Incremental Value of Gift Cards

The following is from the March 2008 Drilling Down Newsletter.  Got a question about Customer Measurement, Management, Valuation, Retention, Loyalty, Defection?  Just ask your question.  Also, feel free to leave a comment. 

Want to see the answers to previous questions?  The pre-blog newsletter archives are here.

Q: I found your web site through a Google search on “incremental business” and “gift cards”– but, then again, you probably already know that.  Didn’t find anything specific to “gift cards” on your site, but I’m wondering your opinion of them as CRM tools?

A:  Well, as I’m sure you know, they can be used in lots of different ways.  From an incremental perspective, some approaches are not so profitable and others quite profitable.

Q:  My quest at the moment is to try to help a client “prove” the incrementality of the business produced through gift cards and what avenues of sale might be more profitable than others.  Is there a correlation to this  quest and information in your book, i.e., marketing model versus financial model, success based not on “response” but on “profit” of the program?

A:  That’s pretty much what the entire book is about – how do you set up, test, and measure these kinds of ideas? The marketing model IS the financial model, from my perspective.

Q:  By the way, I’m not the only one pondering this in my industry.  Might be a topic you want to explore in your future endeavors which would be of interest to a host of us.

A:  OK, let’s do some of that.  My answers to e-mails like this frequently become newsletter or blog material (and I won’t reveal who asked the question), so perhaps I can both help you and get some writing done!

From a broad perspective, I don’t think there is any way to know the answer to your question without testing using control groups, and the ability of the client to execute on that idea can be limited if they are a mass retailer.  Plus, you have not told me anything about your client or how they promote the cards.  So we probably have to speculate based on what we know about behavior in general from other sources – loyalty programs and so forth.

In my mind, there’s no question that some portion of the gift card business is incremental.

You start with the breakage – cards not ever redeemed.  If I give a gift card to someone who doesn’t use it – $8 billion in gift card sales last year are in this bucket – then as the retailer ISSUER (as opposed to the gift card seller) I have to be in the black on it, from an operational  perspective.  I can’t see any way there’s no incremental profit in that idea.  Incremental SALES, maybe not, but profits?  Have to be there, industry as a whole.

In case the above is not clear, the issuer would be where the card is redeemed.  Originally this point of clarification would not be required but as you know, now there are lots of stores that sell gift cards from other retailers!  Whether that kind of operation is incremental to the SELLER of the card is a merchandising issue, but I’m pretty sure it is incremental to the ISSUER – the store where the card is to be redeemed – based on the industry breakage.

So, if your client is a retailer, an ISSUER that sells their own cards, either through their own store or other stores, than I’m pretty sure there is incremental business there. If they are a seller of other store’s cards, or a processor of some kind, then I’m not sure.

But let’s say 100% of cards are redeemed.  Now it’s a little more tricky, you have to look at the incremental cost of the cards / processing versus the “float” on the money.  This is a pretty simple equation.  The costs are whatever premium may be charged for the creation / processing of the cards versus the interest on the money taken in from the sale of the cards.

For example, if the average “days to redemption” of a card is 90 days, and the average value of a card is $100, and the interest I can get on that $100 is 4%, then I make $1 ($100 x 4% / 1/4 of a year) for every $100 card I sell just on the “float”.  If the incremental costs (say, versus a regular credit card transaction) to issue and redeem this card is less than $1, then as the Issuing retailer I am making the difference as incremental profit – even if there is 100% redemption, which for sure is not the case.

Now, if the retailer is doing something else with these cards – using them as rewards, store of value, etc. – the story could be different.  For example, “buy $100 worth of merchandise and we will give you a $5 gift card” or “redeem your loyalty points for a gift card”.

That’s a different story, now the card is not a “product” it’s a transactional device / store of value and that changes the dynamics.  In this case, the card is no different than issuing coupons and you get into problems because these kinds of promotions tend to attract best customers, and their purchases using the card may not be incremental.

As far as incremental profit goes, now you stand a good chance of being in the hole, at least with the best customer segment.   And since frequently the volume of losses in this “best” segment for promotions like this will dwarf any gains from these promotions on any other segments, you end up in the hole with incremental profit.

Put another way, the best, most engaged customers are highly likely to purchase anyway and giving them a discount changes nothing about their spend, they simply buy the same amount at a discount.  This aggregate discount is usually greater than the aggregate incremental profit on not-so-best customers, so the entire promotion operates at a loss.

The good news is this: the actual incremental profit of programs like these is simpler to measure, because you have all the transactional data and you can control / put parameters around the issuance.  Typically in a scenario like this you would  set issuance rules that threshold above the average spend rate of the customer segment.

So, for example, let’s say the average monthly spend of a best customer is $80 or $960 a year. The correct promotion then looks like this: buy $100 worth of merchandise **this month** and we will give you a $5 gift card.  Hopefully, at minimum you would see a total spend of $980 that year – $20 more than average.  You would be on your way to incremental profits at this point, depending on what margins are in the business.

What you *do not* want to see is the customer spend $100 during the promo month and then spend $60 the month after, which is a typical thing that happens with best customers.  This is a sign you are not driving incremental sales, you are simply moving the existing spend around and giving up $5 in profit as you do it.  Not good.

For more on setting up these kinds of tests and measuring these types of effects, see this article.  Hope that gives you – and the rest of your industry – a starting place!

(Follow-up Question)

Q:  You have however validated my thinking that we can’t measure incrementality without creating control groups.  In asking the question, I was second guessing myself and wondering if there was something I was missing.  I think to some degree we can use existing sales data to measure uplift (either over the value of the card itself or over the client’s average transaction) for the current purpose which would move them to the next phase of specifically measuring incrementality.  For this, I’m sure your book will be helpful and I shall use it accordingly.

A:  Yes. Along those lines, in the “threshold” example, we have seen a $10 off $50 generate an average sale of $120.  Given the customer segment had an average purchase of $45 – hence the $10 off $50 – it would be safe to assume there’s some incremental in there, and long as the customer segment spend doesn’t tank by $70 or so over the next several months, you could assume pretty safely you have incremental profit.

“Proof” is another thing, but if you’re dealing with pure retail, proof is a matter of degree, you take what you can get.

(Follow-up Question)

Q:  P.S. Your point about the promotional use of cards, this company has separate business units which are their own P&L centers.  So, while the promotional use of cards might be incremental to the business unit which runs gift cards, it’s only incremental to the company to the degree that it produced new business or “stole” it from a competitor less than value of the gift cards it took to produce.  Again, greatly value your time and input.

A:  Yes, well, that’s quite another matter, and gift cards are not the “root cause”, if you know what I mean.  There is a long tradition of “intra-company sales theft” between divisions that seemingly goes unchecked.  A lot of direct marketing companies are sensitive to this issue, but that’s because they can measure the effects,  Even then, there are only a few who have really unlocked the riddle of how much / where / when it happens, especially relative to web sites versus catalogs and retail stores. Segmentation of Recent customer buying patterns is the key.

Anyway, this is a “governance” question (strategic), not a marketing / gift card question (tactical).  If a company really wants to measure channibalization, they can by setting up specific tests and using control groups to measure outcomes.

The question is, do they really want to know the answer?

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