Why Starbucks Wants You to Load Up Its Prepaid Visa Debit Card

By Markets Fool.com

Starbucks COO Kevin Johnson shows off the upcoming prepaid debit card at the company's annual shareholder meeting on March 23. Image source: Starbucks Corporation.

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Starbucks Corporation executives often state their goal of building a digital ecosystem using Starbucks Rewards "stars" as a type of digital currency. Last week, the company announced another step toward this dream at its annual shareholder meeting. Late this year, consumers will be able to use a prepaid debit card, which the company is developing with JP Morgan Chase & Co. , to earn stars wherever the "Visa" symbol is accepted for payment.

The reloadable card, dubbed "Starbucks Rewards Prepaid Card from Chase," is first and foremost an attempt to increase Starbucks' brand visibility and loyalty. Customers will be able to apply for the card on Starbucks.com and, even more conveniently, apply from within the company's mobile app. Chase has confirmed that the rewards card will be free of some of the fees often associated with prepaid debit cards, including loading, overdraft, and monthly service fees.

Starbucks' deal with Chase achieves several additional objectives for the company. As I mentioned at the outset, the card expands Starbucks' budding digital ecosystem, while potentially drawing new customers to its existing rewards program. It also firms up the relationship with Chase, which has all but become Starbucks' primary transaction vendor for its ecosystem. The company recently named Chase to succeedSquare as its transaction processor for non-mobile payments. Chase is also charged with rolling out chip-enabled payment terminals in Starbucks' stores.

As Chase is forgoing some fee revenue, as well as potential financing revenue had the two companies jointly issued an affinity credit card, the bank most likely views this deal as a relationship investment in anticipation of further revenue opportunities in the coming years.

Creating a "digital currency" isn't easy
The details of how stars will be awarded on the Visa rewards cards haven't been shared as yet, and it's likely the company hasn't completely answered the question internally. Starbucks' Chief Operating Officer, Kevin Johnson, noted last week that stars wouldn't be earned at the same rate as coffee and food purchases through the newly revised loyalty program.Under the new loyalty program rules, points will be earned at the rate of two stars for every dollar spent, starting in mid-April.

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Allowing customers to accumulate stars through everyday purchases may create value in cardholders' accounts which is difficult to reconcile with the current value of $0.50 per star. For example, even if Starbucks comes up with a highly depreciated formula, say, one-tenth of a star per Visa card dollar spent, what happens if a customer spends $1,000 in a month on a reloadable card? Will the customer then be eligible for $100 of Starbucks coffee and food? Even at a rate of one-twentieth of a star per dollar spent, a reward of $50 for every $1,000 in purchases doesn't sound like a profitable proposition for Starbucks Corporation.

To solve this problem, the company may turn to limiting either the amount that can be reloaded onto a card in a given month, or the number of stars one can earn during the month. These star value considerations, and their limitations, are indicative of a larger issue that Starbucks will encounter if it truly wants to convert its rewards stars into a type of digital currency. For each partner or new deal the company adds on, it will have to keep the value of a star in at least approximate parity with existing star-earning opportunities.

A prepaid rewards card offers one tangible reward for Starbucks itself
Despite some possible rewards points complexity, Starbucks stands to reap a specific benefit from its card deal with Chase: better cash flow. The company discovered something of a minor gold mine when it began offering its own non-debit prepaid loyalty cards a few years ago. On these transactions, when cards are loaded, the coffee retailer receives funds instantly. It records accruals each month against liabilities for unused card balances, and even gets a small profit boost from the monies left on cards which aren't redeemed after a reasonable period.

In fact, if you pore over Starbucks' operating cash flow for the past few years, you'll see that, excluding a one-time $2.8 billion legal accrual over a licensing dispute with Mondelez International , no other item has affected working capital with as much effect as the balance sheet account known as "stored card liability." Offering prepaid cards has resulted in a positive net cash benefit to Starbucks, which has averaged $150 million annually over the past three years.

This is one of the most cogent reasons for Starbucks to issue a prepaid debit card with Chase, versus the more typical credit card we're used to seeing offered up by the airline and hotel industries. Starbucks loves being paid up front, often well in advance of having to render merchandise back to the customer. But which well-run business doesn't?

The article Why Starbucks Wants You to Load Up Its Prepaid Visa Debit Card originally appeared on Fool.com.

Asit Sharma has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.