Sunday, February 7, 2010

Profit at the Expense of the Consumer, Part I: Gift Cards

Gift cards have become increasingly popular with consumers in recent years, and for good reason. Say you are looking for a gift for a friend. You know she loves music, and you know what kind of music she likes, but if she really likes an artist she may have already bought most of his albums for herself. That makes it hard to select the right gift. If you buy her a gift card, she can choose for herself, and she always gets the right gift. In a culture such as ours that frowns upon giving cash, gift cards are a good option, both for the giver and the recipient.

Gift cards are popular with merchants for an entirely different reason: about 10% them are never redeemed. Best Buy sells a $100 gift card for $100. Seemingly, there is not profit on that transaction, just a small cost in creating and handling the card. But on average, $10 of that card will never be redeemed. That money does not get forfeited to the State, nor donated to charity. Rather, it is nearly pure profit for Best Buy; a plastic card sold for $10. The business of selling gift cards is less risky and more profitable than selling televisions, computers and cell phones.

Gift cards are only profitable because consumers make mistakes. Consumers buy cards that they do not need, they lose the card or just put it in a drawer and forget about it. If everyone cashed in their gift cards, the business model would not work. It is a business designed to take advantage of people's mistakes; no mistakes, no profit.

Compare that with the ordinary business of Best Buy, which involves selling consumer electronics. Certainly, Best Buy could increase its profits by selling shoddy or overpriced goods, or by misleading or otherwise cheating customers. But none of those things are necessary in order to make money as an electronics goods store. On the contrary, at its core, the business of selling electronic goods is based on the principle of selling consumers what they want and making a profit at the same time: a win-win business model.

No, I do not think gift cards are the devil, or that they should be banned. But, consumers should be aware of what is going on. And, when you buy a gift card, you are buying a very high profit item and you should expect to get a little something in return. For example, Peet's Coffee gives a dollar off for every $20 added to a Peet's card. That makes sense; the consumers share in the windfall profits generated by the gift card business.

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