The proprietary gift card has been a stunning success in recent years, and has increasingly become a ubiquitous product in the offerings of payment card acquirers for their merchants. Gift cards were a highlight in an otherwise mediocre 2006 Christmas shopping season, with the National Retail Federation estimating that over $26 billion in closed-loop gift cards were purchased in that season. In recent research, First Annapolis examined gift card pricing policies of acquirers with respect to small merchants—Visa/MasterCard sales of $10 million or less—and found that pricing structures in 2007 had some important differences from the structures we found through similar research in 2004.
In the single-purpose gift card market, Comdata Corp.’s Stored Value Systems and First Data Corp.’s ValueLink dominate the national merchant market, which is nearly fully penetrated in the sense that almost all major merchants have a program by now. The regional merchant market is much more fragmented and much less penetrated.
In 2004 and again in 2007, First Annapolis studied the overall pricing strategies of acquirers representing 54% and 62% of industry volume, respectively. These acquirers ranged from small non-banks to the largest of acquirer/processors.
In 2004, only 25% of acquirers reported offering single-purpose gift cards to small merchants. By 2007, more than 80% of acquirers indicated they offered gift cards. Of the acquirers that offered gift cards in 2007, approximately two-thirds did so through a reseller arrangement with some other prepaid card issuer or processor. A surprising one-third of acquirers provided gift cards through an in-house capability.
Dissimilar Pricing
Though the broader prepaid market is becoming more complex with the proliferation of product types, functionality, and target markets, the single-purpose gift card requires a fairly simple form of processing capability at the moment. One school of thought is that gift card processing will consolidate aggressively due to the effects of scale economies over time.
The presence of several specialized gift card processors plus the acquirers with in-house programs tend to underscore the argument that there is overcapacity specifically in singlepurpose gift card processing.
Earlier in 2007, First Annapolis completed research measuring the penetration rates of single- purpose gift cards in the U.S. and Canada in four merchant categories: retail, mail order/ telephone order, hotels, and restaurants. This research updated similar research from 2003, and we found a significant increase in penetration of gift card programs in these small-merchant categories: from 2% in 2003 to 28% in 2007. This penetration rate was up significantly in every merchant category we tracked. The rate increased from 6% to 55% in restaurants alone.
Interestingly, the penetration rates differ materially between the U.S. and Canada. Restaurant penetration levels are similar in the two markets, but the other categories show different patterns, no doubt driven by different market developments and competition.
Pricing for large merchants, as with many transaction-processing markets, tends to be highly customized and negotiated, but pricing to small merchants tends to be driven more by policy or list prices. For general Visa/MasterCard transaction processing, acquirers gravitated to similar pricing structures and price points over the last several years. In contrast, gift card pricing for small merchants with these acquirers has a different character as acquirers often operate with dissimilar billing elements and dissimilar price points. The most common pricing line items were monthly management fees, set-up fees, per-card fees, and per-transaction fees.
The price points for monthly fees have fallen since 2004, and a greater proportion of acquirers did not use monthly fees in 2007. The median range for monthly fees charged to merchants was $10 to $15, which was down from $16 to $20 in 2004. More than 60% of acquirers charged $15 or less in 2007, but 32% of acquirers did not use this billing element at all compared with 22% in 2004.
The use of set-up fees has declined since 2004, but the price points for those acquirers that do charge the fees have increased. In addition, the use of set-up fees appears to be correlated with certain sales and marketing strategies. The median set-up fee range was $100 to $200 (up from $50 to $100 in 2004), but 32% of acquirers do not use this fee type, up significantly from 11% in 2004.
Challenging Model
One of the factors influencing this phenomenon is an auto-enrollment strategy at a small number of acquirers that have packaged gift cards into their basic offerings. The acquirer provides a merchant a certain number of gift cards as part of a bundled service at the time the acquirer signs the merchant. These acquirers charge merchants primarily for gift card transactions and as the merchants reorder cards after the initial batch.
In a sense, the gift card becomes a loss leader, but acquirers pursuing this strategy report higher retention levels for merchants with both acquiring and gift cards. These acquirers also report a higher effective penetration of active gift card merchants using auto-enrollment. In other words, auto-enrollment results in a greater proportion of merchants using a gift card program than other sales approaches.
This is essentially the difference between auto-enrollment— effectively a negative-response marketing approach—and opt-in, positive-response sales approaches either at the time of the initial sale or thereafter. Acquirers using autoenrollment tend not to charge set-up fees for small merchants.
The use of per-card fees is very similar to 2004 levels. The median fee per card is unchanged at 25 cents to $1. One-third of acquirers do not use this fee type, which is about the same as in 2004.
By contrast, transaction fees were somewhat more prevalent in 2007 than in 2004. The median transaction fee was 21 to 25 cents, the same as 2004. But 74% of acquirers used this fee in 2007, compared with 67% in 2004. The transaction fee is the billing element where acquirers reported the highest degree of negotiation on pricing; acquirers indicated that approximately 5% of merchants differ from the pricing policy.
The picture that emerges from this research is an industry where merchants are adopting the single-purpose gift card at a significant rate and where, in response, acquirers to varying degrees have made gift cards a central aspect of their offerings. There is not a consensus on the revenue model, however, since acquirers use divergent pricing structures. There is some evidence of price competition, at least at the billing-element level, as certain fees have fallen in prevalence or their median price point has fallen, specifically set-up fees and monthly fees.
These findings are consistent with the overall industry trend toward gift cards becoming a more widespread offering among merchants. The study also underscores the challenging economic model associated with the most basic forms of the prepaid products and the need for acquirers and other providers to investigate value-added prepaid product offerings and distribution models.
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