Tim Harford, whose writings I usually much like, explores whether frequent flyer programs are inefficient for the economy. He’s right to suggest that they create product differentiation among air carriers that might otherwise be commodity products. And as differentiated products, consumers have preferences (driven by value created by the program’s loyalty program)>
Certainly in the context of business travel, employees with a preference for air carrier may make a choice that’s different from what’s in the best interest of the employer.
That’s sometimes true. Agency problems exist any time someone is spending another person or entity’s money.
On the other hand, the personal benefits from frequent flyer programs make business travel much more palatable. Employees with elite status fly relatively hassle-free, aren’t charged checked baggage fees that they’d otherwise expensive, often receive meals in first class instead of buying food and billing the company. And they’re more willing to take on the flying that benefits their employers because of this treatment. They get priority on waitlists, help during irregular operations, and are more likely to make their meetings and waste less time along the way. Much better for employer productivity.
Moreover, the employees are getting compensation from the frequent flyer program (in the form of free future travel) in exchange for their business trips instead of from their employers. It’s as reasonable as Harford’s assumptions to believe that without the ‘kickbacks’ from frequent flyer programs, that employers would have to compensate their employees more to take on high volume business travel.
Harford suggests that frequent flyer programs “artfully create what economists call “switching costs”, by offering employees an incentive to stick with an individual airline.”
And there are elements of this, but it fails to understand the specific industry behaviors that have developed by competitive firms to offset this effect and encourage customers to switch carriers.
Sure, an elite member of American Airlines AAdvantage wants to stick with AAdvantage because of their elite benefits. But Continental realizes that the customer is a valuable one, and that it’s difficult for that customer to switch. So Continental will ‘match’ the elite status of that American Airlines customer with status in their own program on request. (This is usually a once in a lifetime proposition, and nearly all U.S. programs offer some form of status match or expedited status program.) Boom, switching costs due to elite status gone.
When frequent flyer programs began they realized that a depleted account meant a customer might leap to a competitor. It was commonplace for a carrier to award, say, 5000 miles to a customer who depleted their account so that there’d be reason to continue accruing in that program.
That’s no longer the case, and likely reasons why. Having mileage balances in a particular program hardly create switching costs. A member reaches a mileage threshold and receives a free trip. Account depleted, no more switching costs. Customers don’t even need to stick with their existing carrier in order to continuing accruing miles up to the point they have enough to redeem. More than half of miles are earned from sources other than flying, a customer might charge some more to their credit card or credit some hotel stays to an airline program.
Finally, Harford’s claim that frequent flyer programs drive up price seems to run counter to empirical facts — that prices are far lower on an inflation-adjusted basis than they were before the introduction of such programs.
Frequent flyer programs are both a marketing expense and in and of themselves a profit center. In most cases they are the most profitable part of an airline. They drive business to the airline and to their partners who buy miles from the carrier. And they generate consumer value, customers use them to access not just flights which replace those they’d otherwise purchase for cash but travel they would never otherwise be able to experience — a middle class collector of miles who flies in flat bed first class offerings with good champagne, caviar, and complimentary airport limousine transfers. Miles are the great democratize of travel.