Ever looked at a gift card and thought, “If I’m paying $25 for this gift card, and it’s worth $25, how is this business making any money?” Obviously gift cards cost money to produce, ship, and maintain. This article covers how gift cards work for a consumer, how businesses make money off of them and the behind-the-scenes technical aspects of an average gift card program. So, how do gift cards work? Before we get started, we’ll need to cover some basic terminology; there are two types of gift cards:and. Open loop cards look like a credit card and are accepted nearly everywhere. If you’ve seen a Visa® gift card before, that’s an example of an open loop gift card. Closed loop cards are cards that only work at one store, or with one corporation’s brands. These are the cards you see for Amazon, Walmart and Target next to the checkout register in grocery stores. They typically have a magnetic stripe on the back and can be swiped just like a credit card, but some are simply scanned like a UPC or manually redeemed.If you have an open loop card, you might be wondering “How does my gift card work?” The answer is that it will behave almost exactly like a credit card; swipe it, the total will be deducted from the balance and you’ll be able to walk out with your purchases. There are some exceptions: for example, fuel purchases. Gas stations will preauthorize cards swiped at the pump for up to $100 or more, since they don’t know what the final purchase price will be and they want to be sure the card can cover the cost. This can cause a gift card with a lower balance to be declined; the solution is to prepay with the card inside first. Finally, some gift cards might not be accepted in certain locations because of special restrictions. For example, most open loop cards are not accepted at an ATM, MoneyGram, or PayPal because these services could be abused to launder money. For closed loop cards, you’re stuck with a particular merchant. However, companies with several brands will often honor gift cards at all of their affiliated brand locations; for example, a Red Lobster gift card can be used at Olive Garden, or any other Darden Group restaurant. If you still can’t find an appealing place to shop, you can always sell your gift card to a gift card exchange: we are one of many sites who buy gift cards . Depending on the card and the site, you can get back as much as 92% of the face value.Businesses earn a return from gift cards in a few different ways; here are three of the most important:
Gift cards let loyal customers refer other potentially like-minded consumers to a business. The consumer who purchases the card will usually evangelize a product, service or brand that a business offers as part of the gift-giving process. The cash on the card provides an incentive for the recipient to visit the issuing merchant and test-drive a company’s product or service. If they don’t like it, the business is only out the cost of producing the card, which they usually can absorb with the margin of the purchased product or service, and the customer is only losing the time it took them to experience the process. This makes a gift card a very low cost, low risk proposition for a business looking to bring in new customers, and a cheap alternative to traditional advertising. Plus, gift cards tend to be very ‘sticky;’ consumers hold on to them for a while and can be reminded about a business every time they open their wallet. They’re almost like miniature billboards.
On open loop cards, most issuers charge a small, up-front fee to cover the cost of production and processing fees. Since closed loop cards live on brand’s internal systems, there are no third party fees to offset, so cards can be sold at face value. The cost of producing the physical cards is made up for in the margins of the product purchased. Additionally, if a gift card is either never or only partially redeemed after a few years from purchase, the business can charge a small fee against the remaining balance. This means a customer who spends under the balance of the card can eventually provide a small return for a business.
Gift cards usually come in neatly rounded balances, like $25, $50, or $100 dollars; however, sales tax typically makes spending exactly $25 hard to do. Most customers will find something else they want and then pay a little more to ensure they spend the entirety of the card in one visit. This means the business earns additional marginal revenue from those customers (typically around 20%).
Open loop cards require a bank, which securely holds the funds, a network, like Visa, that connects all the banks and the merchants, a processor, who processes and routes the transactions, and a seller or manager, like Giftcards.com, who works with the banks to offer the cards and manage customer needs. When an open loop card is purchased, the purchaser determines the denomination of the card. They are then charged that denomination, along with any fees the issuer assesses. The cash is held by the bank, which will disperse it via the processor to the merchants at which the card is eventually used. Once the card is approved, it is produced and mailed to the intended recipient. The recipient will activate the card, typically either by phone or online. Then, they can begin to spend the card’s balance. Whenever the card is swiped, the processor confirms the card has a high enough balance to cover the transaction. It then checks a merchant identifier that tags along with the transaction, to ensure that there are no restrictions on the card being used at the location it was swiped. If everything clears, it will deduct the total of the transaction from the balance from the card and send it to the merchant. Closed loop cards are a little more nuanced. Depending on the merchant, the funds might be held in different locations, but generally they fall under the same domain as the rest of the business’s internal accounting. These cards will only work within the merchants’ systems. Although, that doesn’t mean they can’t be used at different brands; remember the Red Lobster card being used at Olive Garden example? Generally, they operate with a magnetic stripe, like a credit card, although smaller businesses might opt for a card that they can scan in with a bar code. Most modern POS systems are equipped so that any merchant can set-up a closed loop system and process the cards using the same technology, but some systems require a different piece of technology, such as a separate scanner, in order to work. So, there you have it; the ins-and-outs of how gift cards work. For a consumer, gift cards, especially open loop cards, offer an easy and convenient way to shop at businesses they love. There can be some painful moments – having to pay inside at a gas station, for example – but with a little preparation, those snafus can be easily avoided. For businesses, gift cards offer a cost-efficient way to introduce new customers to your products, give customers a “sticky” piece of collateral that will live in their wallets for a long time, and encourage customers to spend a little more when they visit your locations. Gift cards work by cooperation between an issuer, a bank, and a processor, who operate together to process transactions as they come through the card. ~~ Dan Wilkerson
This is just one of the stories from our “I’ve Always Wondered” series, where we tackle all of your questions about the world of business, no matter how big or small. Ever wondered if recycling is worth it? Or how store brands stack up against name brands? Check out more from the series here.
Marketplace listener Mark McCullough from Miami sent in this question:
“Why do stores sell gift cards for other stores at grocery stores and gas stations? What profit do the stores make selling the gift card for another store, and why does that store allow a gift card to be sold at another location? What do they get out of the deal?”
The simple answer is: All sides get something out of deal. The store selling the gift cards gets added foot traffic, and the brands with gift cards that are being sold get more shelf space. Plus, there are third-party brokers who handle the gift card business and negotiate cuts of the sales for everyone. That wall of different gift cards hanging on hooks at the end of a drugstore or grocery story aisle actually has a name: the gift card mall.
At a Target in downtown Los Angeles, John Jenkins and his daughter stood in front of one such display, talking about which option her friend might want for a gift. The Jenkins’ had dozens to choose from — gift cards for iTunes, Starbucks, Netflix, Harley-Davidson, Facebook, plus other retailers and restaurants.
Jenkins said he’s happy the store-within-a-store is there.
“Convenience is definitely it,” he said. “You can do some shopping and get a gift card all at the same time.”
But it wasn’t always like this. Remember when, in order to get a gift certificate, you had to go to that particular store and some poor clerk would fill it out by hand?
Shelley Hunter, a former product analyst who now writes for giftcards.com as the Gift Card Girlfriend, said the shift to plastic actually started with Blockbuster Video.
“They were having all sorts of problems with people making counterfeit gift certificates,” she said. “They were the first company that converted to a plastic gift card that ran through the cash register. It was basically a fraud-prevention measure.”
It worked. All the big brands adopted it.
So how did their different cards end up in a gift card mall like the one John Jenkins was so fond of at Target?
A third-party broker. Two major companies, Blackhawk Networks and InComm, manage and distribute many of these gift card malls in the United States. Teri Llach, chief marketing officer at Blackhawk, said the business took off about 15 years ago and now their business takes care of the whole process.
“We get the cards, produce the cards, process the cards, develop racks that were easy to shop, merchandize those racks,” she said. “We basically come at it with, ‘Grocery store, don’t worry, we’ll take care of everything, and we’ll get this category up and running for you so it’s really a nice value added for your customer.’”
Brands pay Blackhawk to get in the gift card mall, and Blackhawk passes some of that money onto the stores that host the mall.
“Whomever’s card it is, they’ve decided that the extra distribution in the grocery stores is worth them giving up a little bit of their margin on that card,” she said.
Blackhawk also acts as the go-between for the brands and the retailers on what to include or not. In Target, you won’t find an Amazon or Walmart gift card.
But according to Ben Jackson, who follows gift card developments for Mercator Advisory Group, Blackhawk Network didn’t begin as a gift card processor.
“It actually started with phone cards, long distance cards and international calling cards,” he said. “That’s where these companies began.” He said prepaid calling cards gave Blackhawk expertise in processing transactions. “And then they slowly expanded into gift cards,” he said.
Now gift cards are a $100 billion industry.
At a CVS in Los Angeles, customer Marcelina Chavira said she reluctantly picks up a gift card on occasion.
“If you’re in a hurry and you forgot it was someone’s birthday, you can pick up your toilet paper, and pick up your Gatorade, and pick up your gift card for whomever likes whatever specific gift card they have on the stand,” she said.
It’s convenient for the customer. It makes money for all involved, with just the slightest bit of aisle space.
Is it the most ideal, personal gift? Probably not.
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