall, but not at another Gap down the street," says StoreFinancial CEO Jeffrey Brown.

Consumers still have plenty of flexibility, the argument goes, because they can use the card at dozens of stores in a given client site. The benefit for the center is what Brown calls "lift" — the ability to bring people into a shopping area through promotional means.

Where this all gets a bit complex is at the back end. StoreFinancial partners with Bank of America, UMB, and Peoples Trust, which issue the cards and take a cut, as do the shopping center and StoreFinancial. "We manage and settle the monies, and provide the accounting and pooling of funds," says Brown. The company also provides reporting and other back-office support. — R.B.




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