What Economics Tells Us About Mileage Inflation, and Why United is Now a Banana Republic

Ten years ago on Flyertalk I outlined a simple model of why we can expect frequent flyer programs to devalue over time.

I explained that frequent flyer miles are a currency, but they are printed by a single company and there’s no independent central bank or other body whose job it is to defend the value of that currency.

When programs ‘print miles’ but the number of redemptions available doesn’t increase proportionally, prices will ahve to rise.

We can understand the move to offer ‘miles for merchandise’ and even ‘miles as money to buy travel’ as (partially-failed) strategies to help increase the number of redemption options and serve as a release valve.

Milton Friedman…showed the world that inflation is a monetary phenomenon — increase the supply of money in the economy, and the general price level will rise.

The famous and deceptively simple formulation of this is: mv = pq

m = quantity of money
v = the speed at which money circulates in the economy
p = general price level
q = quantity of goods

Friedman argued that the speed at which money circulates is, generally speaking, constant. Folks plan over time for their spending needs. On the whole, if people get paid on Friday they don’t spend all their money on Saturday but spread the spending out until their next payday. (Obviously this isn’t universally true, but on a macro level it winds up being true.)

The upshot of this famous formulation is that when m goes up, p or q needs to go up. If the quantity of goods remains constant (q), that means that p (price) must rise and you have inflation.

I think that this simple formulation is helpful in thinking about loyalty programs.

If m = miles, v = the speed at which folks redeem awards, p = the price of awards, and q = the supply of available award seats, then…

Sometimes the speed at which awards are redeemed goes up. For instance, when loyalty program members are uncertain about the future of their points. There is a common belief that when United declared bankruptcy, there was a ‘run on awards’ — people believing that they needed to cash in now while the airline and the loyalty program was still around.

But on the whole, the fact that 8% or so of seats go to award redemption (over time and across programs) suggests that v is usually stable.

That means that if m — the quantity of miles or points — goes up, then one of two things has to happen:

Either the quantity of award seats have to become more available, or the price of awards has to go up. Otherwise there will be a shortage.

…And since it’s so much easier to accumulate miles than at any time in the past — as programs sell miles to all comers, and miles have become such a popular phenomenon and useful marketing tool — the quantity of miles is ever increasing. It’s profitable to the airlines to sell miles.

That means one of two things happens:
* The quantity of award seats goes up
* The price of awards goes up

I said that means we’re going to see devaluations. And we have, in fairly predictable patterns.

They don’t really happen during recessions, and not just because you don’t want to anger customers when few people are buying your product. Seats and rooms are empty so there’s not a ton of pressure on your inventory. Prices of that inventory are down. But when the economy comes back nd seats and rooms fill up, inflationary pressures return.

The Washington Post basically laid out this same theory on Friday, with the subhead “Why Hilton and United Airlines should think about hiring Ben Bernanke.”

Loyalty points are a form of money. And their value is determined by the policies of the company that issued them. Similarly, real money is issued by the government (specifically by its central bank), and has value that is ultimately determined by the actions of that government.

The loyalty points that a company has issued amount to a liability on the books of the company that issued them.

…But unlike when the company borrows money from a bank or bondholders, with loyalty points the firm has total control over what those liabilities actually are worth. The company keeps the power to devalue the points at any time, which would make its balance sheet look better.

That gives a CEO facing a rough patch every incentive to devalue the points. It is a way of improving the company’s financial position just with a change of policy. But while it seems easy, it comes at a long-term cost. You are angering some of your most loyal customers, essentially exacting a tax from the people who fly your airline most often. If you get a reputation for devaluing points all the time, they may even switch their loyalty entirely, and start flying Delta instead of United or staying in Marriotts instead of Hiltons.

This is exactly the dilemma facing governments. A government that has a lot of debt can improve its financial position by devaluing its currency. Suddenly the debts it has incurred are worth a lot less! It is the easiest way to fix a problem in the short-run.

…in the long run, a country is better off with sound monetary policy that preserves the value of the currency (most modern industrialized nations have concluded that annual inflation is optimal around 2 percent).

The advice I gave in 2003 remains true today:

I’m not saying that we should all burn our miles with abandon. But I am saying that the best way to enjoy these programs and capitalize on their superior value propositions is to redeem miles as you earn miles. Waiting simply means that past earnings will buy less in the future.

That is, until we get an independent central mileage bank. And until we install Paul Volker, Alan Greenspan, or Joe Brancatelli as Chairman.

The Post‘s mention, of course, is of Ben Bernanke. But I didn’t know he — or Janet Yellen — would lead the Fed in 2003.

After United’s big announcement of devaluations of in some cases more than 80%, we can now think of MileagePlus as ‘the Banana Republic of loyalty programs’. The IMF won’t lend to them. But presumably Chase still will…


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. I believe that with people `investing` in points for travel more now, not just the people who read blogs, but the boomers going on their once in a lifetime trip, we WILL see government action regarding devaluations soon. I have been saying it for years now.

  2. If UA ia a banana republic, what is Delta? You coined Skypeso’s, so I imagine they could be Venezuala? Honduras?

    How about Air Canada? The Iceland of mileage plans?

    I hope AA and US hold out (don’t devalue), either together or merged.

    But, I am following your advice from 2003 in the event they devalue too: Earn, Burn.

  3. Most United customers redeem their frequent flyer miles for Saver Award coach seats, and to them this devaluation is virtually meaningless.

    In fact, I’d argue it’s a good thing for them. At least you know that United’s mileage chart should be free from devaluations for the next few years.

  4. I think your analysis is very interesting. However, maybe it should be tweaked a little.

    (1) In the case of the US dollar, the US government has passed laws that make the dollar legal tender. There is no substitute to the dollar in the US. In the case of miles, there are substitutes, paying cash [cash back anyone] or flying for another airline. Therefore, if the value of miles falls below the price of miles, then people (though Adam Smith’s invisible hand) will move to the substitute.

    (2) “The IMF won’t lend to them. But presumably Chase still will…” Yes, Chase might lend to United based on Chase’s lending standards. As of the publication date of the 10K (February 2013), UAS was rated B by S&P, B2 by Moody’s, and B by Fitch), low junk. Not too good. Most likely any debt is secured and/or disbursements are restricted by covenants.

    (3) Although I have not looked at the contract between Chase and United with respect to miles, I believe that Chase is not lending to UAL based on miles, instead they are purchasing the miles. If the demand for miles goes down, then the volume of such purchases will also go down.

    (4) In the instance of advance purchases, clearly, anything that affect the value of miles to Chase (or other credit card companies) will be reduce the price that Chase is willing to pay for large blocks of miles. Further, devaluations should eventually how affect much Chase is willing to pay for miles. (This depends on how much value Chase is obtaining from the miles.)

    (5) For a below investment grade entity, liquidity is very important. Selling miles is a source of liquidity. If the customers do not see value in miles, Chase will not see the value in miles, and will not be willing to buy large blocks. This could be material if United is in a cash crunch and need immediate liquidity.

    Therefore, although I think your currency analysis is spot on, I believe the above considerations should also be taking into consideration

  5. Nice post. I really don’t mind the award price going up but in such huge amounts is a mistake in marketing I think. They should adjust the amounts annually in small amounts to stay on pace with costs, etc. Also what is interesting is if it cost say 50k for an award ticket and you earned those 50k miles over 5, 10 or 15 years. As the cost of travel increased so the did points or miles cost so there should really be no adjustments ever as they make more money per point or mile that you earn. It’s a pure increase at the expense of the customer. If the other airlines are smart they would not try to match this United reward cost increase. That could push more business toward them from frequent flyers.

  6. I am not a frequent flyer but I am a reader and have several of the credit cards you recommend. Before I found your site I thought FF miles were of very little value to me. I still think that. I like the Hyatt card through Chase. I get one free night a year for $75 and I can redeem my points without unreasonable blackouts — at least so far. But for someone like me who take one or two long distance trips a year I am thinking of switching to a cash back card. I know this won’t get me much but what I get will have value.

  7. So given the situation, I am planning to move to a different Star alliance carrier because the redemption chart is more favorable in other programs if you want to redeem on partners. One good thing left about mileage plus is 25, 50, 75, 100% bonus for elites but with the current devaluation, it is not that attractive anymore.

    US airways is going to join OneWorld, so that means I have to find non-US airlines. Any suggestions? Ideally, a program that gives bonus to premium cabin travels and has an ability to earn wide range of fares on *A.

  8. Gary, there are a lot of interesting points to be had here, and a lot of questions to be asked. But my grasp of economics is tenuous at best, so I’ll stick to a simple one…

    Why do you think that these programs devalue in such vast, unnanounced increments, rather than perhaps just doing an annual adjustment that comes to be expected, the value of which depends on the previous year’s financials and redemption statistics?

    Wouldn’t the latter case go over much better with customers?

  9. Any chance you have any old award charts saved and can let us know what amount of miles were required for redemptions back in the day?

  10. The airlines need to kill these programs as they have become monsters.

    The miles represent a call against future delivery of their product for which they’ve already been paid. They reduce the value of their premium, high margin/profit product and worst of all from the airline’s point of view allow customers to effectively trade low margin purchases (points earned on discount coach travel) for a high margin reward (travel in F and B).

    The original thinking that the reward was worth near zero because you can’t sell an airline seat once the door is closed. What that ignored was the arbitrage opportunity. When these programs began every seat was available for award travel. A First Class ticket was 50,000 miles, the airlines were giving triple points and an round trip from SF to NY was $198. Do the math. For just over $600 you could “buy” a ticket in F anywhere the airline fly. On TWA that 50k award also allowed you to upgrade a second person from the most deeply discounted coach to F on top of the free one.

    No wonder they went bankrupt.

    Obviously the airlines had miscalculated and UA’s recent move is another towards reducing the value of the rebate to a point where it is insubstantial. That is the end game here. The days of being allowed to travel upfront for a small fraction of the market price are slowly, but surely, coming to a close.

    Having used these programs as a source of cheap financing (we’ll gladly fly you someday in the future if you will pay us today) that they would rather not have to pay back, they simply render their currency increasingly worthless. Sound familiar? It should, because its just how nations that can’t, or don’t want, to pay their debts act. Inflate your way out of the problem rather than outright default.

    So travelers aren’t only the airline’s customers, they are their creditors as well.

    United has shown how they intend to handle their debt obligations, which is to say effectively default. It will be interesting to see if other airlines take the same road or if some of them realize they can gain significantly by taking a very different route and if so which ones will go which way.

  11. @David, spot on. Still depends on your short term goals. Cash will always be king (except in Weimar republic). For your average spend, get a cash back card. Sign up bonuses are still attractive.

  12. I get utility out of having the miles as well as burning them. With two young kids, I’m not going to Mauritius anytime soon. But it gives me comfort to know that if I really wanted to, I could. So for me, earn and burn isn’t the full answer.

  13. Frankly it’s not clear to me that the earning part of “earn and burn” is still a good strategy. I say burn and stop earning; fly based on cost and convenience.

    I also agree that ultimately miles programs were bad for airlines.

  14. @Steve. I am talking in theory since I have not actually looked at United’s financial statements trying to figure out the real Frequent Flyer (FF) program numbers. Therefore, I will use simple hypothetical numbers to illustrate a point. Suppose there are two cases of the world:

    (1) Assume FF points are sold for 1 cent, but tickets from the airlines tickets on average cost 0.5 cent. In this case, every year, the program is additive to income. Although a sudden devaluation of points might improve the balance sheet and make Smisek look good, it might kill an ongoing business and will weaken the airline in the long run.

    (2) Assume FF points are sold for 1 cent, but purchasing tickets costs 1.5 cent. Then of course, the program is cash negative and the Company should increase price of miles and decrease the payouts to be cash positive.

    You seem to think the case if “OBVIOUSLY”, Case 2. I am not so sure. People do not have to fly. The demand curve is very elastic depending on price.

    Listening to Smisek, he seems to think he can increase the price in tricky ways (fees) and reduce quality (getting rid of high quality cashews in business, reducing the quality of meals in business, decreasing the value of FF program, reducing access to economy plus, packing more people in planes…) and not reduce demand. Therefore, I lean towards case 1. In the short run, Smisek will increase the bottom line, but in the longer run, people will figure out what he is doing and demand for product will reduce.

    But you are arguing Case 2. I think you were arguing because many years ago some people got too good a deal. Maybe you could explain further. Even better, maybe you could go the United 10K and figure out what the real numbers are.

  15. You are waaaay overthinking this Gary.

    UA’s move here is very simplistic. Redemption of premium class partner award tickets has become extremely popular in recent years, largely because of people like you blogging about them! These awards are expensive for UA to “buy” from their partners. They did not anticipate that expense, and they want to reduce it to what they think is reasonable. They have BARELY devalued the program for most flyers; they just want to discourage their customers from spending their miles the way you like to spend them (which is costly to UA).

  16. Great analysis and analogy – and very true!
    United is improving their financials by reducing their outstanding debt. Because they sold a lot of miles to credit card companies, they now are increasing the price of the seat.
    I disagree with some of the comments that the loyalty programs are bad for airlines – they worked in their original form, by increasing loyalty. I earned the vast majority of my United miles through business travel on premium tickets. And the program encouraged me to consolidate my spend with one airline.
    I think the excessive selling of miles to credit card companies in the US forced the devaluation, especially of the partner tickets – it is a lot harder to earn miles through credit cards abroad than it is in the US!
    I had to chuckle (one of those painful ones) about the “banana republic”, sad but true.
    If Delta has SkyPesos, I suggest to name United’s currency the StarDongs – the Vietnamese Dong is 21,000 to the USD (vs 13 MexPesos to the USD)…

  17. I don’t think Gary is overthinking it. It’s a huge devaluation for basically all of UA’s frequent fliers. If you take a listen to the latest quarterly earnings call its pretty obvious UA’s management is under pressure to improve financial performance. If they had industry leading PRASM and profits they probably wouldn’t need to take this rather short sighted approach which has the potential to backfire.

  18. For those of us who’ve been earning FF miles since the programs started in the 1980s, the latest round of devaluation is just one more episode in the loss of benefits. When the programs started most offered a pair of F tickets anywhere the airline and/or its partner carriers flew for about 150K. That’s 75K a ticket which will soon be going for 180K, give or take a few thousand. But that’s not all. We also got a week in a hotel suite AND a week’s luxury car to go with it. (And each element could be taken separately, as could the F airline tickets!) So while this latest round by UA (and AC before it and we can assume AA soon…my three primary programs) is upsetting, we long timers have learned to expect such winnowing down of the value of our nest eggs, and no longer expect to be winging around the globe on our “retirement” FF accounts.

  19. “It’s a huge devaluation for basically all of UA’s frequent fliers.”

    That is empirically untrue. Gary has the comparison chart a few posts below. It is only a “huge devaluation” if you enjoy flying up front to Europe and Asia on UA’s partner flights. Gary certainly does, and I don’t blame him one bit! It’s nice — way nicer than the service you can get on UA.

    But it’s also been painfully obvious that these luxury redemptions were underpriced before. Like a 5-star hotel doesn’t cost only 2x the price of a 3-star hotel. Certainly the airfares on these routes weren’t only 2x the price of comparable coach airfares. It is no secret that these high value redemptions were the prize spoils of credit card churning — not necessarily UA’s actual “best” customers. Generally, when folks are getting a deal “too good to be true” — and that deal is heavily publicized it changes. That’s all that happened here. You can still get around the world for very cheap. You just can’t do it in the lap of luxury for very cheap anymore.

  20. DavidB —

    I remember those great redemptions. But they did involve actually FLYING the airline to get them. And partner awards were few and far between. And there weren’t any crazy credit card bonuses.

    Times change. Overall, even with the latest changes, I can’t say I’m worse off today than I was then.

  21. I don’t understand this obsession with credit card churning. I think credit card churners reflect a tiny tiny fraction. I have had 3 UA/Chase Sapphire/CO credit cards in over 10 years of flying UA/CO and I suspect I’m the higher end of the spectrum. If you are spending $20K+ a year and racking up several hundred thousand miles a year guess what: Going to Orlando in economy is not a great use of your miles. I agree some people may just want to do that. But United’s high revenue customers in general don’t. And that’s who the are screwing over with this change, their best customers.

  22. @Nick

    United is definitely screwing over that segment of Mileage Plus customers who choose to redeem their miles in the front of the plane. Whether those are United’s “best” customers is an assumption of which I’m unconvinced.

  23. I’ve never seen a blogger toast to himself as much as here, especially when making fairly simple and non-controversial predictions or claims, like points devalue over time.

    FYI – monetarism has many drawbacks, such as excluding factors that also affect the real economy, like productivity and level of employment.

  24. Flyer Fun,

    The problem isn’t as straight forward as you make it out. Consider for example yield management. The goal is to maximize the total amount of income for each flight. This is accomplished by attempting to price each ticket at precisely what each customer is willing to pay, never charging less where someone would pay more nor losing a sale because they were only willing to pay a bit less. That alone is a very tricky problem.

    But Y is a commodity without cache, so there is good reason to attempt to sell every seat at some price since the value of an empty seat the moment the door closes is zero.

    Now consider F. It’s a very different product. It’s not just a sleeper seat or a good meal but ability to buy being apart from the riff raft. For a price anyone can, for a time, buy being royalty.

    The F customer in a suit wants to see others in suits or he thinks he’s been cheated. The customer in a T shirt want to see everyone else in suits making him even their betters (Hollywood trumps Wall Street). It’s the image of themselves from buying F that sustains the price. When that goes, the price the airline can charge, and the profits, plummets. That’s why yield management has been all but absent in B (although its creeping in a bit) and almost invisible in F.

    Don’t get me wrong, I love these programs. I also think they saved the legacy carriers but only because they allowed the airlines create the illusion that flyers were going to be able to cash in those miles for trips that the airlines simply could not give them.

    Pan Am’s program used to have a quirk. If you didn’t use the miles pretty quickly you lost them. You could also use them for any seat. Look up their financial statements because the quarter everyones miles were due to expire their revenue tanked as everyone cashed in to fly F.

    The response was to impose capacity controls. But the airlines kept issuing miles, miles that simply could not be redeemed because there weren’t enough seats to where people wanted to fly. So the only thing left was to devalue and then do it again and again until the contingent liability was at least manageable. That alone will make the miles pretty much worthless because the whole idea of of these programs was to sell otherwise unsaleable inventory. But if the airline can sell the inventory, its real lost revenue and that is a whole different kettle of fish.

    So you have two things working against these programs. First, they degrade the value of the premium class products which is where these carriers make the bulk of their profit. The excess inventory they have isn’t enough to satisfy the demand.

    Buying an airline ticket with an expectation of a future trip from the miles, charging on a card, or buying them outright is no different than making the airlines a loan. Only in this case the borrower reserved the right to devalue the currency allowing them to borrow as much as they want with no obligation to repay. It’s like buying a country’s debt denoted in their currency. If they inflate the currency you get paid back all right, but its not worth the same.

    So, what happened when countries do this? People refuse to lend to them. I’d say its the same for airlines. A prudent traveler either values the miles at zero on the assumption he’ll probably not be able to get a seat where he wants to go or if he does the number of miles to obtain it will be high enough the value of the rebate is trivial, or he goes to another airline.

    An airline has to be able to maintain their profit margins up front (as some airlines have done) while giving a modest rebate (as a percentage of their profit) primarily by gifting seats that weren’t going to be otherwise sold and keep their customers happy for these programs to deliver on what people think they bargained for.

    UA can’t do that. They sold way too many miles. Like a country that has borrowed well beyond their means to repay, they inflate.

    I think UA is gambling that their hold over their customers is enough that they’ll shrug, the programs will cease to be a meaningful part of the customers decision and eventually they’ll die. I think their probably right for low yielding domestic traffic. But who in their right mind would choose to buy a ticket on UA in B, let alone F if there is an option to fly LH or EK for the same price? Up until now the difference was you got the miles and so a later flight in on LH but with that gone the only thing left if for UA to drastically cut the price of their F and B tickets to match the product they have or lose market share.

    It will be interesting to see whether the LH, BA and EK’s of the world use this as an opening to go after the legacy carriers long haul business. It’s not hard to imagine a world where the legacy carriers are screaming for protection in a few years from the big, bad foreign carriers who are eating their lunch because the game of offering a rebate that you can’t cash in is gone.

  25. With the US printing money at a fast pace and watching items we buy going up in price every day I can’t believe I didn’t see this United deval coming, especially with all the bloggers pimping out the Explorer credit cards and UL transfers.

  26. Great, great article.

    Does anyone have a guess how soon AA will devalue their awards chart if the merger survives the lawsuit?

  27. @Steve
    Actually, I thought your last post was pretty measured. Just a thought. You said: “I think UA is gambling that their hold over their customers is enough that they’ll shrug, the programs will cease to be a meaningful part of the customers decision and eventually they’ll die.” I think next year, they will be surprised how many.

  28. agreed on that they are a currency, but simply being more doesn’t mean they are being redeemed more often… i have more than i can conceivably being used while being stuck with this whole “job” thing. i imagine many of us have a lot of miles, although we can’t exactly leverage them with reckless abandon (as we could with dollars.) i’m sure more people are playing the game and getting credit cards and awards, but i wonder how significantly this number has actually grown. i *spoon feed* friends and colleagues how to get enough to go on even a single trip for free via 1-2 credit cards and they still take no action!

  29. You say either the availability of awards or their price must increase, or there will be a shortage. Hasn’t there been a shortage (especially in certain programs, such as AAdvantage) for a few years now?

  30. @Randy – it’s not either/or, the effect is linear, the more miles the greater the shortage. Customers have always thought there was a shortage, in reality for the most part the challenges have been technological. I’ve faced no AAdvantage shortage, only a reduction of award space on American’s own flights.

  31. Hi Gary,

    What do you mean by “shortage”? I thought it just meant fewer awards than redeemers, which is what we’ve had for a while (as you say, AA has reduced availability on their metal).

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