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Why Retailers Love Gift Cards So Much

By James Sullivan – Jan 13, 2016 at 7:07PM

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Gift cards mean money for the recipient and the store.

Starbucks gift cards. Image source: Starbucks.

Gift cards have been the most requested gift for nine years straight, according to the National Retail Foundation. They are easy to give and easy to use, but the real winners with gift cards are the companies, such as Starbucks (SBUX -0.49%), that offer them. Let's look at some of the ways gift cards are good for businesses.

Time value of money
Money in the hand today is worth more than money in the future. If Starbucks sells $10 million worth of gift cards -- and it sells much more than that -- it receives that whole sum up front. It can use the money for payroll, dividends, investments in new stores, or anything else that it sees fit. At some point it will have to deliver on $10 million in products, but that may be weeks, months, or years in the future. Sometimes the company won't have to deliver goods at all.

Breakage refers to the amount left on a gift card that is never redeemed. A person with a $100 gift card may purchase a $98 item and throw the card away or toss it in a drawer, never to be seen again. When this happens, the retailer delivered $98 of products for $100 in revenue. This helps with margins.

Sometimes a consumer may receive a gift card for something that not wanted or needed. That $25 McDonald's gift card given to the person beginning a strict diet may never get used. That $25 drops almost entirely to Mickey D's bottom line. The ninth annual CEB TowerGroup report on gift cards says unused or expired gift card value has dropped to 1% of total gift card value, thanks partly to legislation regarding fees and expiration dates. The report estimated total 2015 gift card spend to hit $130 billion.

Gift cards are advertising for the retailer. If you've never heard of Texas Roadhouse but receive a $200 gift card at a holiday party, you'll probably find a location and check it out with family and friends. If you enjoy your experience, the restaurant has just acquired a new customer.

Texas Roadhouse gift card. Image source: Company.

Gift cards encourage customers to join loyalty programs as well. If you get a Starbucks gift card, it makes sense to sign up for the rewards program. It prevents loss of value if the physical card is lost, and you can begin to earn rewards toward free drinks and food. People who belong to loyalty programs tend to be more loyal and spend more. This is true from your local sub shop's "buy 12, get one free" offer to Starbucks, which had more than 20 million My Starbucks Rewards members late last year and said that Rewards customers spend three times as much as non-Rewards customers.

For those that sell inexpensive products
A company, like Starbucks, which sells relatively inexpensive products, can benefit from gift cards that have a small amount on them. Someone with $0.72 left on a gift card probably won't have an incentive to buy an iPad, but that person might decide to get a $3 cup of coffee. Standing on a corner and deciding between Starbucks and a competitor, that $0.72 gift card could be the difference between another sale or a missed opportunity.

My Starbucks Rewards Loyalty Program. Image source: Starbucks.

For those that sell expensive products
A business that only sells relatively expensive items can benefit from gift cards in a special way. Imagine a store that sells only high-end musical equipment. If the cheapest guitar is $2,000 and someone receives a $500 gift card, the business is guaranteed either profitable "breakage" or a minimum of $1,500 more revenue.

Starbucks' secret sauce
Starbucks is a wonderful company with dedicated leaders and a compelling business model. It has a lot of growth ahead of it, both domestically and overseas, but its biggest advantage against local competitors is its technology, mobile app, and gift card sales. Gift cards act as advertising, help grow sales, and increase the base for its loyalty program.

Nearly 2.5 million Starbucks gift cards were sold just on Christmas Eve in Canada and the U.S. in 2014 -- with the company estimating that one in seven American adults received a Starbucks Card during the holidays in 2014 and expecting an even better 2015. Last year the company even offered limited quantities of deluxe gift cards, including stainless steel cards embellished with Swarovski crystals that cost $200 (plus tax) and came loaded with $50. The company says that since Starbucks Card launched 15 years ago, more than $25 billion has been loaded on Starbucks Cards in the U.S. and Canada.

There are a lot of reasons to own Starbucks' stock, and its gift card program is a check in the plus column. 

James Sullivan owns shares of SBUX and TXRH. The Motley Fool owns shares of and recommends SBUX. The Motley Fool recommends TXRH. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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