A Market On The Brink
Overwhelming consumer demand for open-loop prepaid gift cards created a $5 billion market in four short years but if pending legislation passes, and preemption is lost, it is likely some states will see existing open-loop gift cards withdrawn entirely. Meanwhile, other states will see a dramatic increase in the price consumer pay for gift cards.
The resulting higher cost will result from the need of gift card suppliers to create a unique gift card portfolio for each state that creates a unique set of pricing and fee constraints. American Express and Discover have already stopped selling their open-loop gift cards in states with particularly restrictive legislation and more states will be abandoned if pending legislation eliminates preemption for open-loop gift card suppliers.
Open-loop gift card suppliers will exit states with restrictive legislation because profits for open-loop prepaid gift cards are dependent on a common product achieving high volume. When multiple product variants need to be introduced to meet state regulatory requirements, it adds tremendous operational costs to Network Branded solutions because each new implementation is, in essence, it???s own card portfolio. Unlike merchants that can create new cards whenever its suits them, each new Network Branded card portfolio must be signed off by the issuing bank and by the network the portfolio operates on and is then assigned a specific range of potential card numbers with expiration dates. As a result each new card portfolio requires a new distribution plan, new end-user and distributor legal terms & conditions, a new Web site, a new IVR customer service script, a new customer service help desk script and associated operator training, new costs from processors because most charge transactions fees that are based on active and inactive cards within each unique portfolio, and perhaps even a separate card production run.
The Intrinsic Nature of Open-Loop Prepaid Products
It is not as if the Network Branded prepaid industry would not like to have greater flexibility to introduce new cards with different operational characteristics. Indeed, the cost and effort associated with introducing new variants is one of the major challenges that delay the introduction of innovation. Indeed the high cost of releasing small batches of a new Network Branded prepaid card prevents test marketing which in turn slows innovation, since every new feature needs to be put into full production. The need to introduce changes into as a major new product release greatly increases the risk of failure.
This risk then limits significant enhancements since businesses are risk averse. If suppliers of open-loop prepaid gift cards won???t implement a card that isn???t going into full production today, they are unlikely to do so tomorrow for individual states. However, if they do, the cards will cost more which will reduce sales, despite the fact that consumer purchase behavior demonstrates that consumers love prepaid gift cards.
Suppliers Are Exiting Markets Today
American Express, one of the largest open-loop gift card suppliers, already states that: ???American Express is no longer shipping Gift Cards to the states of CT, HI, NH, and VT. Based upon legislation in these four states, it is cost prohibitive for American Express to sell our Gift Cards.??? Discover also refuses to ship to the following states, presumably for the same reason: ???Not for sale or shipment to residents of CO, HI, RI, TN and VT.??? With reduced competition, consumers in these states will see higher prices and a smaller selection.
Simon Property Group (the operator of Simon Malls) operates the largest open-loop gift card program in the world and fought for preemption. State regulators, including Attorney General Eliot Spitzer, were creating legislation to force Simon Group to craft individual state-specific gift card programs. Simon instead adopted a business model that the courts have already ruled fall under federal preemption. Without preemption it's likely Simon Group would have left the states demanding a unique gift card program, but even putting that what-if aside, it is clear state actions have already reduced open-loop gift card availability.
A Different Approach Is Possible
While not a law firm, Mercator Advisory Group believes it is likely that if pending legislation does amend Section 920 of the Electronic Fund Transfer Act as proposd, then each state will have the right to define its own regulatory framework for open-loop prepaid gift cards. This will override existing law that provides preemption to open-loop gift card suppliers today. With the elimination of preemption, the ability to address the entire U.S. market with a single open-loop gift card product becomes impossible and so open-loop gift card suppliers will increasingly leave the market on a state-by-state basis, as they have already started to do. This market departure will either increase the cost of open-loop prepaid gift card products in those states or eliminate the market all together.
Mercator Advisory Group believes that consumers have the right to know what they are buying. As such, legislation that demands full disclosure of all fees would be a far better approach to protect consumers. It would maintain the role of preemption which creates a national market while also creating a competitive environment for suppliers to lower their fees, which would also maintain a healthy prepaid industry.