The Economics of Gift Cards

Have you wondered what is common among single-use appliances, cookbooks, and gift cards? Yes, they often go unutilised. They probably gather dust and take some place in your closet.

Gift cards, both open-loop and closed-loop, are a convenient and suitable substitute for making payments. They act as a medium of exchange and store of value. Open-loop gift cards like American Express can be claimed anywhere where that brand of card is accepted whereas a closed-loop card can be redeemed only at the retailers like Amazon issuing the card. Companies and banks issue gift cards to generate brand loyalty, to boost foot traffic and to drive sales. During festivals like Diwali, Christmas, etc, they are gifted by employers to employees.

Source: CartoonStock
Source: Reddit

However, did you know that this negligence of letting the gift cards gather dust helps the retailers generate revenue in some countries? According to the Mercator Advisory Group, about 2% to 4% of gift card money goes unused every year. Amazon had unused gift cards worth $ 3.3 billion in 2019(Baldwin, 2020). The retailers as well as the banks can claim the untapped funds as breakage revenue. Breakage revenue is a source of income for the company when it recognizes that a portion of liability will not be claimed by the customers and prepaid services, thereby converting it into income. However, in some countries, the government earns revenue with the unredeemed gift card amounts and not necessarily the retailer/bank. For example, in New York, the unspent gift card sums are turned over to the state government under the abandoned property laws.

In his celebrated paper titled, ‘The Deadweight Loss of Christmas’ published in The American Economic Review, American economist Joel Waldfogel concludes “between a tenth and a third of the value of holiday gifts is destroyed by gift-giving.” In 1992, he approximated the total value of deadweight loss from holiday gifts at $4 billion and $13 billion in the US economy.  To put it simply, while the gift-receiver knows exactly what he would like to receive, the gift-giver does not know. We all have that one dinner set that we received as a gift and we don’t know what to do with it. We can’t wait to pass on to another as a gift. In other words, a part of a gift’s value is destroyed when the recipient does not appreciate it. This is what Waldfogel called a ‘deadweight loss’. It is defined as the loss of economic efficiency for consumers/producers such that the optimal or allocative efficiency is not achieved, in terms of utility. If the recipient’s personal valuation (V) of a gift received is lower than the cost (C) incurred by the giver, then the difference, C−V, represents deadweight loss. Alternately, if the yield of the gift, Y = V/C, is less than one, then it is said that a deadweight loss or excess burden / welfare loss has occurred (Chakravarty, 2017). For example, if you get your friend a Gucci bag worth Rs. 3000 and the value of the gift is around Rs. 2000, then the welfare loss is Rs. 1000.

Source: beyondcostbenefit.wordpress.

Economic theory postulates that cash is often superior to gifts in-kind for maximizing welfare. However, it must be noted that there has been no empirical consensus on whether in-kind gift-giving destroys or creates value. This is why economists generally prefer gifting cash instead of gifts so that the recipient can maximize her/his utility.  Regrettably, gift cards, too, restrict choices for recipients. A research paper by Jennifer Pate Offenberg came to the conclusion that the average welfare loss on gift cards was 15%, considering the difference between the face value of the gift card on eBay and its resale value. She found that recipients were willing to sell their gift cards online for 15 percent less than the original cost of the cards, on average, excluding shipping fees. (Offenberg, 2007)

Gift cards provide a possible market solution to the deadweight loss associated with in-kind gifts. They help eliminate the ickiness of gifting cash. In recent years, gift cards have become highly popular. Gift cards illustrate a compromise between gifts in-kind and cash. Nonetheless, in addition to restricting recipient choice to specific stores, gifting cards frequently impose non-usage fees and expiration dates which erode their value. Another research paper concludes that a deadweight loss for gift cards is more than 14% which is nearly twice the average loss on gifts in-kind (Kristine E. Principea, 2009).

Source: memebase.cheezburger

The global economic slowdown due to COVID-19 has resulted in a changing consumer’s gifting pattern. It has driven  the e-commerce industry along with a rise in the  purchase of gift cards. It’s a trend that is likely to continue for the foreseeable future as digital adoption continues to rise. One of the reasons leading to widespread usage of gift cards is self gifting via gift cards, supported by discounts offered by retailers as well as growth in online shopping.

According to Qwikcilver, a global leader in end-to-end gifting & stored-value solution, the gift card market in India is expected to grow more than threefold in the next four years from about Rs 10,000 crore per year, with non-metros likely to account for 40% of it within two years.

Source: The Economic Times

Studies have shown that we often feel guilty when we buy something to fulfil our desires over necessities and when we see the resources depleting with our naked eye. We also get this feeling when the depletion of our resources – our cash – is visible rather than hidden or deferred, as it generally is with a credit card. Therefore, people tend to spend recklessly on consumption of gift cards. Otherwise, an inactivity fee is liable on certain cards on it’s non usage. Furthermore, inflation reduces the value of the gift card. Either way, retailers or governments generate enormous revenue on the issue of gift cards. To conclude, as consumers it is important to make judicious choices with respect to utilization of gift cards in order to maximise utility and obviate deadweight loss.

“The identity of an individual is essentially a function of her choices, rather than the discovery of an immutable attribute.”

~Amartya Sen 

– Merlin Sebastian (Guest Writer)

SYBA, St. Xavier’s College (Autonomous), Mumbai

Edited by: Saloni Vichare (Editor, Econ Declassified)

 

References:

Baldwin, S. (2020, May 24). Consumers lose $3 billion a year in unspent gift cards. CNBC. https://www.cnbc.com/2020/05/24/how-amazon-and-walmart-make-money-from-unused-gift-cards.html

Chakravarty, M. (2017, December 25). How do economists view Christmas? Mint. https://www.livemint.com/Money/dHCNzJiNNnBN6YqgT2wb1J/How-do-economists-view-Christmas.html

Offenberg, Jennifer, Pate. 2007. “Markets: Gift Cards.” Journal of Economic Perspectives, 21 (2): 227-238.DOI: 10.1257/jep.21.2.227

 Kristine E. Principea, J. G. (2009). Gift-giving and deadweight loss. The Journal of Socio-Economics.

Further Readings:

https://www.pbs.org/newshour/economy/the-economics-of-wasteful-spending-the-dead-weight-loss-of-christmas

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