Frequent Flyer Miles are a Profit Center, Not a Tax on the Airlines (Again!)

I’ve said it before, and will keep reminding everyone until the world stops saying ‘frequent flyer programs are going to end’ and ‘airlines need to cut costs by chopping from their frequent flyer programs.’

It’s important to understand the frequent flyer programs are the most profitable part of airlines.

Airlines aren’t just about transportation. In some cases they aren’t even primarily about transportation.

Their loyalty programs in particular were huge innovations. And I’ve written in the past about how United Airliens continued to fly through bankruptcy, that it needed to stay in operation, so support the underlying credit card business(!). That’s why the issuer of the co-branded United Visa provided its debtor-in-possession financing, and also provided its exit financing, not to mention prepurchased blocks of miles to provide additional liquidity.

I’ve given examples of this last notion — the prepurchase of large chunks of miles — with Delta in the past. One more than one occasion American Express has ponied up as much as half a billion dollars at a time to prepurchase miles. They’re determined to keep Delta going and liquid, and are confident enough to put real money on the line.

Alaska Air’s profitability is in large measure driven by Bank of America’s purchase of miles, the volume of which tends to be tens times as great as the airline’s annual profit or loss.

And US Airways’ acquisiton by America West was made possible in large measure by funding from Juniper Bank — which in turn acquired the right to issue a US Airways Mastercard.

Meanwhile, Air Canada’s Aeroplan managed to spin off its frequent flyer program as a separately traded entity, raising much cash. And it has further managed to obtain ongoing fnancing from this separate company.

So it should come as no surprise that American — in announcing $2.9 billion in new liquidity — generated a full $1 billion of that from the advance sale of miles to Citibank, which issues American Airlines co-branded credit cards.

Airlines sell their miles. They have a model where they offer seats that in large measure might otherwise go empty so the programs purchase those seats from the airlines at a discount. They spend less on redemptions than the revenue they raise per mile. They make a profit. And they’re totally in control of their cost structures and inventory.

As long as they don’t mess with the consumer perception of value in their programs, they’re a perpetual money making machine. And the engine that drives their businesses.

That’s why I constantly remind proprietors of these loyalty programs not to kill the golden goose. It’s often tempting to try to ‘reduce costs’ by either limiting the availability of awards or raising the price of those awards. But the long-run effect is to turn off consumers to the programs, undermining their profitability.

Of course, some dimunition in value is inevitable. These are proprietary currencies with no central bank. And as they print more ‘money’ without corresponding increases in the total award seats available, the price of those seats will rise or else severe shortages will occur. Basic monetarism.

Which is why you should always redeem your miles now, they’ll never be worth as much in the future as they are today. But keep earning miles, just burn them in roughly the same period or under the same award chart as they were earned…

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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  1. So how do you explain JetBlue? Certainly no one was flying them because of their frequent flyer program, right?

    I think your argument is mostly limited to the dinosaurs. They’ve become unprofitable and have trouble competing with the low-cost carriers. But the low-cost carriers don’t need frequent flyer programs to attract passengers.

    I also happen to disagree with your overall premise. I think on the whole FFPs are a cost to airlines that they would gladly *all* get rid of if they could (but they can’t because those that continue to offer them would benefit). Imagine a world without FFPs at all. Airlines are all out of business?

  2. The programs are profitable, the major airlines wouldn’t get rid of ’em.

    The smaller carriers are gradually learning how to leverage their programs — once they have sufficient members — hence JetBlue issues an Amex and becomes a Membership Rewards transfer partner.

    There are pletny of things wrong with major carrier business models. Which is why the underlying airlines are unprofitable. But the bright light the legavies have is an accumulated base of customers for their loyalty programs which do make money.

  3. But what is wrong with my logic? The programs *aren’t* profitable, but they would be in worse shape if they got rid of them (because they would be at a competitive disadvantage with respect to those that did).

    I don’t necessarily buy into the “if they weren’t profitable they wouldn’t have them” logic. In business there are many instances where services aren’t profitable but they are kept, for a variety of reasons.

  4. How does the credit crunch play into this scenario as more and more consumers see their credit lines decline and their access to new cards limited?

    Will the decline in credit card usage be the next ball to drop with airlines?

    Less credit leads to less need for miles purchases from the bank.

  5. @Scholar in Training, you miss the point, the programs report their financial results independently and are in fact profitable. Why do you say they aren’t? They sell miles for more than the cost to redeem the miles….

    @Ric – no doubt the credit crunch, and recession more generally, means less spend. And less spend means less mileage purchase. That hurts the programs at the margin. On the other hand you see a flight to value, people looking to get more for their dollar, and perhaps that compensates somewhat. We’ll have to continue to monitor SEC fiings to know the actual effects.

  6. Gary, the airlines report financial results of selling miles but are the costs of miles seats reported? Last I checked they were not. Otherwise how do you justify the claim that the miles are a profit center? We need to know *all* the costs associated with having a miles program, including overhead, administrative, using up inventory, etc. etc.

  7. Check out UAUA’s results, it’s all broken out with full profitability for the business unit (UAL Loyalty Services Inc is a separately incorporated entity). Then come tell me you disagree 🙂

  8. Gary – do you have (or do you know where i can find) the company names for various loyalty programs that file with SEC? I would be really interested in looking at them. thx

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