The Value in Stored-Value

By Lauri Giesen

Marketing stored-value cards such as gift cards brings in fee income and may help attract some new customers.

Banks often borrow ideas from retailers, particularly in the realm of branch design and customer service. But products? There hasn't seemed to be much of a correlation between financial products and the things you can buy at, say, Borders and Starbucks.

Now there is. The product is a gift card, the stored-value card that retailers found to be especially popular with their customers during the Christmas holiday season. A survey by Dallas-based Paymentech, a processor of retail payments, estimates that 30% of consumers received a gift card last holiday season.

Inspired by this success, the bank credit card associations have come up with an array of card products that can be used by consumers or corporate employees, either to pay for goods in stores or to retrieve cash from automated teller machines. In addition to gift cards, these Visa- or MasterCard-branded product packages can include payroll cards, travel cards, teen cards, incentive cards and project cards. They're known as "stored-value" cards because the monetary value is stored in an account held by the issuer and accessed by a magnetic stripe on the back of the card.

Financial institutions can benefit from these cards in several ways. Providers generate fee income by selling the cards to consumers, as well as through interchange revenue, typically just under one percentage point of the purchase price, whenever the cards are used to make purchases. Some early issuers also say they've been able to attract new customers with these cards — particularly those previously "un-banked" — and reinforce loyalty from established ones.

Potential drawbacks would include the risk of criminals getting hold of the cards, although issuers say the amount of actual fraud has been extremely small thus far. There are also some operational issues involving staff training in the branches and making sure sufficient card inventory is available.

Another potential problem relates to litigation involving debit cards. The recent settlement has the potential to reduce the interchange fees banks can earn from stored value cards (see sidebar). But none of these issues should deter institutions from taking a serious look at this market.

A couple of dozen banks have already dipped their toes in the water, including such major institutions as Bank of America Corp., Citigroup Inc., and Comerica Inc. And the field is expected to get crowded quickly. Half the 20 large banks responding to a recent survey by Unisys Corp., Global Concepts and Talson Associates said they were interested in issuing stored-value cards, although only a few were ready to reveal specific plans. Of the stored-value products on the market, payroll cards attracted the most attention from these banks, followed closely by the gift cards.

"Banks are definitely interested, but most are still trying to decide how they will play," says Janet Jones, consulting manager for Unisys' North American payment practice in Charlotte, N.C.

Consumer Direct

Most stored-value cards fall into one of two categories — direct-to-consumer and workplace-related cards. The first group includes gift cards, consumer travel cards and teen cards. Travel cards are purchased by consumers as a substitute for traveler's checks, while teen cards are purchased by parents for use by their children. The parents fund the cards and then the teenagers can use them to make purchases at any retailer that accepts Visa and MasterCard. Parents can often set limits on usage — for example, banning purchases at liquor stores or bars.

Workplace cards include payroll cards, which are issued by corporations to employees in lieu of a paycheck; corporate travel and entertainment cards; incentive cards, given as employee bonuses; project cards, which allow employees to pay for supplies and related services needed to complete work-related projects; and medical insurance cards, which are used to manage the funds employees put into their flexible spending accounts.

The most popular stored-value card today is the gift card, which retailers have seized upon to build a $38-billion business that is growing rapidly, according to New York-based Bain & Co., a business consulting company. A recent Unisys survey of 101 national merchants found half of them either currently issuing or planning to issue gift cards this year.

Despite their popularity, these retailer-issued cards have one disadvantage: they typically can only be used at that retailer's store. Many customers would prefer to give gift cards that can be used in a wide variety of locations and incorporate the same benefits and protections against loss that they receive from credit cards. Hoping to fill that need, some banks are issuing gift cards with their own brands as well as those of Visa and MasterCard.

The market does seem to hold potential for banks. Only 3% of consumers in the Unisys survey had purchased gift cards from a bank or credit card company, compared with 52% who bought them from retailers. Yet, 28% of consumers responding to the survey indicated some degree of willingness to buy the cards from banks.

One of the first banks to sell gift cards was National City Corp. For several years, the Cleveland-based bank had offered a re-loadable teen card. Over time, it found customers wanted a lower- priced, disposable card that could be given as a gift. This past November, National City began marketing Visa-affiliated gift cards from its Web site and branches.

Cards purchased via the Net can be personalized with an embossed name or message or ordered in a standard form. The branches sell only the non-personal cards. The personalized cards sell for between $4.95 and $8.95, depending on the denomination retained in the card, while the plain cards cost $2.95. Cards are sold in various denominations between $25 and $500. Unlike the teen cards, the gift cards are not re-loadable.

While National City initially viewed gift cards as a way to satisfy established customers, the bank has also found the product has generated some new customers. "Because few banks are selling these cards from their branch counters yet, we have an edge," says Roger Piskos, senior vice president and group manager of emerging technologies. "A lot of consumers are coming into our branches just to buy these cards, which gives us the opportunity to present our other products and services."

Bank of America, pioneering another approach, has partnered with Simon Property Group Inc., the nation's largest owner and manager of shopping malls, to create a Simon-branded Visa gift card. This card is sold at customer service stations in the 249 malls owned by the group, but can be redeemed at any store that accepts Visa gift cards. Bank of America reportedly shares with Simon in the revenue generated by the card. BofA also sells its own Visa gift card directly to consumers.

Cards for Work

While gift cards seem to be leading the stored-value charge for now, work-related cards may offer even more potential for financial institutions.

In late 2002, MasterCard unveiled an array of stored-value cards that banks can promote to their corporate customers, who then issue them to their employees. The most popular of these cards are payroll cards. Typically directed toward people who don't have checking accounts, payroll cards allow corporations to load the value of an employee's pay onto a card, which then can be used to access funds held in a special account. The employee can use the card to retrieve cash from ATMs that sport the MasterCard logo and make purchases at any location that accepts MasterCard. Visa offers similar payroll and work-related products and formed a separate division in 2002 to oversee all its stored-value card products.

Unlike gift cards, which are typically secured by a signature, the payroll cards generally involve the use of a personal identification number so that they can be accepted at ATMs and other retail locations that accept PIN-based debit transactions. These cards also can be used with a signature at those locations that do not feature PIN pads.

St. Louis-based First Banks Inc. was one of the first institutions to look at payroll cards. Since last year, it has sold MasterCard-branded payroll cards through two third-party companies. Starting this summer, it plans to sell the product directly to its commercial customers. Several larger banks, including Bank of America, Comerica, ABN AMRO Holding N.V., and J.P. Morgan Chase & Co., also offer stored-value cards to corporate customers.

Shannon Phelps, vice president of card products for First Banks, says many corporations want to shift more of their employees to automatic deposit in order to cut administrative costs, but are hindered by the fact that many employees lack bank accounts. Such workers include teens, part-time staff, temporary employees and immigrants. Stored-value cards provide the employer with the same cost savings as electronic payments while making it easy for employees to access their cash.

In a recent study of the economics of the payroll card, Boston-based Celent Communications estimated about 13% of U.S. households are un-banked and that it costs employers $1.90 to cut a paycheck for each employee in these households. In addition to the cost of actually issuing the checks, these employers spend between $10 and $12 per check replacing lost or stolen checks. Corporations that shift from checks to plastic cards can reduce their total check costs by 70%.

Employees also fare better with cards. According to Celent, un-banked employees who use check-cashing services pay an average of 2.5% of the check's value to check cashers, with some fees reaching 8%. These numbers would indicate banks could charge either the corporation and/or employees a few dollars for each card per pay period and still provide both with cost savings.

Banks can also offer corporations a variety of other stored-value products for employee compensation. Corporate travel stored-value cards, for example, can be used to fund the travel of employees who venture out only a few times a year. Such limited travel may not justify the issuance of a corporate credit card, but stored value provides a similar ease of payment for an employee while giving the corporation documentation, including a monthly statement that shows how funds are being spent.

Value Exchange

There are several ways that banks can make money from stored-value cards. With the consumer cards, there is first the upfront fee, typically a couple of dollars per card above the value retained. Then, with re-loadable cards, there is usually a flat fee charged each time the card is loaded. Additionally, card issuers receive interchange fees when a card is used to make a purchase.

Executives with National City and First Bank say they are booking interchange fees on a par with what they get on a signature-based debit card transaction, which currently exceeds 1%. That amount is expected to be lowered to about 75 basis points starting in August, due to the recent settlement of litigation between a group of retailers and Visa and MasterCard.

Finally, on the disposable cards, there are often unused amounts that banks get to keep. For example, if a consumer is given a $50 gift card and spends everything but 75 cents, he or she may decide to just toss the card. National City's Piskos describes the unused funds that the bank keeps as "quite small," but even small amounts can add up to a significant sum when spread over millions of cards. And as gift cards grow in popularity, these funds may become quite substantial.

With employee cards, banks can structure deals with the sponsoring corporation in a number of different ways. Sometimes, employees may be charged a monthly fee. Other times, the corporation may pay the bank a monthly or flat servicing fee for all its employees. Or both the corporation and employee could share the cost. Either way, banks also receive interchange from payroll cards when those cards are redeemed in retail locations.

Float is a big factor with payroll cards because the amount of funds that consumers keep on their cards can be quite high. While business travel cards and other work-related cards may not involve sums that large, float continues to be a factor because the funds often stay on the card a lot longer than is the case with payroll cards.

In addition to direct revenue, banks have the potential to use stored-value cards to attract new customers, although there is disagreement about the effectiveness of this strategy. Taking the positive view, Bill Mathis, senior vice president of member relations for MasterCard International in Purchase, N.Y., says stored-value cards are "great at increasing bank brand recognition and at going after the un-banked market, particularly young, newly-employed consumers who are just entering the job market."

Others point out that this un-banked market can be costly to serve. "A lot of banks find they're generating a lot more traffic in their branches, but it may not be traffic they want. Customers they attract may not keep large balances in their accounts and may not be very profitable to serve," says Les Riedl, executive vice president of Speer & Associates, an Atlanta-based bank consulting firm.

Riedl concludes that banks not wanting to actively pursue the un-banked market might be better off selling gift cards from the Web or via telephone orders.

Managing Risk

The risk of loss from fraud also has the potential to offset gains from any new business activity. But bank executives who have issued stored-value cards say the incidence of fraud is lower than they had expected. "Our fraud rate has been much lower than with either credit or debit cards," says National City's Piskos. "And there is a lot that banks can do to reduce their exposure."

Small amounts of personal information about the user captured at the time of purchase can be used to verify identity at the point of sale, for example. Also, banks can put a freeze on all cards reported as missing. "With stored-value cards, you don't have to worry about credit risk or whether the customer has the funds in a checking account to cover the purchase, because with gift cards, you always know the funds are good," Piskos says, referring to the fact that stored-value card funds are stored in a separate account.

In the case of gift cards, most institutions also limit the value of funds that can be retained on the card — usually to about $500 — so even if the card is misused, the loss to the bank is usually small.

Both Visa and MasterCard offer banks assistance in risk management by replicating some of the fraud prevention efforts they've developed for credit and debit cards. "We help the issuers understand the risk, and we've developed guidelines and procedures that work to mitigate any losses," Mathis says.

Outside of fraud risk, there are other costs associated with running a stored-value program. If banks are to sell gift cards or other consumer card products in the branches, staff training is required. And there are inventory issues for banks with large branch networks. "You have to make sure all the branches have enough cards and remember that during the peak seasons, such as near graduation and holidays, you'll need a lot more cards," Piskos says.

Re-loadable cards may create other concerns, according to Phelps at First Banks. "If you're going to issue re-loadable cards, you have to make sure that you have reloading mechanisms accessible to your customers. The teens usually like to use the Web to load value, but many un-banked cardholders may not have Web access."

But once these logistical issues are tackled, banks issuing stored-value cards say they're happy with the programs. "Early sales have exceeded our expectations and we've found little risk," says Piskos. "Overall, the program has been quite popular and we're looking to expand into other stored-value card products."

Ms. Giesen is a freelance writer based in Libertyville, Ill.

Copyright © 2003 by Banking Strategies, published by BAI.

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