Guest author Josh Breinlinger is a venture capitalist at Sigma West. 

I am constantly fascinated by the gift card industry. It’s a case study in behavioral economics. Every year, US residents turn $110B of cash into a far-less liquid asset and pay a few percentage points in extra fees. This is all for the privilege of giving a “gift” to someone who now has reduced option value and must exert effort to redeem the alleged “gift.”

Why does this happen? The answer is one of misaligned incentives.

There are 4 stakeholders (sometimes more) in a typical gift card transaction. 

1. The Merchant 

When you buy a gift card from a merchant, they receive a few wonderful things: immediate cash flow, brand exposure, viral customer acquisition, and potential increased sales beyond the card value. The average overspend is about $20.

2. The Retailer That Sells The Card

Every time you go to a grocery store, you’ll see a whole bunch of gift cards near the register. And why not? They have incredibly high “value density”—lots of revenue generation for a very small investment in shelf space. Retail density is a game of maximizing revenue per square foot of space, meaning you can either increase revenues per square foot or increase the number of items sold per square foot.

Both matter. You can make the model work with frequent purchases of low value items (paper towels) or infrequent turns of high value items (gift cards).

3. The Purchaser Of The Gift Card

Gift givers win because gift cards require near-zero effort. These people are able to get something done on their to-do list without expending any effort thinking about a useful and meaningful gift.

Far better to put the burden of effort on the gift receiver. They can get that Christmas shopping done in two minutes at your local Safeway and cross everyone off the list. On the plus side, giving a gift card forces the recipient to “treat” themselves to something nice—which of course is the intent.

4. The Recipient Of The Gift Card

I put the intended benefactor of the entire process at the end of this list intentionally, since the value here is the weakest. These people theoretically received a gift, but they had no choice in the matter and now have something that looks kind of like cash but that's usually restricted to a single merchant.

Now they have to hold on to the physical cards, travel to a store location, plan purchases to meet the gift card amount, and remember to use the card. The key issue here is that now the recipient must expend effort to redeem the gift card. This is precisely why many cards go unredeemed. In fact, an estimated 20% of gift card value nationwide goes unused—make that, over $20 billion per year. This in turn supports such ludicrous businesses as PlasticJungle, where, for yet more fees, you can turn your gift cards back into cash.

The world should not work this way.  

Studies do show that recipients would prefer a gift card over an actual gift of comparable value, but that's not the right comparison in my opinion. Compare to cash and see what you get.

The misaligned incentives of stakeholders #1, #2 and #3 have created a crappy experience for the intended benefactor, #4. Businesses that don’t have the best interest of the consumer in mind—meaning they favor merchants first and consumers second—eventually die off in favor of a better model. It’s high time for a new and better model for gift cards that puts the gift recipient in mind first.

A Better Model 

E-gift card usage is growing rapidly: 21% of all consumers purchased an e-gift card in 2012. The main reasons were that e-cards are delivered immediately; they're easy to email, and they're straightforward for recipients to redeem. The primary resistance to e-gift cards is the lack of a physical present. People want to give a physical card.

The trend towards e-gift cards is encouraging, but I believe the industry hasn’t gone far enough to really place the desire of the gift recipient front and center. There is an opportunity to go further. We could eliminate the redemption challenge and merchant restrictions, and thus close the gift card loop. Here's how.

First, a quick story. A couple of months ago, I was taking a Sidecar to an event. Upon arrival, to my surprise, I got a push notification from some law firm that said, “Congrats, your Sidecar ride is on us. Enjoy the party!”

That was such a wonderful gift. It was a surprise. It was thoughtful. It required absolutely no effort on my part. I absolutely loved it. 

This One's On Me

Five years ago that gift would have been impossible. There was just no way a gift-giver could have been with me at the exact time of my transaction in order to step in and say, “Don’t worry about it, it’s on me.”  But with an increasing number of transactions going through mobile, it's now much easier for consumers, merchants, and businesses to do the exact same thing.

Imagine that the next time you pay any merchant with Square, you get a message that says, “Josh wanted to surprise you with a gift. This Sightglass Coffee is on him!”

The product might work something like this:

  1. Build a network of merchants accepting payments via Square, Stripe, Balanced Payments, Braintree, or Paypal.
  2. The gift giver buys a “credit” for recipient. This should not be merchant-specific—it’s too restrictive. It could be price specific and maybe even category specific: coffee, transportation, etc.
  3. The recipient receives a gift notification the next time they make purchase at one of the in-network merchants. “Congratulations!"
  4. The gift giver is notified of the redemption. “Hey! Josh just used that gift certificate you got him at Sightglass Coffee.” This closes the gifting loop and makes the gift-giver feel good that the recipient enjoyed it.

Voila! Gift given, recipient happy and surprised, no effort required, and the redemption rate is now 100%.

Some Caveats

A solution like this has some potentially huge drawbacks. Number one being that the recipient is not “forced to treat themselves.” Many gift-givers (especially aunts, uncles, and others that aren’t particularly close) are intending for the recipient to treat themselves to a spa day, or a new set of bed sheets, or coffee from Starbucks. Whatever it might be, giving this type of gift eliminates some of that gratification, since it simply picks up the tab for something the recipient was clearly going to buy anyway.

Another drawback to this is the lack of notification on gift day. If you’re trying to give someone a birthday present, you want her to receive it on a specific day. The final drawback is the simple lack of a physical card. I believe people will eventually get over that.

These obstacles, of course, aren't insuperable. It might be easy enough to send someone a card on their birthday notifying them that you've given them a surprise gift. And even if this approach never caught on for individual presents—the "treat yourself" issue is sort of hard to get around—it may well be a power and much better received system for corporate gifting, in which a single company may gift thousands of partners, customers and suppliers.

Either way, it's got to be better than the system we have now.

Image courtesy of Flickr user LaniElderts