Gift Cards in a Gloomy Economy: A Losing Bet?

They may not be the most thoughtful presents in the world, but they sure are convenient. Gift cards relieve shoppers of having to find the perfect size, style, and color of any item on a shopping list. They also avoid scenarios where what the buyer views as desirable is antithetical to the receiver’s outlook.

Consequently, consumers spend billions on these small plastic “gifts” each year. The Purdue Retail Institute estimated that U.S. consumers purchased approximately US$40 billion worth of gift cards just during the 2008 holiday season.

However, the ongoing economic downturn has tarnished these shopping aids’ name. Consumers have been saddled with millions of dollars in worthless gift cards as retailers large and small have filed for bankruptcy. With gloomy economic news on the horizon, the question becomes: What does the future hold for these convenient items?

Convenience Is Key

Consumers like the gift card option because it makes gift-giving simpler and more convenient. “Gift cards are often bought as an impulse item, something purchased at the checkout counter before a consumer heads out of the store,” Richard Feinberg told CRM Buyer. Feinberg is a researcher at the Purdue Retail Institute, which studies consumer retail purchasing trends.

In addition, companies have been promoting gift cards more extensively. A growing number of retailers are giving consumers incentives — for example, buy a $20 gift card and get $5 one for yourself.

The availability of gift cards has been expanding. Purdue Retail Institute found that department stores continue to be a popular outlet (40 percent), along with restaurants (30 percent), but in 2008, use spread to new venues such as food stores, supermarkets, gasoline stations and superstores.

$1 Million Stuffed Under Your Socks?

While gift cards have their pluses, they also possess some serious downsides. What happens if your gift card gets tucked away in the bottom of a drawer and is not used, sort of like a winning lottery ticket that you forgot to cash?

A few years ago, K-Mart and Darden Restaurants, which owns eateries like Red Lobster and Olive Garden, put restrictions on gift cards that were not used in a timely manner, in some cases voiding their value and in others reducing it. Consumer advocacy groups petitioned the Federal Trade Commission (FTC) to stop the practice. The government agency sided with the consumer groups and mandated that companies make such practices clear to consumers.

In addition, states moved in to thwart companies from cashing in on consumers’ inattentiveness. Thirty-five states now have laws under which unused gift cards revert to the status of unclaimed property as opposed to cash back to the retailer. Consequently, many retailers abolished the practice of voiding older gift cards.

The Bankruptcy Court Line Grows

The recent wave of major retailers like Circuit City going belly-up raises a question: What happens to a card when a retailer goes bankrupt? If a consumer receives a gift card from a store that is in or near bankruptcy, he or she should use it immediately: Do not sit down, do not go home, just spend it fast, Feinberg said.

The reason is that typically, such cards are worthless. Companies rarely put aside money to pay off gift cards in case their business fails. As a result, gift card holders are forced to figuratively stand in line in bankruptcy court along with lots of other creditors, many of whom are owed more money and have more clout than they do.

Last year, high profile cases involved Bombay Co. and Sharper Image, which filed for bankruptcy protection and left gift card holders with millions of dollars that bankruptcy court typically considers unsecured debt. Consumers Union, which publishes “Consumer Reports,” brought the problems to light. It said that when Sharper Image filed for bankruptcy protection, consumers were saddled with $20 million in unused gift cards and maybe as much as $40 million if one included merchandise certificates and related promotional cards

Initially, Sharper Image said it would not honor the credits. Later, it successfully petitioned the court to allow it to accept gift cards if consumers spent twice the value of the gift card on a single transaction.

In August of 2008, home-furnishing retailer Bombay Co., which closed 388 stores, won approval from a U.S. bankruptcy judge to pay off gift card holders — at the rate of 25 cents on the dollar.

Heading to Washington, D. C. for Help

In September, a coalition of organizations including Consumers Union, Consumers Federation of America, National Consumer Law Center and the advocacy group U.S. PIRG (Public Interest Research Group), asked the FTC to protect shoppers avoid losing money on gift cards when retailers file for bankruptcy. The coalition said retailers should be required to place money from gift card sales in a trust account that would be used to honor the cards if the merchants continued operations under the protection of the bankruptcy court. The government agency is evaluating such a policy but has not set a timeframe for making a decision on such a change.

In the meantime, consumers have choices to make. “Certainly, consumers have felt a little bit less confident about buying gift cards recently, and some are avoiding them altogether,” Richard Giss, a partner at the Los Angeles office of Deloitte Touche Tohmatsu, told CRM Buyer.

Consumers can also become gift card speculators. People can trade, buy and sell gift cards at sites such as Giftcardbuyback.com, Plasticjungle.com, and eBay.

Insurance policies may also help to assuage customer concerns. In select cases, renters and homeowners insurance protects against gift card losses; one caveat is that usually receipts are needed to make a claim. In part due to the bankruptcies ushered in by late 2008, there has been talk about insurance companies or credit card companies offering specific protection to consumers to guard against gift cards losses. Such plans are in the formative rather than formal stage.

Moving into 2009, questions about the economy will continue to lead to concerns about the viability of gift cards. In the meantime, if consumers are worried, their best option may be giving an old fashioned gift: cash.