Gift cards and loyalty programs can be effective tools in generating sales, developing brand awareness, generating actionable customer data, and driving repeat business. When these programs are implemented on a single-store basis they fairly straightforward to administer. When rolled out through a network of independently owned franchised business, these programs require more attention and planning to be effective and compliant. As you look to implement a gift card or loyalty program with your franchise system, keep in mind the factors below.

1. Is the program permitted by the Franchise Agreement and documented in the Franchise Disclosure Document?

A complex system like a gift card or loyalty program system is best implemented if the franchisor has the express rights to do so under the franchise agreement and the possibility of such a program has been disclosed in the FDD. Most franchise agreements written within the last 5-10 years probably have this reserved right. However, if the franchise agreement for some or all of your franchisees does not grant the franchisor this express right, there is an argument that the franchisor’s requirements for franchisees to participate in advertising and marketing programs may extend to gift cards and/or loyalty programs. Ideally the franchise agreement should also provide that franchisees cannot implement their own versions of these programs.

Disclosures in the FDD about gift card and loyalty programs will vary by the specifics of the program, but in general:

• Any fees charged to franchisees and paid to the franchisor or its affiliate for the programs need to be disclosed in Item 6. If a fee to participate in the gift card or loyalty program has not been disclosed in advance, then it cannot be charged to franchisees without their consent.
• The supply relationships for the technology, vendors, and materials needed to operate the program may need to be disclosed in Item 8.
• The technology requirements to implement the system need to be disclosed in Item 11. Item 11 also contains disclosures about the franchisor’s role in advertising and the franchisee’s advertising obligations and the program may need to be discussed as part of these contexts.

2. Create and maintain customer-facing and franchisee-facing policies.

The terms and conditions for customers to participate in the gift card and/or loyalty program should be clear and comprehensive. When customers can readily understand the benefits and limits of the programs, there are less issues for franchisees and the franchisor to manage.  Chances are these terms and conditions will become more detailed with time as you gain experience with specific issues.

The customer terms for gift card programs might include rules about expiration dates, where the gift card can be redeemed, how returns and refunds will be treated for items purchased with the gift card, any applicable usage, replacement, or dormancy fees, and any items for which the gift card cannot be spent.

The customer terms for loyalty programs are similar. A franchisor should think through how the points will be generated and redeemed, limits on purchases that generate points, items for which the points cannot be redeemed, expiration of the points and benefits, how returns and refunds will be treated for items generating points or for which points were redeemed, and when an account become inactive. The franchisor should reserve the right to change these policies at any time, for any reason. In practice, customers should be given adequate notice of any significant change.

Uniform application of these policies promotes the best outcomes and franchisees should be educated on how to operate the program. Some franchisors may want to grant franchisees the right to have limited discretion in areas such as customizing exclusions, running special promotions to issue additional loyalty program points for local customers, and responding to customer concerns about the program.

The franchisee-facing Brand Standards Manual should discuss the terms for franchisees to participate in the program, limits on their discretion, and the franchisor’s approach to the topics of data privacy, redemptions, and compliance.

3. Thinking through data privacy compliance.

Franchisors typically assert ownership of customer information in franchise agreements. They do so to more effectively control use of data after franchisees have exited the system and to ensure their rights to use data without restrictions. The responsibilities associated with the right of ownership often include the duty of the franchisor to comply with data privacy laws, even if the franchisee first collected the data.

One of the advantages a loyalty program offers a franchisor is the opportunity to gather customer information. That information is then used to communicate with the customer, market to them in a tailored way, and analyze purchasing trends. Most programs we’ve seen require at least a name and an email address or telephone number to register. Some programs may require, or offer the customer an opportunity provide, additional information (birthday, address, purchasing preferences, payment information, etc.).

Gift card purchases traditionally have not required the input of any personal information. However, new e-gift card programs may require the purchaser’s information and the recipient’s information, much like the other details needed when purchasing products online.

In collecting customer’s personally identifiable information, brands need to be aware of data privacy laws that, among other things, can restrict the kinds of information collected, stored, used, or shared and that require advanced disclosures to customers.  For example, California has a robust data privacy regime requires a company to disclose financial incentives offered to customers in exchange for their information. Some types of loyalty programs may require these additional disclosures.  

4. Establish and administer redemption policies.

Gift cards and loyalty programs pose some accounting challenges both at the individual unit level and across the franchise system.

Under general accounting principles, revenue from the sale of a gift card cannot be recognized until the gift card is redeemed. Most franchisors apply that principle and consequently charge the royalty only on the amounts the franchisee receives from gift card redemptions.

If a gift card is only redeemable at the place where it is purchased, that accounting principle is easy enough to administer. However, customers of national or regional brands are likely to expect that they will be able to redeem their gift cards at any location. Applying the sale vs. redemption accounting across multiple locations gets complicated quickly.  The solution commonly looks like this: Customer purchases a $50 gift card at Location A. That $50 is deposited (monthly, weekly, or daily) at an account controlled by the franchisor, its affiliate or a vendor. When the $30 of the gift card is redeemed at Location B, $30 is remitted to Location B and Location B counts it as revenue. If the remaining $20 is spent at Location C, Location C would receive $20 as revenue. Franchisors typically rely on a vendor to manage the program rather than developing the accounting and technology procedures themselves.

Similar questions arise for loyalty programs. What do you do if a customer earns all of the points at Location A (giving Location A the benefit of the purchase revenue) but redeems the points for a free product Location B (giving Location B only the cost of the promotion)? Franchisors have a variety of solutions to this issue, and their approach often depends on industry, technologies available, and size and sophistication of the system. Hotel franchisors are an example of where a robust approach to the loyalty program redemptions is necessary and these businesses use nuanced systems to make the accumulation and redemption of points equitable across locations. In contract, for a start-up retail business, such these adjustments may not be necessary. There, franchisors and franchisees may operate under the “you win some you lose some” mindset.

5. Researching and complying with federal and state laws.

State and federal laws aim to protect customers from unethical or fraudulent business practices. To date, these laws have focused on gift cards rather than loyalty programs.

The Federal Credit Card Accountability, Responsibility, and Disclosure Act of 2009 applies to many types of retail gift cards. This act establishes a minimum expiration date of 5 years, limits the window when inactivity fees can be charged, and mandates disclosures of the expiration date and any fees.

State laws cover similar topics but can vary widely in their requirements for expiration dates (some states prohibit expiration dates), fees, and required disclosures. Some state laws also require a gift card to be redeemable for cash if the value drops below a certain dollar amount ($10 or $1 commonly). The law most protective to the customer will apply if there is a conflict between the requirements of state and federal laws.

Some states have escheat laws that apply to gift cards. “Escheat” is revision of individual property to the state. The principle originated to address situations where a person died without a will and no heir could be identified. In some states, a percentage of the unspent money left on a gift card must be reverted to the state (commonly 60%), while the balance can be treated as income. In other states, the entire unspent balance will revert to the state. It can get especially tricky if the expiration date of the gift card does not align with the escheat dates. A reputable gift card vendor can assist with administration of the escheat process, if required.

Gift cards and loyalty programs are a favorite with customers and can add value to businesses. Under the surface, these programs can bring a host of compliance burdens to franchisors and franchisees alike. Contact your franchise attorney at Manning Fulton for additional advice about how to implement a gift card or loyalty program in your franchise system.