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Gift Cards: A Holiday Grinch?

'Tis the season to be jolly -- provided you aren't a retailer stressed by what could be the worst holiday sales season in five years. Inflationary pressures, lingering credit woes, and housing weakness have consumers spreading a little less cheer this year. But recessionary conditions aren't the only reason I'm pessimistic about upcoming holiday sales. The growing trend of retail gift cards may have retailers singing "Blue Christmas" this holiday season.

No wrapping paper needed
In prior years, parents wrestled in toy-store aisles for Tickle Me Elmos, or camped out for Sony PlayStation 3 consoles. But this year, debt-laden consumers face rising food and fuel costs. That's prompted retailers like Wal-Mart (NYSE: WMT  ) to slash prices and focus on value-oriented strategies, rather than hyping "must-have" products. With the exception of the lower-priced Apple iPhone, this year's lack of hot items may lead shoppers toward gift cards instead.

According to the National Retail Federation, U.S. gift card sales could rise as much as 6% to $26.3 billion during the holidays. Consumer Reports found that 62% of consumers are planning to purchase gift cards this year. Swapping tiny cards for bulky big-ticket gifts could leave more space beneath the tree, but it might also have retailers ringing in a very unhappy new year.

Plastic cards transforming retail
At first glance, gift cards appear to benefit everyone. Shoppers face less stress and hassle over finding the perfect gift. And retailers can essentially earn free cash from unused gift cards. More than $8 billion in cards remain unredeemed from last year, and Home Depot (NYSE: HD  ) and Best Buy (NYSE: BBY  ) both added nearly $43 million to their bottom lines last year from unused cards. Better yet, some shoppers end up spending more than the amount of their gift card.

On the other hand, gift cards can ultimately reduce profitability. Retailers know they can mark up the price of goods before the end of the year, since shoppers need to purchase items before the big gift-giving days arrive. After the holidays, leftover inventory is deeply discounted to clear shelves for new spring merchandise.

When shoppers buy gift cards, products aren't actually purchased, and revenue isn't accounted for, until after the holidays. Thus, gift cards encourage shoppers to purchase lower-margin items, rather than the full-priced goods they would have bought a few weeks before.

Additionally, shoppers who walk into American Eagle (NYSE: AEO  ) and browse for gifts are more likely to purchase "me too" items for themselves. These impulse transactions can account for 25% of holiday sales, but this year, they're expected to decline. Consumers are more likely to buy gift cards at the front of the store and immediately exit, rather than sticking around to spend more money.

It's beginning to look like Christmas ... in January
Consumer spending accounts for approximately two-thirds of our GDP, and many retailers earn 50% or more of their revenue from November and December sales. Needless to say, retailers depend heavily on these months.

But shopping patterns we once saw in December could now shift to January. This year, I think we may see more retailers delaying post-holiday sales to better capture full-priced purchases from gift-card recipients.

It'll be harder to tell how adverse economic conditions will affect the holiday shopping season, since fourth-quarter results will reflect cash received from gift cards as a liability. Fools shouldn't fret over this; that cash will eventually be recorded as revenue when the gift cards are redeemed. But I do think Fools should monitor margin trends to assess just how merry and profitable this holiday season turns out for retailers.

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