Understanding Frequent Flyer Miles as a Proprietary Currency With No Central Bank, or What Unannounced Changes to Expect From Your Favorite Frequent Flyer Program?

Recently on Flyertalk there were dueling threads in the “MilesBuzz” forum (which I moderate) about whether miles were on their way to increase or decrease in value. The latter contained the usual arguments of doom and gloom, and perhaps it was just one member’s effort to be contrarian but the thread about miles increasing in value sought to turn the usual arguments on their head.

It didn’t make the claims I’ve offered in the past about the relative ease of earning miles compared to the past and the advent of alliance awards that give you access to the award inventory of airline partners allowing you to travel across the globe in ways that didn’t exist in the “good ‘ol days.”

Instead, the argument was that as the price of oil goes up, capacity falls, and prices rise, award tickets generate more bang for the buck. A simple 25,000 mile award might have secured a $250 ticket a couple of years ago, but it might be redeemed for a $750 domestic ticket a couple of years from now. Tripling in value. Bam!

Of course, this analysis is probably wrong, because it assumes (1) that the mileage price of an award stays constant rather than requiring more miles for the same award and (2) that the award seat you want is available, or at least just as available as it was when the ticket price was $250. Neither condition is especially plausible.

I’ve found that the best model for understanding frequent flyer miles is that of a proprietary currency. Miles and points are like dollars, printed by airlines and hotel chains instead of by a government. And while I may have my issues with Federal Reserve policy now and then, in the case of these proprietary currencies there’s no independent central bank or other constitutional constraint that causes the currency issuer to avoid inflation.

Given an analysis of miles as currency, a rudimentary monetarist formulation of mv = pq sheds a great deal of light.

M = quantity of miles (money)
V = velocity or the speed at which that currency circulates
P = average price of goods purchasable with that currency, in this case the award chart
Q = quanty of goods (award seats)

If the speed of recemptions stays constant, and the quantity of miles outstanding grows, then either the quantity of award seats needs to go up or the price of those seats has to go up.

That works well in an expanding airline universe, where new planes and new routes are coming online. And it works well when airlines are flying empty planes, there are simply more unsold seats to get redeemed as awards.

But when capacity isn’t growing as quickly as outstanding mileage liability, you get either a difficulty in redeeming awards (a slowing down of ‘v’) or an increase in the price of those rewards (gutting the award chart aka an increase in ‘p’).

I first wrote about this model in 2003, and it’s served me well. There are very few cases where the value of a given set of miles has gone up. In most cases the value of miles has gone down. Most often this has happened through airlines increasing the cost of awards (it takes more miles to redeem for the same seat). In some cases it’s taken the form of increasing the cash cost that accompanies miles (telephone booking fees, now American even has a web booking fee, fuel surcharges on award tickets to a free ticket is no longer free, and higher award change fees).

And yet I’m not a mileage pessimist! My advice isn’t to “walk away” from mileage programs, as so many commentators offer. They still offer amazing value. I still redeem for international first class awards every year, and have had the pleasure of enjoy the offerings of All Nippon Airways, Asiana, Thai Airways, Lufthansa, Qantas, Air Tahiti Nui etc. over the past couple of years. That has meant free access to the Thai Airways spa in Bangkok, the Lufthansa First Class Terminal in Bangkok, Asiana’s amazing long-haul service and Korean food, etc. etc. Worthless? I think not!

The advice, instead, is to both earn miles and burn miles at a roughly equal pace, to redeem in the same period you earn so that both sets of activities roughly correspond to the same award chart. And not to save for a rainy day, but enjoy the dream trip now and then start saving for the next one.

This is especially important because the frequent flyer world is changing as airlines’ fortunes change. Of course, if their profitability returns, it’s entirely possible that their loyalty programs will morph again.

But the value proposition of mileage programs to airlines (the story is a little different for hotels, and I won’t deal with that here) is changing.

Take that simple 25,000 mile North American domestic coach award as a simple example. Mileage programs are set up to sell miles — whether to their affiliated programs or to their partners like credit card companies. Say that they sell those 25,000 miles at 1.3 cents apiece and generate $325. Then they go about redeeming the miles for seats on their affiliated airline at roughly the marginal cost of the airline carrying an additional passenger. Say the cost to the program is $25 for that seat. It would otherwise go unsold, which is why the airline makes it available as an award. The loyalty program makes $300 in profit. Great business!

Here’s the problem. What happens when there aren’t very many seats an airline expects to go unsold, due to shrinking capacity and strong demand? The airline can’t sell that seat for $25 any longer, since it would be displacing a paying passenger. So either the seats at the 25,000 mile level dry up completely — a bad value proposition for members and something that will undermine this multi-billion dollar business — or the program is going to have to start shelling out more for the seats, enough to compensate for the passengers they’re displacing. If they have to pay $400 for a seat, they can’t really do that on $325 in revenue. They need to charge more miles. A 50,000 mile award that generates $650 can profitably cover a $400 seat.

As long as the airlines are shrinking capacity, and unless the number of miles being awarded correspondingly contracts (hardly likely), we have to see an increase in the scarcity or price of awards.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community InsideFlyer.com, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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Comments

  1. >As long as the airlines are shrinking capacity, and unless the number of miles being awarded correspondingly contracts (hardly likely), we have to see an increase in the scarcity or price of awards.

    I think it’s quite likely that the number of miles being earned will decrease. As miles become worth less, people won’t “purchase” as many through credit card use. Actual flight miles will decrease with capacity cutbacks.

    But award prices could still increase or availability could decrease even as the total amount of miles earned decreases slightly. People are definitely looking to unload their miles these days, if for no other reason that to avoid paying $600 for a domestic round trip.

    Southwest Airlines allows you to restore an expired round trip award for a $50 fee. It seems to me that intentionally allowing an award to expire with the intent of paying $50 to use it in a future year would be an excellent way to insure yourself against fare increases. Except that the $50 fee could increase or the option could be eliminated.

  2. British Airways actually severely decreased the number of miles earned on cheap economy tickets a couple of years ago.

    I would be interested in a few words about the hotel chain point/miles situation

  3. I concur with the challenges presented by frequent flyer currencies and the inability to translate the currency into a seat or other desired item.

    At LoyaltyMatch(yes I am the cofounder), we take this challenge seriously and are working to provide relief to frustrated FF members.

    Check us out at http://www.loyaltymatch.com and let us know if our solution is as Tim W at Smartertravel.com stated “the next big thing” to assist frequent flyer currency challenges?

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