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Gift cards: Why cash is still better

Consumers don't lose every battle against sneaky fees. In the case of retail store gift card fees, it's time to claim victory -- just in time for holiday shopping. So-called dormancy fees -- where gift cards leak value over time if they’re not used -- have just about become a thing of the past. You can thank several consumer advocate agencies, along with widespread consumer disgust, and perhaps a pang of corporate consience, for the change. Most retail gift cards will never expire or lose their value now, a welcome change.

Of course, the fight against fees is far from over. Bank gift cards, like the ones available from Visa and MasterCard, are still a terrible deal. Later in this column, I’ll show you how a $50 bank card will cost you $60 and could easily be worth only $40 to the recipient.

And you should know retail stores that have eliminated fees haven't done so entirely out of the goodness of their own hearts. Dormancy fees are peanuts compared to the money retails stores are making from gift card "breakage" – the unspent balances on cards that sit tucked away in wallets and sock drawers. A recent survey shows that the average U.S. adult has two gift cards gathering dust bunnies in dressers across America. About half of us have at least one unused card. I'll bet you do. So before you gift wrap a gift card this season, give some serious though to who the recipient will ultimately be: your loved one, or a retail store's corporate headquarters?

First, the good news. The Montgomery County, Md., Office of Consumer Protection is the final word on gift card fees. For the past four years, the agency has conducted a comprehensive survey of gift card policies, exposing unfair expiration dates and dormancy fees. Three years ago, the survey indicated that half of the top retail cards came laden with such fees. But this year, only three of the top 40 cards have expiration dates (Bloomingdale's, Macy's, and Blockbuster). And the trend is headed in the right direction – both Toys R Us and Red Lobster expired their expiration fees in October.

"(The fees) are coming close to being a thing of the past," said Evan Johnson, the author of the study. He credited a set of state laws banning certain fees and an aggressive enforcement action by the Federal Trade Commission against the owner of Red Lobster restaurants for failing to properly disclose the fees.

Great odds for the company

So there's one less thing to worry about when you give a gift card this season. But when you do, you should know that odds are 1 in 10 that the money you give will be going directly to the company instead of the recipient.

There is a lot of money at stake in the gift card business -- $80 billion will be spent on the cards this year, according to Tower Group. And its data suggests that 10 percent of that money, about $8 billion, will never be spent, something known in the industry as “breakage.” The amount of breakage is so significant that some analysts have suggested it contributed to lackluster holiday shopping sales figures the past two years. Retailers can't book the revenue from gift card sales until the cards are redeemed (or expire), so the bottom-line benefits card sales are postponed. According to Deloitte, $18 billion was spent on the cards during the 2005 holiday season, and $2.5 billion of it hadn't been redeemed by the end of January 2006. That's a lot of suspended revenue.

Breakage is so valuable that last year Home Depot was able to claim $43 million extra in revenue from unredeemed gift cards, for a one-quarter earnings-per-share bump of 4 cents. Why irritate consumers with dormancy fees when breakage contributes that much to the bottom line?

In some states, unclaimed property rules called escheat laws give state governments a legal claim to this unspent money. Don't think retailers haven't noticed. Deloitte says they are rapidly moving gift card operations to states like Ohio and Washington, where escheat laws are more favorable. It's not clear which state laws apply on nationwide gift cards, so there's bound to be some bickering over all that money. No matter how it turns out, you should know there's a good chance your gift will never actually be given to the recipient.

All this is rather amazing when you consider that cold hard cash has no expiration date, will not end up in a smelly sock drawer, and certainly won't end up as a donation to a company’s bottom line some day. And yet, social conventions prevent us from giving cash when we don't have time or inclination to select a genuine gift. Instead, we give plastic. This entire $80 billion a year business -- and the gift of $8 billion a year to retail stores -- is born out of this social convention.

Money in the bank's bank

One last note about the other gift cards in the gift-giving universe: Bank-issued gift cards. They might seem a bit more thoughtful, as recipients can use them anywhere. But beware: Bank gift cards will be in the first class when the Sneaky Fee Hall of Fame is built. All the cards cost an extra up-front fee for buyers (MasterCard's Good2Go card costs $9.95 -- meaning a $50 gift card will cost you $60). Most of the cards ding the recipient a buck or two for each transaction, for examining balances, for withdrawing cash at ATMs, and even sometimes for not doing anything at all in a given month. Bank gift cards used for multiple purchases quickly fall to $40 or less in value – and by the way, they all expire, meaning they all become worthless at a certain point. A bank gift card is the least thoughtful gift of all. And yet, TowerGroup says $23 billion will be spent on bank gift cards this year, and the Network Branded Prepaid Card Association (bank card PR agency) says one in five U.S. consumers plans to buy at least one this holiday season.

If you or someone you love is in danger of buying one of these crazy cards, please offer to help. A greeting card store near you will gladly show you the section with the money holders.