Saturday, February 4, 2012

Coupons vs Gift Cards

I read a Quora question that asked "How do the economics of gift cards compare to coupons for retailers?" Since I've worked a bit in the gift card and payments space* and am super nerdy when it comes to business models and other behavioral incentives,** I wrote a lengthy answer and copy-pasted it below:


From a revenue perspective, it depends on the size of the transaction to which the gift card or coupon is applied. Most gift cards don't change the amount of revenue a retailer receives. That is to say, there is no discount given with the gift card so a $50 gift card represents $50 in revenue to the retailer. The retailer may pay for distribution of the gift card, in the form of a discount to face value, but this is a separate question.*** From an accounting perspective I don't know if the retailer can recognize revenue at the time the gift card is sold or has to wait until it is spent. A coupon cuts into their revenue, as by definition it is a reduction in what the customer would otherwise have paid for the same items.

The above, of course, assumes that the customer would have bought the same items at full price regardless of whether an incentive (gift card or coupon) was offered. There is a lot of research and writing on how gift cards and coupons affect purchasing behavior, but that is beyond the scope of this question. What I have anecdotally observed is that versus gift cards, coupons tend to drive more spend outside of the item on which the coupon is used. I.e. I'm more likely to walk into a store to use a coupon and find myself buying more things than just what the coupon is for than I am to do the same with a gift card. To use one example, if I buy $50 of goods in a store and use a $10 coupon, the coupon will directly reduce revenue to the retailer by $10, but it may have indirectly increased revenue by $40. The real question on the use of coupons and other discounts is not their effect on current-period revenue but their effect on margins and as a customer acquisition tool (see for example AT&T's argument that while it loses money on each iPhone it sells at a discount to what it buys them at, it makes up for that loss by the lifetime value of an iPhone subscriber).

With the gift card in fact I may never spend the full value of the gift card, a phenomenon called breakage which benefits the retailer and is built into the business model of the gift card industry.

Balance Sheet

Coupons do not generally affect the balance sheet. Gift cards on the other hand represent a liability, as their balance is indeed owed to the gift card holders, much like a bank deposit. To continue the bank deposit analogy, it is unlikely that all gift card holders would ask for what is owed to them at once. The exception would be a run on a bank, or in the case of a retailer, fear of a bankruptcy. For this reason retailers whose outstanding gift card liabilities represent a material part of their assets should disclose not only the size of this liability but how quickly they expect it to be redeemed (I don't know if this is actually required by the SEC).

The outstanding liability is one reason that gift cards expire after a certain period. One can imagine an extreme case for an older retailer that if there were no expiry date, the sum of all of the gift cards ever issued that were lost or otherwise not redeemed might end up being more than the rest of the retailer's balance sheet! (the other reason is the breakage component of the gift card business model that is mentioned above)

Which Is Better for the Retailer

The answer to this one, like all good questions, is "it depends." This is really a narrower form of the question "What is a good pricing strategy?"

As Aditya points out, a gift card preserves brand equity better for luxury or higher end brands. On the other hand, for a retailer whose brand positioning includes being low cost - e.g. Walmart, T-Mobile, most grocery stores and pharmacies - a coupon might enhance their image.

For more directly financial advantages to each form of shopping incentive, the answer is completely dependent on the particulars of the campaign, including the size of the coupon/gift card, the nature of the incentive, the item or items being discounted, the distribution channel, etc. For example, a coupon can be for a percentage vs fixed discount; for a particular item vs run of store; have variable expiration dates; have a minimum spend to trigger the coupon (e.g. $10 off your purchase of $100 or more). 


* I helped Univision launch their gift card in addition to broader experience w/ other forms of payments.

** Because isn't that what business models really are - ways of influencing consumer behavior?

*** If you are interested, this is referred to as B2B gift cards - as opposed to B2C that are sold directly by the retailer to the consumer - and includes channels such as employee incentives (when a corporation buys gift cards to give their employees), gift card malls (online or offline locations that offer a wide selection of gift cards in one place. You'll often see these in drug stores near the checkout areas), and scrip (gift cards used as fundraising solutions, wherein community organizations such as schools buys gift cards at a discount and then resell them to community members at face value, collecting the difference as a donation). All of these channels share the characteristic that there is a wholesale buyer of the cards, who receives an appropriate wholesale discount.

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