The pandemic has clarified one issue we long-suspected but now have numbers to back-up: airlines are in the loyalty business to make money and those frequent flyer programs are the reason why airlines performed so well financially prior to the pandemic. The reliance on loyalty creates a dilemma for airlines: will squeezing more profit through cutbacks and “enhancements” actually increase profit or ultimately diminish it?
Airlines Make Money Through Loyalty Programs, Lose Money Flying
Chew on this: in 2019, the American Airlines AAdvantage program generated $5.9 billion in cash collections with a margin of 53%.
As noted in the Wall Street Journal, Stifel analyst Joseph DeNardi projects that the equity in AAdvantage is $31.27 billion while the equity of the core airline business is -$19.45 billion.
Sure, the pandemic has exacerbated the issue, but even before it American Airlines lost money flying. And a lot of it…
Delta and United also leveraged their frequent flyer programs. These programs also count for the bulk of their profits and DeNardi also projects that United Airlines loses money flying.
The Implications For Airlines
My financial analysis stops here. Instead, I want to discuss the implications for loyalty and issue a warning to folks like Rick Elieson at American Airlines, Karen Zachary at Delta, and Luc Bondar at United.
Airlines need loyalty programs to survive. But it’s more than that: they need consumer interest in those loyalty programs. That means they need to offer value in order to cajole customers to be loyal. And when they do, customers pay more. Certainly, I can personally testify that I often pay more for airlines I want to fly.
We’ve seen nasty devaluations over the last year at Delta and United. Many of my readers have responded by cutting up their airline co-branded credit cards. I have too. Let’s not kid ourselves: we’re not the only ones.
Being an airline free agent has its advantages, but historically there has been such a tremendous two-way benefit to loyalty. Customers still want that. I certainly still want that.
And so, particularly as we enter the beginning of the end of the pandemic, airlines face a choice: continue to tighten the screws which push away discretionary passengers or offer the sort of value that rewards those willing to go out of their way to fly your carrier.
I’m talking about many things. Onboard service should return to pre-pandemic levels, a reason I paid a huge premium to recently fly JetBlue (and would do it again). Loyalty program devaluations should not punish those who redeem for premium cabins by removing sweet spots that were mutually beneficial and thereby mutually profitable.
A continued erosion of value in the frequent flyer program will inevitably lead to more customers simply cutting up their co-branded credit cards. When that happens, the gravy train ends.
It’s really that simple.
As airline loyalty programs devalue, discerning customers will simply pivot to cash-back credit cards or cards with flexible transfer partners. It’s already happening, but it’s not too late for an innovating airline to offer more value in a way that will attract new customers. Coupled with honesty and transparency, I view that as a recipe for financial success.
I find the numbers shocking, but not just because I never figured airlines relied so heavily on loyalty programs to drive profits. I also find the numbers shocking because I view many of the customer-unfriendly devaluations we have seen over the last year as biting the hand that feeds it.
That only works for so long.
Spot on target Matthew.
I am a Southwest loyalist and value the clarity, predictability, and ease of the program. The value proposition is clear – I know I won’t get outsized value on my redemptions, but I can expect that I will be able to book any seat on the plane with my points if I need or want to. I know that every dollar I spend on my Southwest credit card is one point earned toward re-qualifying for my companion pass, which has provided my wife and me with a ton of value over the years. Again, never any outstanding value on spend, but a thoroughly decent place to park unbonused purchases with a clear value proposition and very little goalpost-moving. It is a nice contrast to other major programs, which it difficult to find redemptions on the schedule you need.
I finally “cut up” my last UA card. Not out of spite, but because they made it worthless vis a vis impossible status requirements. They clearly don’t want people like me chasing status each year. Well fine. There goes my $1000 in UA tickets plus $25000 transacted at Chase. I just flew on AA for the first time in over a decade (maybe ever). So actually, some spite may have been involved 😉 But I still think FFPs are a good value proposition (better than cash back cards). Outsized value as gleff likes to say!
AA, DL, and United think customers want a small rebate for their next economy flight. They keep saying that is what most redeem for. That may be true. However, aspirational travel or the idea you can redeem for something you generally wouldn’t pay for is what generates “irrational behavior”. These execs are overpaid and don’t understand what people want.
Has anyone thought or pondered what effect on cost of travel would be if all the “rewards” programs halted? Years ago we had the “green stamps” and yellow ( Value stamps) amazing one day they’re gone and prices dropped. I don’t think anyone out there believes we are not paying for the privilege of belonging to one of these programs I mean someone has to pay for all this and that person is the traveling g public irrespective whether you belong or not. I remember when Eastern Airlines sent their high mileage customers a special card etc for upgrades to FC space available, free. But then those days we also had blank tickets which we could simply walk up to the counter write out a ticket and board, damn I’m old.
Just think of all the privacy and data collection we are giving up in the name of “Free”
I find it hard to believe that FFP are raising prices. Ostensibly, they are simply selling inventory that would’ve gone to waste. Even if you consider overhead, they are raking in tons of money from flyers, banks, partners, etc. This is in contrast to giving away toasters, which has very tangible costs: the toaster, storage, shipping, printing catalogs, CSRs, etc.
I like to say these airlines are really just miles/points programs with auxiliary flight operations.
“the American Airlines AAdvantage program generated $5.9 billion in cash collections with a margin of 53%.”
What does that mean? Is that $5,9 bn generated from ticket sales to AA members? Numbers can be misleading because just because a person books through their loyalty account does not mean their primary reason for booking was loyalty to AA. It could also be that AA had the better schedule/route/price.
There are things that can be measured easily. Those include your costs and your revenue. Then there are the things that don’t measure well. Those include the effect your actions have on the systems of biases and heuristics that are your customers. If you do it right, you can reach a point where your customers will think a good value what gives you far more revenue than costs.
But, here’s the thing: the correlation between cost and perceived value isn’t clear, and the temptation is always to keep cost down, since perceived value cannot be easily measured
So, under cost pressure, amateurs cave. Pros refine to maximize profits. Remember, two dollars a head in extra cost makes sense if you keep the number is pax the same and range in ten dollars a head more money.
So, yeah, I’ll spend more money on a trip if the experience is more human. I’m not the only one — another rule is that IRROPS define the retail interaction. What happens when something goes wrong? Do you give gate staff and passengers rolling “15 minute” delays? Or do your get a decent estimate, with updates?
Very well said. I closed my last Delta credit card a few devaluation cycles ago – in October. My first years involved in miles and points I was rabidly loyal to Delta as an elite despite never getting an upgrade. Over time Delta managed to poison that loyalty sufficiently that at this point I will fly pretty much any other airline before them. Loyalty programs are supposed to induce people to make irrational choices that favor the company. Frequent flier programs in the US are moving in exactly the wrong direction on this. Remember well under a decade ago when Delta literally asked what your frequent flier program has done for you lately? Contrast that with the way they’ve acted since and it’s not a pretty picture.
I think it will take a while for this to shake out, and I suppose airlines could always pivot if it becomes blindingly obvious to them that things aren’t going back to the way they were before.
But right now, not many people are earning miles by flying, but are earning miles by spending – and not using a lot of them. In my case I am sitting on over a million on Amex and a nonbranded VISAs that can be used for any number of transfer partners. And that is on top of a couple of hundred thousand stranded at AF and BA. I doubt I am the only one like that. Once people start traveling more, particularly international, those are going to hit the market and get used up before people spend cash to fly.
In the meantime, I am flying solely domestic, and based on the route and then who has the best service. And I usually buy F or business, while using miles transfers for family members. Paying more for an inferior product just to chase a status level that is now ridiculously out of reach makes no sense.