Why do firms sell gift cards although consumers prefer cash to gift cards?

Abstract

We provide a novel rationale as to why firms sell gift cards, although consumers prefer cash to gift cards. Issuing gift cards enables firms to charge higher prices for products. Since gift cards have the effect of price discrimination by discounting the product prices only to card-holding consumers, the card-holding consumers become less price sensitive, and thus firms can raise prices due to the elasticity effect. Although gift cards lock consumers into the card-issuing firm, the lock-in effect is not essential for our result. We show that in the absence of lock-in effects (when competing firms honor their rival's gift cards), the equilibrium price, surprisingly, rises even higher due to a double elasticity effect. Our results predict that rapid growth in the gift card market is likely to continue, and that it could attract additional regulatory scrutiny based on their anti-competitive effects.