Cost of Fungibility – Price of Target Gift Cards

I came across $100 Target gift card for sale on eBay for $90 (thanks to Zach). It is a deal for selling you $100 Target gift card for $90. Let us assume here everything is legitimate and not add other external factors.

Can you think of why anyone would take less than face value of the gift card?

On the other hand, can you think of a scenario when someone would refuse to a fair trade of $100 cash for $100 Target gift card?

Looking at the seller and number of deals sold, this is a case a wholesaler who likely struck a deal with Target to get $100 gift cards for less than $90 and trying to make a profit.  For Target such a deal would make sense because of assured $100 sale (it is as if they are giving, say, 20% discount) and there is always breakage (people not using full value of gift cards).

Seems like rational automatons making spreadsheet driven decisions.

Now how about refusing to trade even for fair value?

A while back I wrote about a case of Target gift card. It was an offer for you to trade a $20 Target gift card for cash that is lot more fungible than a gift card.

I offer to take that gift card from your hand for cold hard cash – cash that is lot more flexible than the Target gift card which has the limitation that it can only be spent at Target.

As a Homo Economicus you should be willing to accept any reasonable offer that is just about less than $20

There exists a scenario where the gift card guarantees more hedonistic pleasure than fungibility of cash that creates conflicts. Applying Prospect Theory, a gift card represents money that is already spent. So there is less or no additional pain from buying things with it. When you trade it in as cash it becomes “unspent” and creates more pain (Prospect Theory) when you buy things with it.

Furthermore, if it is a gift card you know you have to spend and there is no mental conflict. When it is cash, the very fungibility creates choices – could you be paying rent or saving that money instead of spending it?

That is where some will refuse to trade in their gift card for cash.

What will you do?



The Incredible Starbucks Steel Gift Card

To refresh your memory, just before the holidays Starbucks launched a limited edition (5000 only) steel gift card priced at $450. The card carries a value of $400 and comes with some sundry benefits like free refill on brewed coffee and free drink on birthday.

That is correct. It costs you $450 to get $400 because Starbucks said it costs them a lot to make this steel card. While I called this egregious pricing, at least 5000 people did not think so. The card was sold out and worse was sold for much higher prices on eBay.

By last check there were 510 sold listings.

  • 70 odd listings were for just the empty card ($0 value) sold from $325 to $650
  • Most of the listings were with the full $400 value and sold from  $670 to $1250
  • Very few listings with $5 and $25 value and with no other values

What can I say about this?

Pricing on $0 gift card provides great insight on buyer perception. It appears keeping the full $400 value of the card helped increase its value among buyers. That is, when sellers left $400 on the card buyers bid additional $600 for that $400.

We can try to explain away why anyone would pay $650 for an empty card. But nothing in rational economics can explain why someone will bid $1.5 for each additional $1.

But I think the only reasonable point we can make from this data is – the left tail of human civilization has at least 5000 people, the left most has at least 510 people (those who won the auctions) and rightmost has 510 people, those who made a profit.  (Note: Subtract the 510, those who sold, from 5000 and add back those bought and you get 5000 in left tail.)

And you my friend, I know, is in the right tail, simply because you are reading this.

From Effective Pricing to Egregious Pricing – Starbucks

starbucks-steel-gift-card--4_3_r560In the past I have only written praiseworthy things about Starbucks pricing. I always admired how they set prices for their drinks, decide to raise prices when everyone else was running price promotions and how they communicated their price increases. This time I think they have crossed over from effective pricing to egregious pricing.

First time I wrote about Starbucks pricing it was on their decision to increase prices when the global economy was going into recession

In the case of Starbucks, how did they arrive at price increase, going against the flow? The simplest calculation here is, when price conscious customers moved out all they are left with are price insensitive customers who prefer their products. Hence it makes sense to charge more for them as long as the loss in profit from further drop in customers is less than the increase in profit from higher price. (Here is an attempt at formal proof on why increasing prices yields better profits).

Later on it was on their price communication,

As you read this multiple times you will find all kinds of reasons except, “We cater to a somewhat higher-income customer and we price our products based on customer willingness to pay. Besides we don’t expect any push back from these high income segment”.

A key attribute of those practicing value based pricing is never explicitly saying that they are practicing value based pricing. There are always other reasons and you never say pricing at customer willingness to pay. A key part of practicing effective pricing is effective pricing communication and managing customer perception.

Even when they announced $7 lattes I only had good things to say. After all they likely have more data on their customers and buying behaviors than any of us do. They likely found a segment willing to pay $7 for lattes and are simply targeting them with a product version at a price those customers are willing to pay (second degree price discrimination).

Even if there is no such segment, a $7 price tag helps to improve the reference price in the minds of rest of their customers and hence will provide Starbucks with a way to increase prices of their other drinks.

All these are effective pricing. No doubt. But now I think they crossed over from effective to egregious, launching a contemptuous attack on their customer’s intelligence.

Starbucks recently introduced its new Steel gift card that is sold only through and costs you $450 but buys you only $400 worth lattes.

If we leave out the last phrase “$400 worth”, everything else about this product is indeed effective.

  1. They chose the right customer segment and set a price specific to that segment
  2. Set a hard limit on number of units they wanted to sell – a result of their understanding of the size of the segment and a tactic to create artificial scarcity
  3. Designed the product to be distinctive (Steel over Plastic) – making it a conspicuous consumption. Imagine flashing this card in your local Starbucks, the baristas and the rest of us mere mortals have no option but submit to your opulence (Disclosure: I go to Starbucks only when someone else is buying)
  4. Selling it only through luxury goods website and not at every Starbucks outlet – thereby not only reaching customers with high reference price, high willingness to pay and high wherewithal to pay but also not targeting rest of their customers
  5. Guaranteeing profit from a high value gift card that locks up future sales and the possibility to add 10-15% of face value as profit from breakage (customers not using full value of the card)

Had they stopped right there, a $450 card worth $450 lattes, that would’ve been effective pricing. Then they took it one step further.  They decided to extract even more profit by setting the value of the gift card to only $450. And as they were wont to do with giving cost reasons they said,

One reason the card is so pricy is because it isn’t made of plastic — but specially etched steel. That guarantees the heavy metal wedge with the familiar Starbucks logo will stand out in your wallet and at the cash register.

The Starbucks card costs $50 to make,

Even if it is true, why should the cost matter in this case? This is not a true product. This is like the US Treasury asking you to pay $550 in change for a $500 bill because it costs them $50 to print that bill.  While it made perfect sense to use cost argument to push through price increases, cost has no relevance to take away value of the gift card.

What they have demonstrated here is utter disregard for the customer. They probably think, if these customers were willing to pay $5000 for a luxury product that costs $50 make why not take $450 cash from them for $400 worth lattes.

The sad part is they may be right and they likely will sell out all 5000 of their limited edition steel gift card. After all don’t we all pay $100 more for 16GB additional flash that only costs pennies? May be the steel gift card is laser etched and designed to fit so perfectly in your palm and that alone is worth $50 for some.

My outrage is probably misplaced and egregious pricing is likely the new effective pricing.

How are you going to react when you see that startup founder flashing the steel card at Starbucks, especially when his product is free?

What are you willing to accept for your $20 @Target gift card?

Say you are in possession of a $20 Target gift card. It is likely someone gave this as a gift to you as it is farfetched that one would buy oneself a gift card.

I offer to take that gift card from your hand for cold hard cash – cash that is lot more flexible than the Target gift card which has the limitation that it can only be spent at Target.

As a Homo Economicus you should be willing to accept any reasonable offer that is just about less than $20

As you can see Eric above was willing to accept even $19. There is likely a distribution of offers. But if  offered  exactly $20 in cash in exchange for the gift card of same value anyone should willingly accept the offer. In fact the added benefit of complete flexibility is the consumer surplus that makes this a high value transaction.

However there exist a set of people who would firmly hold on to the gift card despite an even offer.

I polled a non-scientific sample of 15  third graders on this even transfer –

You got a $20 Target gift card for your birthday. Would you trade that with me for $20 bill?

The answer from all was a resounding no.

The reason? If I have the gift card then I know I have to spend it and I can only spend it. No doubts and no pain. But if I have that as $20 bill then another option opens up. I could save some of it another day. And I don’t want that painful choice.

Cash adds more choices – the money can be spent on other utilitarian needs or even saved. Keeping it as gift card seem to provide the justification that they have to spend it all with no other option. So the easy way to avoid the hedonistic conflict is to reject the offer to exchange gift card (hedonistic) for $20 bill (utilitarian). (See here)