By  on December 8, 2004

NEW YORK — Prepaid gift cards threaten to dethrone apparel as the number-one gift choice this holiday season and in the process are raising questions about the impact on point-of-sale operations and merchandising readiness.

“I am not sure retailers’ systems are positioned against the ‘January Phenomenon,’” said Deloitte’s Tara Weiner, in reference to the post-holiday store traffic surge expected when gift cards are redeemed in greater numbers than ever. “The transformation of January has significant supply chain considerations,” she added.

A recent Deloitte survey of nearly 16,000 consumers found that gift cards will edge out apparel as the number-one gift choice for the first time this year, said Weiner, who is vice chairman, national managing partner of the consultancy’s Consumer Business Industries division. In 2003, gift cards were the number-three gift choice (60 percent) behind number two, CDs/DVDs (62 percent) and front-runner, apparel (70 percent).

U.S. sales of prepaid gift cards are expected to jump 22 percent this year to more than $55 billion, according to TowerGroup, a financial services research company now owned by a division of MasterCard International. The momentum comes on the heels of a 50 percent sales spike in 2003, the banner year for gift cards until now.

Gift card redemption is a double-edged sword for retailers. On the one hand, it dampens same-store sales growth in December when the cards are bought, since the sales aren’t actually booked until the cards are redeemed. But gift-card redemptions can substantially boost retailers’ comp sales in January, generally a more difficult month for stores.

As a result, stores should resist moving into clearance mode and be ready with fresh, full-price merchandise to maximize profits, Weiner said. However, she is skeptical that retailers are prepared to exploit the opportunity. “I don’t believe the supply chain, merchandising and other systems have been set up for this,” growing opportunity to cash in on sales in January, she said.

“It’s probably much too late this year to think about that,” acknowledged one apparel retailer who requested anonymity, “but we may want to look into it for next season.”

Another executive, a vice president of planning for an East Coast apparel chain, said his company recognized the trend taking shape last year but was unable to respond in time. “This year,” he said, “we are in a position to capitalize on this.” His company is linking gift card redemption to its loyalty card program and stores will be showing what he calls “January freshness,” new colors and fashions, “as opposed to markdown styles.”Neiman Marcus Group will be ready for the January jolt, said Phillip Maxwell, senior vice president and chief information officer at Neiman Marcus Group. “Even when we have our sales,” he said, “we try to have a pretty good supply of full price, too. We are always conscious of full-price selling.”

Sears, Roebuck & Co. is seizing on the growing popularity of gift cards with the introduction of its store-branded photo frame gift cards, now available in increments of $5 to $500. The new gift cards feature a translucent plastic sleeve into which the gift-giver can insert an image, either of a suggested gift or a family photo, said Rochelle Mangold, a Sears spokeswoman. She said personalizing a gift card in this way shows the recipient that thought was put into the idea.

“I think it’s a great idea,” said John Gould, director of consumer lending and bank cards at TowerGroup. “Anything you can do to make it easy for the buyer to personalize this without going through a big effort plays into the whole [time-pressed, convenience-oriented] environment we are in now. I especially like the idea of a family photo” used to personalize a gift card.

Weiner said Deloitte’s holiday survey research indicates 60 percent of consumers will continue to do some gift buying after Dec. 25, and that group will spend 21 percent of their total gift budget, on average, during the post-holiday period. “January is the story,” she added.

Store-branded prepaid gift cards that can only be redeemed at the retailer issuing the card outsold universally accepted third-party gift cards by a 14-to-1 margin last year, according to TowerGroup. However, the gap is closing. This year, third-party gift cards will account for 13 percent of gift card sales, and in 2007, third-party cards are projected to represent 35 percent of U.S. gift card sales.

Retailers welcome the rising popularity of third-party gift cards branded by MasterCard, Visa, American Express and Discover because of the store traffic generated. However, the growth of those cards has exposed a snag at the point-of-sale that retailers do not encounter with their own store-branded gift cards. Valid third-party gift cards are rejected at checkout when the card balance is less than merchandise purchased.Mallory Duncan, senior vice president and general counsel of the National Retail Federation, said, “We have heard a fair amount of grumbling on this issue [from retailers]. The third-party card issuers are not looking at it from a customer perspective. You may think you have $50 [value on a card] but there may be only $49 remaining. If you try and buy a $50 item, that card is declined and there is no explanation to the customer.”

The frequency with which gift cards are being rejected is a mystery, said Mike Hoffman, director of information systems at the Big 5 Sporting Goods chain, because retailers’ systems cannot distinguish between transactional activity of third-party gift cards and that of credit cards. Hoffman said if retailers had visibility into the available balance on gift cards, cashiers could process a “split tender,” where part of a purchase is covered by a gift card’s stored value and the remainder paid in cash or credit card.

Representatives from Discover, MasterCard and Visa said retailers have brought this issue to their attention; however, only Visa has developed a solution for retailers to view gift-card balances at the point-of-sale.

“We have heard from some merchants about the issue and that is one of the reasons why we have gone forward and introduced this point-of-sale balance inquiry service,” said Seth Eisen, a VISA spokesman. Eisen said he was aware of just one retailer using that service, consumer electronics chain Best Buy.

Hoffman said his company is working with Visa to implement Visa’s point-of-sale balance inquiry solution, but it cannot go live in time for the holidays for fear of disrupting point-of-sale operations.

Although Visa is not charging a fee for the solution, implementation requires system upgrades at a retailer’s expense. Hoffman said Big 5 Sporting Goods has already spent $10,000 to $20,000 for the necessary POS software modifications and that’s in addition to the cost of internal resources.

Hoffman characterized the problem as “annoying, like sand in your shoe at the beach,” and said he could not determine if sales at the $709 million Big 5 Sporting Goods suffered as a result. “It may not be about losing sales,” he said. “That may happen. It is an unknown.”Cy Young, director of store systems at Burlington Coat Factory, agreed. “The biggest issue,” Young said, “is the authorization transaction does not have in it any way to indicate a partial OK,” a function that is built into store-branded gift cards and that would prompt a cashier to process a split tender. Not all retailers’ systems are equipped to process split tenders, however.

Third-party gift card holders can check their available balances online and through toll-free numbers, but retailers say that’s not good enough. “This is an unnecessary impediment to smooth customer relations,” NRF’s Duncan said.

Gregory Papajohn, a spokesman for Mastercard International, said Mastercard has considered offering a service similar to Visa’s POS balance inquiry for gift cards, but has not done so. “The implementation would require merchants and financial institutions to put in place an infrastructure that allows for this capacity,” he said. “Today it is rare this capacity exists. It is not because it is not technologically possible; it is more because of discussions that need to take place between merchants, financial institutions and Mastercard.”

In addition, Papajohn said there are privacy and fraud concerns that would need to be addressed before offering such a service.

“Point-of-sale declines are not good business for financial institutions or the merchant,” he added. “Historically, this has been addressed through cardholder education,” that is, the consumer is responsible for knowing his or her own credit limit.

Big 5’s Hoffman understands that argument from a historical perspective, but consumers using these cards just want them to work. “The onus is supposed to be on the customer: Make sure you know your balance and if you don’t know your balance, call to find out. But, if you hand a 12-year-old child a gift card, they are not likely to record that very well.”

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