Why does GetDebit penalize the value of non-cash rewards?

Quite simply, in almost all cases, non-cash awards (such as store gift cards, frequent flyer miles, hotel points, etc) are not as valuable as the same cash-equivalent award. For example, would you rather have a $100 Amazon gift card, or $100 in cash. Aren’t they worth the same? The answer is a firm NO.

There are at least 5 issues related to non-cash awards that are generally not present (or present to a much smaller degree) with cash:

  • Risk of expiration/loss
  • Limitations on use (time/place e.g. blackout dates)
  • Risk of change in terms of use, insolvency (complete loss)
  • “Making you work for it” trap
  • Time value of money

Risk of Expiration or Loss

Firstly, you could lose the gift card. Sound unlikely? The TowerGroup (a leading financial consulting firm) estimates that the unused value of gift cards (referred to as “breakage” in the industry) has a bigger financial impact on consumers than the combined value of both credit card and debit card fraud. While credit/debit fraud totals $3.5B annually, TowerGroup estimates nearly $8B is lost due to unredeemed, expired or lost gift cards. That’s a full 10% loss rate against the $80B of annual gift card sales. See the article “Unused Gift Card Values on the Rise” for more detailed information.

Limitations on Use

Another downside of many types of awards (gift cards included) is that they restrict you on where you can do your shopping. Running with the Amazon gift card analogy, you may find the same book cheaper elsewhere, and either have to buy it there or actually pay more for the product on Amazon just so you can use your gift card.  Many airlines have black-out dates and other restrictions preventing you from obtaining free flights with your miles when you most want them.  One exception we make:  AMEX-type cash card awards; these are cash cards that can be used anywhere that AMEX is accepted, so (at least in the eyes of GetDebit) their limitation on use is so small as to be negligible.

Change in Terms or Insolvency

Another downside of all of these non-cash programs is that they can change the rules mid-game. For instance, at one point Citi’s ThankYou network had a very favorable redemption offer for airline miles which made their program quite attractive. However, for whatever reason (probably due to our economic woes) they decided to eliminate that redemption offer entirely. In a worst-case scenario, the company issuing the points could actually go bankrupt, and you could lose all your miles/points that you had been accumulating for months or years.

“Making you work for it” Trap

Not all awards are created equal. For example, AirTran Airways has an excellent dollar value per mile at first glance. However, a closer look reveals that many of their flights are not direct, so you end up spending many more hours in the air or in airports than you otherwise would have. You are basically paying for the free award by sacrificing your valuable time.  GetDebit tries to identify and appropriately discount these situations.

Time Value of Money

This is an economic concept which basically states that $1 today is worth more than $1 in some future period. This is because if I give you $1 today, you could stick it in a bank account and earn interest on it, so that at that future period it would be worth more than $1. Most cash-based (cash back) rewards programs tend to let you withdraw the cash fairly soon after you earn it. However, its not uncommon to have miles sitting in an account for 1 year, 2 years or even longer—especially if you don’t travel much on that airline. Those miles are just sitting there, not earning interest (and maybe at risk of expiration!).

Another interesting example of this are certain credit cards which actually give you cash-back rewards, but require you to wait a full calendar year before being able to cash them out.  In this case, we apply a smaller-than-usual cashback penalty, but clearly the program shouldn’t be valued the same as one where you can cash out each month or at lower thesholds, all else equal.

Concluding our Thoughts on The Non-Cash Penalty

While there is no scientific way to quanity the sum of the above risks, GetDebit typically penalizes non-cash programs in the range of 5% to 10% of our estimated value per point or mile. Non cash-card gift cards tend to get the highest out-of-the-gate penalty of 10% due to the outright risk of loss (which seems to happen quite a bit) as well as expiration issues and limitations on use. This is also consistent with the data that about 10% of gift card value is lost in one form or another, and also is consistent with an analysis GetDebit did of completed sales of gift cards on Ebay. Typical sales occurred at 80 cents on the dollar. Airline and hotel programs are usually penalized at 5%, a modest penalty meant to capture some of the risks above.  However, there are other factors that GetDebit takes into consideration which can drive that 5% significantly higher.

In certain cases, we will even move to higher penalty levels when unusual situations exist.  For example, for residents of the US, Virgin Atlantic’s Flying Club frequent flyer program is pretty much only useful for trips to London, so we apply an all-in 20% non-cash penalty to account for this very restrictive situation.

For cash-back rewards programs that allow withdrawals only once per year after 12 months, we tack on a 2% non-cash penalty, really just to reflect the time value of money.

About This Author

Post A Reply