68-Killing the Goose that Laid the Golden Egg

Here is one of the most successful marketing innovations ever conceived. It has created loyal customers and magnificent profitability. It has carried its companies through years of troubled waters and is largely responsible for their ability to beat back very low-priced competition. It also looks like it is unkillable.

Posted 12/22/08

About twenty-five years ago now, American Airlines introduced the first Frequent Flyer Program, which awarded airline passengers miles for the “mileage” they had flown on the airline. These miles were convertible into airline tickets. This program spawned many copy cat competitors, including all the major airlines, hotels, car rental agencies, cruise lines and many other non-airline companies who wished to create a loyalty program. In many ways, the loyalty programs that the legacy airlines offered enabled them to keep their most attractive customers from falling for the blandishments of discount airlines, such as Southwest and Jet Blue. That may be coming to an end.

Up until about ten years ago, I would value an airline mile at roughly four cents, given the price of flying back then. Today, some experts in air travel estimate that the current value of an airline mile today is about 1.2 cents – that is, when you can get it. Many people seeking to cash in their awards can not use the tickets. What happened? The airlines have raised their prices on these programs and reduced the availability of the awards. (See the Symptom and Implication, “Some competitors seek price increases more aggressively than others” on StrategyStreet.com.) They raised their prices by demanding more miles to redeem an economy seat. They also added extra charges for fuel, issuance of award tickets, and so forth. They reduced the seats available to the award programs. Since there are so many miles chasing fewer award seats, the awards are much more difficult to claim.

The airlines themselves redeem the miles at about one cent. Several airlines, including Delta and United, allow passengers to use miles to pay for tickets on their web sites. These programs value the airline miles at one cent per mile. The same web sites offer hotel stays and auto rentals at less than one cent per mile.

The airline programs are becoming uncompetitive. The current programs in the legacy airlines are less generous than those of most of the major hotel companies and cruise lines. The credit card companies, themselves, now offer cash rebate programs that redeem miles at between one and two cents each. The new Schwab Visa card, which we described in our previous blog (#65), rebates 2% on all purchases. Customers who spend a lot of money are likely to notice these more attractive programs. (See the Perspective, “Failure Shifts More Share than Success” on StrategyStreet.com.)

The legacy airlines are in the process of losing one major advantage they had over the discounters. Only 48% of airline program customers are satisfied with the value they get from the Frequent Flyer awards programs. The percentage who claim that the airline award programs sway the way they make ticket purchases is even lower. It is 25% today, down from 31% only two years ago. Yet, the program’s major purpose is to win and hold customers who fly a lot and spend a lot. It looks from here like those programs are likely to falter.

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Update 2022:

The decline in the value of frequent flyer mileage programs has slowed. Now, however, there are significant differences among competitors, especially when you consider actual dollars spent on an airline.

In 2022, Nerdwallet analyzed the program value per hundred dollars spent for several of the top airlines.  This analysis included considerations of rewards ratio, basic economy flight costs, fees, entertainment costs and pet policies.  This analysis was based on main cabin flight fares and actual dollars spent per flight. If you are a traveler who sits at the front of the plane, the rewards rates will likely differ.  In 2022, you could expect to get about 9 cents in value for every 100 dollars spent with the best airline program, Alaska. That’s far above the 4 to 5 cents per 100 dollars spent you can expect from the big three: American Airlines, Delta Air Lines and United Airlines.  Southwest is 3rd in the industry at 6.6 cents per100 dollars spent.

An alternative more traditional analysis determined and average value per mile for each airline.  The leader in this category was JetBlue Airlines at 1.5 cents per mile.  Southwest was at 1.4 cents, Delta at 1.3 cents, American at 1.2 cents and United at one cent.

The airline industry is using its mileage program as a way to deepen its customer relationships and to raise prices, either through channels or directly with customers, by using the optional components of a price. Some concepts of these optional components follow.

 Change the Optional Components of Price: These Optional Components of Price include several alternatives to obtain premium payments from customers, or to reduce the capital assets the company must use to support the customers. We have found several relatively common components that companies use to raise their effective prices. You may change these Optional Price Components as follows:

Audio Tip #152: Optional Component of the Price

• Add an extra fee on top of the normal variable charge: This extra fee increases the company’s margins and usually reflects a separately identifiable cost in the company’s Performance offering. The company identifies previously free or lower priced benefits that have separately identifiable costs. The company then increases its margins by charging a fee on top of its normal variable charge to improve margins by covering the costs of the newly identified separate benefit. Illustrative Examples>>
• Shorten the normal payment term: By reducing the time the company allows the customer to pay for the product once it has been ordered or delivered, the company reduces the capital assets it must carry for the customer. This raises the customer’s capital costs to finance inventories while it reduces the company’s capital costs to support accounts receivable. The Value to the customer declines. Illustrative Examples>>
• Set or raise minimum purchase requirements: This Price Component assures the company of a minimum amount of sales to each customer. These changes require the customers to increase their minimum purchases and pay for any product that they do not take or use. This component raises the company’s margins by ensuring the company a minimum order from each customer. The Value for the customer declines because it must finance a larger inventory on its balance sheet. Illustrative Examples>>
• Eliminate forms of discount: Virtually all customer relationships involve some discount offer to the customer. The company may raise its prices by eliminating some, or all, forms of discount it offers its customers. This elimination of a discount raises the effective price the customer pays and the margins the company receives on the sale. Illustrative Examples>>
• Set limits on the usage of the product: The company may raise its effective Prices, especially with customers who use the product intensively, by setting limits on the amount of product the customer may use during a period of time. Illustrative Examples

For more context on how to raise prices go HERE. You can use our many pricing concepts and examples to brainstorm improvements for your own company situation.

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Update 2/26

These credit card-based airline loyalty programs have become critical for both customers and the airlines, especially for the airlines. The value of 1 mile in these airline cobranded credit card programs has stabilized at 1.3 cents to 1.5 cents per mile, in theory. In practice, over the years the airlines have changed the rules on these airline miles in their favor. The inflation factor and difficulty in using these miles seem to increase every year. That has caused some dissatisfaction with Medium and Small customers. However, it is unlikely that these changes in favor of the airlines are likely to have a major impact on the profitability of these programs.

One analyst has remarked that the airlines are running their flight business in order to support their credit card programs. It came as a surprise to me that all four of the top airlines would be losing money without the credit card programs. These programs contribute 8 to 10 points to the margins of the airline companies. Over the last several years, their importance has grown.  These programs have grown revenues at roughly 9% a year, far outstripping the 5% per year growth in global airline passengers.

These loyalty programs are behind much of the success of the legacy airlines beating back low-cost carriers. They create strong loyalties and high switching costs with the industry’s most important customers. Roughly speaking, the top 10% of flying customers fly 50-100 trips a year and produce 45% or so of airline revenues. These are the industry’s Very Large customers. The next tier of customers, the Large customers, fly 11-49 trips a year and contribute roughly 15% of airline revenues. Medium customers fly 3 to 10 trips per year while Small customers fly less than three trips a year.

These loyalty programs have different importance for these various size segments of customers. For Very Large and Large customers these programs are defining and critical to their choice of airlines. These programs provide them with elite status benefits, upgrades and predictability in services and treatment. Any awards from their use of the credit cards in everyday spending is irrelevant to their choice of airlines. The case is less clear with the Medium customers. They do value the occasional free flights and credit card-based airline perks like early boarding.  They choose airlines, however, based on network Convenience first and loyalty second. They value financial rewards from the credit card companies. Finally, these loyalty programs have little affect on the airline decisions of Small customers. Most of these customers choose an airline because of its schedule, not its loyalty program. In turn, the airlines make more from profits on the cobranded credit cards of those flyers than they do from flight revenues.

Overall customer satisfaction is stagnant to declining with these programs. The problems surround the use of the miles to get free flights. The airlines have increased their fees for use of the programs and have made the rules more complex and confusing for passengers. The biggest issue has been the introduction of dynamic pricing by the legacy airlines. Prices may vary from hour to hour.  Mileage requirements follow ticket prices, which means that customers can no longer predict exactly how many miles they need to obtain a free flight. The required miles are far less predictable with dynamic pricing.  Customers feel like the airlines are moving the goal posts on them. Some customers have become disenchanted with the programs and have turned instead to other loyalty programs such as those of hotels and to the increasingly common 1½ to 2% cashback offers on other credit cards.

These credit card competition developments are unlikely to cause financial harm to the airlines. They primarily affect Small and some Medium customers. Some may be willing to switch out of airline branded credit cards. On the other hand, the Very Large and Large customers aren’t going anywhere. Their travel benefits from the airlines have a value far exceeding a 1 to 2% cashback benefit from alternative credit cards. The vast majority of the revenues from these credit card loyalty programs are not going away.

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