Whilst there's some discussion going on around DSE and their gift card fiasco, I just thought I'd write a bit of a primer about why gift cards (in general) are a scam.
First, let's start off with some Finance 101. Skip this if you have some basic understanding of economics and finance.
"The higher the risk, the higher the reward". Simply speaking, the risk you face is the likelihood of financial loss you might incur if the entity goes insolvent. The principle is that creditors are paid first (i.e. people who loaned them money) and shareholders are paid last (i.e. people who invested money in the entity). There are two types of creditors - secured creditors and unsecured creditors. This refers to whether a creditor can seize assets of the entity should it go insolvent. If you have a mortgage, that is a secured loan - if you go bankrupt, they'll take your house. If you have a personal loan, that would most likely be unsecured. The risk of a secured loan (for the lender) is much lower, thus, they will be willing to lend at a lower cost (i.e. lower interest rate).
So what are Gift Cards?
Gift cards are unsecured loans - when you buy a gift card, you become an unsecured creditor to the firm. This means that you are lending them money.
Why are Gift Cards scams?
Lending money to someone without receiving interest means that they are scamming you. On top of the obvious fact that gift cards do not have to be honoured should a business go insolvent, there are also many other clauses such as gift cards having to be used by a certain date. This all adds up to Gift Cards being sold at full cost to be a scam.
If you would not lend a particular business money without charging them interest, then do not buy a gift card from them, you're doing the same thing.
What about Gift Cards sold at a discount?
You have to be careful with this. Firms are always looking for the cheapest way to raise money in order to reduce their cost of capital. On top of that, also remember that often when firms are desperate for cash, it means that they are about to go insolvent. Note that insolvency does not have anything to do with profits or accounting numbers. Solvency is your ability to be able to pay debts as they fall due, this means that you have to have cash on hand to pay your debts. Think of it as you needing to pay a debt today, but you only get your paycheck tomorrow. You might earn $10,000,000,000 tomorrow, but if you can't meet your debt obligations, you're insolvent even if you might turn billions in profit that year.
Obviously, gift cards are a very good way of raising capital in a very quick and efficient way. If you sell gift cards at a 5% discount, people will flock in to purchase them. Many will spend them straight away, which isn't ideal, but ultimately isn't bad for a struggling business because you're converting inventory to cash. Then there is the ideal situation which are the people who hold their gift cards hoping for a sale (that might never come, as in DSE's case, they've gone out of business).
But why gift cards? Because many consumers are uninformed and easy to cheat. How much due diligence would a bank take before loaning a firm some money vs. a consumer duped into buying gift cards before Christmas? Who is easier to con into giving you the quick cash you need?
What is the solution?
Stop lending money without doing due research. Every time you buy a gift card, think of it as lending someone money. If you would not lend them money, do not buy a gift card from them. If you would not lend someone money prior to checking their financial statements, then do not buy a gift card from them without doing so.
I do believe that this is an area in which people can be further informed, e.g. it might be better if gift cards came with specific statements which made it very clear the customer's position as an unsecured creditor and that in the case of insolvency, they would not be honoured until after secured creditors have been paid.
I would also advise people to start giving cash. Personally, I have never received a more stupid gift than gift cards. If you buy me a $50 gift card, I'd rather you just give me $50 in cash. If you insist on buying gift cards, only buy from major, major firms such as Coles Myer. I would honestly steer you towards buying a prepaid Visa card or something like that rather than a gift card, however.
Yeah cheeeeers obviously have too much time on your hands. Personally I've never heard anyone buy a gift card for anything less than face value.