Gas Rewards Points Give Some Gift Card Issuers Heartburn, But Three Is Greater Than Zero

Two sales boosting strategies – third-partygift card distribution and gas rewards points – have come intoconflict at gift card malls. Savvy consumers are turning to giftcards as a primary currency in order to take advantage of rewardspoints, but some retailers are saying the costs are getting toohigh.

A newsletter devoted to investing and savings, “The FranklinProsperity Report,” recently published a savings tip from one ofits readers that captured the essence of the dilemma facingretailers. Here is the crux of the letter:

“So if I know I’ll be spending $50 at Walmartand $50 at Target for example, I’ll buy those $50 gift cards at thegrocery store and get 400 reward points (a 40-cents-a-gallondiscount at the store’s gas pump) and use the gift cards for mypurchases at Walmart and Target instead of checks, cash, or creditcards. It makes me feel like a really smart shopper!”
Unfortunately, this strategy is making some prepaid issuers andrewards issuers feel like really dumb sellers. The reason for theirlow self-esteem is that they feel like they are giving theirmerchandise away too cheaply. Let’s combine those $50 gift cardsinto a $100 gift card and use a hypothetical situation to discoverwhy.

Imagine that a really smart shopper wants to buy something costing$100 from an electronics store. Being really smart, the shoppergoes to the grocery store and buys a $100 gift card and then takesthat card and redeems it as described. Along the way the ReallySmart Shopper collects a slew of gas points which get used upfilling the tank for the trip to the electronics store.

The math for the RSS is simple – everything is less expensive! Forthe issuer of the card and the retailer supplying the rewards, theequation is more complicated.

The issuer spent, let’s say 5 percent of the face value to get thatcard into distribution, and then it paid another 2 percent of thetransaction to process the gift card. Let’s further pretend thatthe margin on the $100 product is 10 percent. So, when the shopperbuys the item with the gift card bought at the grocery, the salemath goes like this:

$100 Sticker Price
– $90 Cost of Item
– $5 Cost of gift card in distribution
– $2 Cost of processing gift card transaction
Profit = $3 (when it was formerly $10)
For the retailer that sold the card and provided the gas points,there is a similar equation that needs to be worked out between themargin they earn on selling the card and the gas points receivedand used by the Really Smart Shopper.

As simple as this math is, however, it does not tell the wholestory. There are two primary complicating factors that keep thisfrom being an open and shut case.

1. Increased shopping at the Issuer’s Store: Really Smart Shopperslike to get deals. They will go to great lengths to get a bargain -collecting multiple copies of Sunday papers for coupons, signing upfor multiple loyalty programs and promotions, and – mostimportantly – changing where they shop to get a deal. An issuer,then, needs to consider the competitive landscape when evaluatingthe benefits of third-party distribution in places that offerrewards. If buying one store’s gift cards provides gas points andthe item they want to buy, and they can’t get the gas points forgoing to the other store, then the really smart shoppers will buythe gift cards that get them the gas points. So while a thinnermargin is less desirable than a fatter one, any margin is betterthan no margin at all. Or, to put it in context of the equationabove, $3>$0.
2. Over-Spending: All gift card issuers know that when a customerredeems a card, as a rule of thumb, they spend more than the facevalue of the card. Estimates on the average amount of overspendrange from one third to twice the face value of the card. Thismeans that if our RSS makes impulse buys, fails to budgetcorrectly, or justifies additional spend because s/he is savingmoney thanks to gas points, the gift card issuer stands to makeadditional sales. Let’s take another look at that equation.

So, beginning again with a $100 sticker price:

– $90 Cost of Item
– $5 Cost of gift card in distribution
– $2 Cost of processing gift card transaction
Profit = $3 (when it was formerly $10)
But now we need to add a second half to the total purchase. For thesake of discussion, let’s hold the margin steady at 10% andpresume, conservatively that the over-spend is half the face valueof the original purchase.

So now, we have a $50 sticker price:
– $45 cost of the item
– No transaction cost (assuming best case scenario of consumerpaying in cash)
Profit = $5
Putting the two together, we get a total profit of $8, with overhalf of that at the originally desired margin and the balance beingfunds likely won from a competitor.

This analysis just accounts for those Really Smart Shoppers who arebuying the cards for self-use, not those who buy them as gifts andtherefore cause new customers or incremental shops to come intoissuers’ stores.

The other item missing from this analysis is the qualitative piece.What is the value of having the brand in the card mall? What is thevalue of having the brand associated with getting a good deal? Doeshaving a connection in customers’ minds with getting a deal on gaslead them to think of the issuer as a place where they can get agood deal on other things? Does it lead to increased shopping andword of mouth recommendations? These are complicated questions thatcannot be answered simply, but they need to be part of theanalysis.

As issuers think about distribution strategies for their giftcards, they need together as much data as possible about thepurchase and redemption of their cards. They also need to take timeto understand the customer’s behavior. Once they have theinformation in hand, they can make an informed decision about thevalue of various channels.