Jay Sorenson has an interesting new report (.pdf) declaring ‘revenue is now king’ that revenue-based programs are the new ‘it’ in loyalty. The piece begins by citing all sorts of reasons why revenue matters to a company, which is of course both true and unenlightening.
While mileage alone doesn’t incentivize loyalty, the goal of a marketing program isn’t to ‘reward customers who spend the most’ it’s to move the needle on incremental business (that exceeds marginal cost). So while Sorenson is undoubtedly correct that mileage is an imperfect proxy for that at best —
Mileage flown is no longer a reliable proxy to represent the value of a customer. The era of deregulation and arrival of low cost carriers changed pricing stability; very often long distance flights in competitive markets were priced at a fraction of short hops. The business traveler paying $600 earned the same 900 FFP miles as the leisure traveler who nabbed a $75 fare. Airline managers questioned the fairness and effectiveness of methods which didn’t better recognize the value of premium customers.
It’s not the case that total revenue is a reliable proxy for profitability at the margin, either. Delta implemented a bold experiment in awarding miles based directly on ticket spend. United and American threw up their hands in a cop out by simply mimicking Delta.
Neither distance nor total revenue is an ideal proxy for profitability or incremental revenue contribution, which is what a loyalty program wants to drive. The current revenue models are ultimately a weigh station along a journey, but the monkey see, monkey do airline industry takes a long time to innovate.
Sorenson suggests that ‘all of the top 25 airlines use revenue to influence mileage accrual’ — which is true, premium fares earn a multiple of miles, in many cases discount fares earn a percentage of distance flown, with airlines around the world.
As Sorenson explains, “Every airline, except American, Delta, and United, currently uses the type of fare purchased by the consumer to help determine the final tally of a member’s mileage or point total.”
However the next statement — that “the distance flown by a member has lost much of its relevance” isn’t right both because distance is still the primary determinant of accrual (longer flights earn more than shorter ones in any given fare class) and because the claim that distance flown has lost relevance is a comparison over time and loyalty programs around the world using fare class multipliers isn’t new at all. European and Asian frequent flyer programs have always been more influenced by revenue than US airlines have.
The better question — the question that’s clarifying in a lot of situations — is what’s changed?
- Delta adopted a direct revenue model for earning miles. They considered a revenue model for redemption, too (a chart with mileage costs corresponding to ticket price ranges) but customers in focus groups pushed back on the elimination of the ability to outsized value for their miles.
- United simply mimicked Delta, just as they had done with minimum spend for status in in raising the spend requirement exactly as Delta did. There was some thoughtful internal opposition to the idea at MileagePlus, but Jeff Smisek personally preferred the revenue option.
- American copied Delta as well. With the US Airways merger this was always going to happen in some form, US Airways had been working on a revenue-based program before Delta launched theirs. It was simply delayed by more urgent integration issues at the airline. Still, the AAdvantage team pushed back on the particulars, seeking to move towards a greater degree of emphasis on revenue in their own way. It’s ultimately Scott Kirby, now President of United, who pushed for simply precisely aping what Delta developed.
What’s changed is that the 3 largest US airlines have moved towards revenue-based accrual for flights (which remains a minority of miles earned, and is only half the earn-burn equation). Even that overstates the trend of course, other than to say that United and American do what Delta does, they admire Delta and assume Delta knows what it’s doing.
There’s no fundamental reason that — even if American and United were going to following in giving more miles to higher fares — that they’d follow Delta in giving up on average fares. When Delta changed to revenue-based earning they set the ‘break even’ at about 20 cents per mile, significantly higher than their revenue average.
Meanwhilee nearly all United fares still earn 1 mile per mile flown when crediting to Singapore Airlines KrisFlyer. Nearly all (non-Basic Economy) Delta fares earn 1 mile per mile flown when crediting to Czech OK Plus. Nearly all American fares earn 1 mile per mile flown when crediting to Cathay Pacific AsiaMiles or to Etihad Guest.
Though Sorenson’s report carries all of the appropriate caveats about picking a strategy that is best for any given individual program, and offers some detail on Alaska Airlines continuing to use distance-based accrual as a differentiator in its battle with Delta in Seattle, the implication that a less than careful reader might take away is that ‘the debate has been settled’ about how best to rebate customers. Quite the contrary — distance is imperfect, total revenue is imperfect, and the airlines haven’t yet made much progress in the best way to incentivize customer behavior.
Distance was simply easy to measure and used to be more correlated with revenue than it is today. It’s an imperfect proxy for wallet share, how much of your business you give to an airline.
For 30 years airlines have been claiming that the changes they make to frequent flyer programs have been to ‘better reward higher-spending customers. Yet when United, Delta, and American moved to a revenue-based program they made the miles even high fare customers earned worth less by raising the number of miles it takes to redeem for most awards. The revenue-based shift is as much about spending less on marketing, when planes are running full, then incentivizing filling seats. Delta says this change doesn’t drive their revenue premium
Calling total revenue a good measure of customer value is to misunderstand the difference between marginal and average, and to fail to understand opportunity cost. The person who buys full fare tickets but doesn’t pick their own travel provider (either because they ignore it, their corporate travel department buys the tickets) isn’t going to spend more money on an airline because the loyalty program is slanted to high revenue travelers.
Yet a program can influence both choice of travel provider and total amount of travel. A business traveler is less reluctant to travel if she’s being rewarded for it. They may not fight against travel when they aren’t just getting their expenses covered but they have something to cash in later. Without a rewarding scheme, business travelers become more reluctant to travel.
- A high fare customer isn’t the same thing as a profitable customer
- You don’t want to “reward” a high fare customer you want to “incentivize” additional business you wouldn’t otherwise get. In other words you want to increase profit (or avoid loss).
It’s interesting that a $300 Los Angeles – Las Vegas fare is rewarded under a revenue-based system the same as a $300 Los Angeles – New York one (and the same as a $300 Los Angeles – Tokyo fare).
- A flyer may buy one expensive ticket with an airline because they’re the only one that flies non-stop on the route. Does it make sense to reward them, if the customer was going to buy the ticket either way?
- In general a high revenue passenger is probably better for an airline than a low fare one. But a high fare passenger may trade off with another high fare passenger (for instance they both buy the last seat available on a flight). That high fare customer wouldn’t actually be profitable in an economic sense (opportunity cost basis).
- A low fare passenger may fill empty seats and be pure profit — or they may ultimately displace a high fare passenger and be very costly if the airline didn’t get their revenue management right.
- Low fare customers may also engage with an airline’s ancillary products. Base airfare isn’t the only contribution to revenue that matters, and other products are often higher margin than the actual airline seat (priority boarding, seat assignments, extra legroom, checked bags etc). Third party partner customers are profitable too. A member who carries an airline’s credit card and uses it, credits points for their non-air travel to the program, and uses their shopping portal may be a profitable customer.
- The program needs to try to influence incremental business. An airline may reward a high spend customer but not get additional business from them than you would otherwise have gotten. They might be able to move the needle with some of your other customer segments.
While knowing nothing else about a customer it’s a reasonable guess that the higher revenue customer is more valuable, the whole point of these programs from the beginning was to get better data on customers, to understand and market to them. They were early revolutionary efforts at big data. So ‘knowing nothing else’ isn’t ever a position a loyalty program should be in. And airlines should at least try to do better.
Ultimately if you take your business seriously, instead of just repeating platitudes, then frequency and wallet share matter — and especially driving greater frequency and increased wallet share — and not just total revenue.