## Here’s Why Frequent Flyer Programs Devalue Their Currency

Programs issue too many miles. There aren’t enough award seats, especially with planes flying full. They need to either increase the number of award seats or increase the cost of each seat, otherwise you just have frustrated members who can’t redeem.

At the same time programs don’t need to spend as much marketing to fill planes when planes are already full. But that’s an argument for reduced earning, not for changing redemption prices.

Programs with set award prices (award charts) usually devalue in a predictable way.

Twelve 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 have to rise.

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 (to a large extent only Hilton devalued during the Great 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.

Here’s the most common reasons that programs find themselves devaluing:

• Sometimes a new program starts, and the people who designed it didn’t know what they were doing, didn’t understand how the program would work in practice. They may have been too generous from the start, or they got the rules wrong so members drove up costs in ways they didn’t predict.

• Other times programs have simply been badly managed. They short-sightedly printed too many miles, got themselves in trouble because they printed currency the program just couldn’t cash. (“Too many miles chasing too few seats.”)

• Travel providers also get in trouble, airlines went through bankruptcies, and they turned to their frequent flyer programs to generate business. They printed loads of miles, and predictably devalued. Classic pump and dump scheme. They convince members to buy tickets to earn miles based on a value proposition, and then change the value proposition.

• Other times programs just see everyone else doing it, and they think they can get away with it too. (“Everybody is doing it so why can’t we?”) Put another way, a program executive thinks that their program doesn’t have to be very good, it only has to be a little good and that’s relative to what others are doing.

At first glance you wouldn’t ever expect a revenue-based program to devalue. As fares rise, you earn more points but redemptions cost more points too. It should have built-in balance.

But there are different kinds of revenue-based programs, and even those that shouldn’t devalue do.

• Revenue-based earning and revenue-based redemption should not ever require a devaluation. Those should be continually in balance. And yet Southwest devalues anyway. And devalues again.

• Revenue-based earning and award charts for redemption will require devaluations. Inflation alone will push up airfares, and thus points earned. It’s untenable for the points cost to redeem for flights to remain constant.

We can expect that more outstanding miles without corresponding increase in capacity will mean award inflation. We can expect price inflation to raise the price of awards in a pure revenue-based program.

What we haven’t seen very much of throughout the history of frequent flyer programs is deflation.

That means you’re unlikely to see your miles worth more in the future than they are today. You should burn your miles now, and then earn more. The key not getting hurt by inflation is to earn and burn in the same period.

#### 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 »

### Comments

1. NRTBound says:

Does the existence of different mileage earning channels relate to the need for devaluations in a program like SW? It seems to me that an airline has different profit margins when I spend \$1 on a plane ticket versus spending \$1 on a co-branded credit card versus spending \$1 via a shopping portal.

So, if customers started earning a higher percentage of miles from credit card spending instead of flying, would the airlines need to adjust redemption models to compensate for the fact that this new earnings mix generates different profit margins than the earlier mix?

2. Josh says:

Airlines devalue award miles!?!?! I am shocked! Shocked!

3. credit says:

Devaluatuion and underreported inflation are stealing. The federal Reserve is full of lying scum. But only redeeming value is that they are doing it for the country.

Ff programs steal from you by devaluing. No reason why you shouldn’t steal from the airline or hotel. What can we steal?

4. Don in ATL says:

Thanks for the explanation. It seems to me that when DL prints SkyMiles, it literally is printing money. Of course, the SkyMiles they give out for flying are tethered to the price of the ticket. And they sell SkyMiles to third parties (Amex, hotels, car rentals, etc) — this is pure profit. The only check (as in checks and balances) on this is if the third parties see that their customers are not falling for this as much (e.g. fewer customers obtaining and using the Amex DL cards, etc) because the customers sense it isn’t worth it, then Amex (Hertz, etc.) won’t be buying as many SkyMiles from DL, and DL revenue falls from selling SkyMiles. Maybe something like this will make DL change its ways — making more seats available. But as long as the printing presses printing SkyMiles translates into more and more money to Delta, only Delta is the winner, and we are the losers. When a government prints money causing inflation — everyone loses, the government, the people, the merchants. With printing and selling SkyMiles, the people lose, the merchants lose, but DL still makes money.

5. James K. says:

I don’t understand why you think revenue-based shouldn’t devalue (assuming that devaluations are inevitable)

Southwest signs 1,000 people up for the Chase card, thereby injecting 50,000,000 RR points into the economy. At their old rate, that was about, what, \$835,000 of Southwest credit floating around the economy?

I’d say there’s a pretty huge incentive to devalue and make that \$835,000 into \$710,000, don’t you? That’s not only a savings of \$100,000, but that leads to fewer points for people to book itineraries with and push out the cash-payers

6. @James K and they’ve been paid for that \$835k credit, like if a customer purchased those tickets.

7. GUWonder says:

Between (a) the governmental waivers and favors granted to the US3 airlines, and (b) airline management/employees being either rewarded for devaluing the program or punished if not growing the program’s profits and profit margins year-over-year, it’s expected that airline loyalty programs should be expected to continue to devalue and devalue worse and worse over time — at least in the US where the government has stacked things in favor of the US3 oligopoly.

8. Greg says:

But what also happens when the value of the award drops significantly. For example years ago dimest F seats were often \$2000, today its half that price. So a 50K award is worth so much less.

International travel. Business class tickets to Europe used to rarely cost less than \$2000 outside of Thanksgiving day fares. Now just about every other day in the premium Flyertalk fares deal there is a \$2000 European business class fare. So instead of 150k United miles to get a J ticket to Europe people pay \$2000 ish dollars, yet United upped the redemption to 150K.

Finally isn’t there more seats today then 12 years ago. Just look at the increased number of seats Emirates has brought to the world.

9. Juan says:

I have a simple solution for the airlines to handle their billions of un-redeemed miles.
Only the person earning the miles should be allowed to use them to fly. Easy to verify. That would eliminate people selling their miles, or “giving” tickets to anyone they want.
Actually I don’t understand why people earning the miles should even think they can share them with everyone. This was never intended to be a socialist program.

10. DCS says:

This is unnecessarily long-winded. Companies that run loyalty programs MUST devalue simply because they decrease their “liability”, which counts against their bottom line. It is as simple as that and let me elaborate.

Honest accounting rules require a company that runs a loyalty program to reduce their revenue whenever they award points/miles. What this means is that the company cannot take credit for the full sale of a plane ticket or a revenue room because a portion of that money will need to be paid back to members later as rewards. That portion of their total sales that loyalty companies cannot claim as the revenue until the points/miles are redeemed or forfeited is called a “liability”, and it is clearly not a good thing have a lot of.

What happens over time, especially with the recent influx of points/miles from various sources, is that a loyalty company’s “liability” will keep increasing as more and more points are awarded than are redeemed. Clearly, if this is allowed to go on for a long time, it would begin to tie up a large chunk of loyalty companies’ revenue. So, they do a number of things to try to remove from circulation as many as they can of the miles/points that they already awarded but had not yet been redeemed. While “devaluation” is the most drastic (and effective) way that companies can accomplish this, we are familiar with the other things that they do that are specifically designed to decrease the points/miles “liability” like:
— expiring points if they have redeemed or there has been no valid account activity after. e.g. 18 months;
— altogether closing out accounts, with all points in them forfeited, due to an extended lack of activity.
— inundating you with those offers to purchase consumer electronics, book a hotel room or rent a car with your miles or, @Gary, giving members a favorable rate of transferring hotel points to airline miles for fast redemption, which makes bloggers go ape about the metaphysical “value” of transferable points currency, when all it is really is a convenient way for a company (e.g., SPG) to decrease their “liability” (other hotel loyalty program prefer to decrease their
“liability” by making their award more affordable; this does not in any way make their points less “valuable”! 😉

The quickest and most effective way for companies to decrease their liability, however, is to devalue their points, as this requires members to spend a lot of them to get a free ticket or award room.

That is , in a nutshell, why companies that run loyalty programs MUST devalue their points. There is no need to invoke Milton Friedman when simple common sense would do 😉

11. DCS says:

I wish “boarding area” would implement an “edit” feature in the comments section of the blogs!

Anyway, more precisely, I meant to say in that second sentence above:
“Companies that run loyalty programs MUST devalue simply because they MUST decrease their “liability”, which counts against their bottom line.

The second “MUST” is key because it makes devaluation of loyalty points the proverbial “necessary evil” 😉

12. AAExPlat says:

Didn’t someone compile the stats for AA earlier this year on FT with respect to how many miles AA has issued per year for the last several years?

And IIRC, AA is issuing slightly less miles now than they used to…so I guess if that information is accurate, I am unsurw why the ailines have to devalue.

13. DCS says:

This hopefully CLEANER post replaces the one above from 4-ish AM [implement an editing utility!] :

This is unnecessarily long-winded. Companies that run loyalty programs MUST devalue simply because they MUST decrease their “liability”, which counts against their bottom line. It is as simple as that and let me elaborate.

Honest accounting rules require companies that run loyalty programs to reduce their revenue whenever they award points/miles. What this means is that a loyalty company cannot take credit for the full sale of a plane ticket or a revenue room because a portion of that money will need to be paid back to members later as rewards. That portion of their total sales that loyalty companies cannot claim as revenue until the points/miles are redeemed or forfeited is called a “liability”, and it is clearly not a good thing have a lot of.

What happens over time, especially with the recent influx of points/miles from various sources, is that a loyalty company’s “liability” will keep increasing as more and more points are awarded than are redeemed. Clearly, if this is allowed to go on for a long time, it would begin to tie up a large chunk of loyalty companies’ revenue. So, they do a number of things to try to remove from circulation as many as they can of the miles/points that they already awarded but had not yet been redeemed. While “devaluation” is the most drastic (and effective) way that companies can accomplish this, we are familiar with the other things that they do that are specifically designed to decrease the points/miles “liability” like:

— expiring points if they HAVE NOT BEEN redeemed or if there has been no valid account activity after. e.g. 18 months;
— altogether closing out accounts, with all the points in them forfeited, due to an extended lack of activity.
— inundating you with those offers to purchase consumer electronics, book a hotel room or rent a car with your miles or, @Gary, giving members a favorable rate of transferring hotel points to airline miles for fast redemption, which makes bloggers go ape about the metaphysical “value” of transferable points currency, when all it is really is a convenient way for a company (e.g., SPG) to decrease their “liability” (other hotel loyalty programs prefer to decrease their “liability” by making their award more affordable; this does not in any way make their points less “valuable”! 😉 )

The quickest and most effective way for companies to decrease their liability, however, is to devalue their points, as this requires members to spend a lot MORE of them to get a free ticket or award room.

That is , in a nutshell, why companies that run loyalty programs MUST devalue their points. There is no need to invoke Milton Friedman when simple common sense would do

14. Cogswell says:

Devaluation is simply part of their business model. They throw bucket loads of miles at consumers, claiming they are worth x amount of flights or hotel nights, but by the time there are redeemed they are, on average, worth much less than that

Now, if only many of the bloggers on these sites would factor in devaluation when trying push credit cards. It’s one of many, many reasons why everyone’s valuations of miles/points is massively exaggerated.

15. Flyer Fun says:

Brilliant analysis. However, I would like to point out one thing:

People seem to always assume that q = quantity of goods is a fixed number. That is, that if a credit card issues miles, the number of miles chasing that fixed number q has increased. Therefore, either inflation or rationing will have to take place.

However, theoretically “q” can be an unlimited number as long as the price paid for miles (either in cash or as marketing value) is greater than the cost of providing the redemptions. In the best case scenario for the airlines, sell more miles, release more seats, and watch the profits roll in.

Of course, the devil is in the details. I do not know if FF programs are profitable as standalone businesses. If they are, then devaluations might be the actions that destroy the duck that laid the golden eggs.

16. Mike says:

Those sharpsters proud of plundering, looting and burning through as many sign-up bonus miles as possible will likely use them as soon as they post and suffer not a whit. Only the little people pay taxes, or get devalued, and it’s Grandma at the last family farm in Kansas who’ll suffer in the end, dead shoveling snow instead of sharing the trailer in Florida with her sister like she was counting on.

17. mbh says:

I agree with Mike. And, for that reason, I really wish the regulators would require programs to give at least 6 months’ notice to the public when they plan to de-value. It’s so unfair to the typical frequent flyer that s/he saves for years for a particular trip (I think something like 90% of F seats to Hawaii are award seats), and then just when they almost have enough, whoosh–it’s 25-50% more miles! I actually left United in the 90s for that very reason–they treated me like scum. Of course, now I want to leave DL, too, and I’m finding it hard to find an airline worthy of my trust/\$\$.

18. DCS says:

@bmh sez: “I actually left United in the 90s for that very reason–they treated me like scum. Of course, now I want to leave DL, too, and I’m finding it hard to find an airline worthy of my trust/\$\$.”

To leave one loyalty program because they devalued their points for another program simply replaces the devil you know with one that you do not yet know. As I showed above, common sense says that every loyalty company WILL devalue their points some time. If the company you jumped off to has not yet devalued, just hang in there; they won’t disappoint — just like DL did not disappoint after you left UA for them 😉

Following the whirlwind of devaluations that hit the loyalty industry in 2013, but especially the hotel loyalty programs, during which Hyatt Gold Passport was slow to devalue, bloggers, who are enamored with Hyatt GP went absolutely ape during the brief period of time that GP was the only program that had not devalued, gushing about how Hyatt had once again shown why it was the “best in the business.” Of course, most bloggers had to eat their words because their praises were premature; the time to devalue had arrived and, like all the other loyalty programs, Hyatt had to devalue…and their devaluation was even more severe than Hilton’s that we keep hearing about!

The dirty little secret and paradox about “devaluations”, however, is that they increase the value of loyalty points for those with loads of them. That is crazy, right? Devaluation literally means to lose value! What am I talking about? Well, it depends on what one means by “value”. If I have loads of points and I cannot find awards to redeem than my points are not as valuable to me. Therefore, devaluations increase the value of my points because they almost always dramatically increase the availability of award tickets or rooms, which devaluations make too expensive for many to redeem points for. It’s rather perverse but it is true. When Hilton devalued in 2003 and folks bailed out on them left and right, I had quite a stash of HHonors points and stayed put. Sure enough, the thinned program made it easy for me to find award rooms. Not only that, my complimentary suite upgrade success rate also went up dramatically and it still has not come down 😉

19. DCS says:

“When Hilton devalued in 2003 and folks bailed…” that’s “2013”….

20. Don in ATL says:

On one level DCS’s explanation of why airlines devaluate their points, makes sense. However, the more I think about it, I’m not sure it is the whole story. For instance, for the airlines who have only one award level and capacity seat control on the number of award seats, the liability for any given quarter (or fiscal year, for that matter) is known, and is simply the number of seats they cannot sell that quarter or that year because they have been designated as award seats. So it doesn’t matter if there are a billion, zillion points in circulation for that airline, all those points are not a liability to the company’s profit for that quarter or fiscal year because those points cannot be used to tie up more seats. Seats are limited and only the points used to buy the limited seats are a liability. The same goes for airlines that have two levels of awards — a known number of seats for awards and a known number of miles to get those seats. Those are the only liabilities that should be counted against income. All the other points out there cannot hurt the profit for that quarter or year because once those award seats are gone, no one can buy any more award seats using points. However, for an airline like DL where they will sell their last seat on the plane for points (a very large number of points, BTW), theoretically all of DL’s seats on all of DL’s flights can be purchased with points, and this is a problem. Then indeed, all those points circulating out there ARE a liability for DL and can ruin profits for a quarter or a year, if they are all used all at once to buy award seats. So in this instance, it makes sense to make all the points in circulation a liability. But that begs the question — what value do they put on each point? Who decides the value of each point — the DL bean counters? Do they value each point for the same price as they sold the points to Amex and Hertz, etc? AND, what if a DL customer “buys” two Delta One seats as award seats and those seats would have flown empty, why is there any value (or liability) to DL for the points that purchased those two seats that would have flown empty? Can DL legitimately tell us (and the IRS too, I believe) that DL SkyMiles officially have zero value, but turn around give those same points value internally when they are subtracting a “liability” against profit on their books? I think the DL ff program is exactly as Ron Lieber described it in the NYT article — a “Magic Trick,” and sleight of hand is the major ingredient.

21. DCS says:

@Don in ATL — Your scenarios have nothing to do with points/miles liability, which is a rather simple concept. Someone who gets a 50k-mile sign up bonus is essentially being given an IOU that has a cash equivalence and will count against the loyalty program’s bottom line even if that person loses interest in miles/points or dies. The number of award seats, etc, simply represents one way liability can be managed, just like making consumer electronics available for purchasing with miles. The liability are miles/points that are awarded vs. those that are/are not redeemed. Period.

22. Don in ATL says:

@DCS, my point was that these ff programs are a “Magic Trick” with major sleight of hand (which was my concluding sentence). My sub-point was, who decides what these points are worth when they (all of the ones in circulation) are counted as a liability? Are they valued at the same price as the third party paid for them? For the 50,000 point sign-up bonus Amex paid DL a certain amount per point to get that those points to give to the customer. Does DL value them at this price or do they make up another price when they are figuring their liability? Or do they value them at the rate one would get when people use points for a magazine subscription or to use in “Pay with Miles”? And finally (and this is why I got into award seat examples), I would argue that on any flight where award seats were issued, but that flight leaves the gate with empty (non sold) eats in either cabin, then the points used for those awards seats were NO LIABILITY to DL, so the points used for the award seats on that flight should be retroactively subtracted from the liability, because no financial liability was incurred. And this phenomenon – a flight having seats in either cabin that were not sold is more common than you think – and they fill those seats with DL employees (non-revs). Do they charge themselves a liability every time an employee sits in a seat that was not sold? Yeah, I guess there is a slightly extra amount of fuel used to transport that award seat person or non rev person to the destination, but it is minuscule. So again, my main point is that these programs are non-transparent, and depend very much on sleight of hand. If we could see what was going on behind the curtain, we could talk about this with more certainty.

23. DCS says:

@Don in ATL — I had a much longer response, which did not post the first time I tried due to a connection error with my smart phone on which I had written the comment. I wound up just writing and posting the short comment above.

In the comment that did not post, I had made the point that loyalty programs cannot cook the books to make their liability look as they choose because for accounting purposes loyalty points are treated exactly like real currency. There are accountants specifically charge with deciding what various points are worth for estimating a loyalty program’s liability, which must go on the books for honest accounting. Dishonesty accounting involving loyalty currency carries the same legal penalties as for real currency. The loyalty companies get to create the points currency but they do not get regulate them when they enter real commerce and get traded for things that are worth real money. The feds get jurisdiction…

You lost me about the notion that if a flight leaves with unfilled award seats an airline should deduct the associated miles from their liability. Why? This is NOT a zero sum game between the airlines and the customers or anyone else. People do not have to fly all the time, much less redeem their points, whenever a flight takes off. If a flight leaves without filling award seats, it could simply be because no one with miles was going where the plane was going. Why should the airline get credit for it? One can, in fact, argue that the seats that the airlines make available for awards would have cost nothing at all because those seats would have gone empty anyway…Why do they get to claim those seats against their liability…

24. Flyer Fun says:

Airline financial statements are audited by accounting firms in accordance to US General Accounting Standards, International Reporting Standards (IFRS), or some equivalent. In addition, for companies filing with the SEC, the SEC has additional requirements. People go to jail for dishonest accounting (see Enron) and major accounting firms go out of business for the same (see Arthur Anderson). So in other words, the accountants at the airlines and the auditing companies decide how miles appear on the income, balance sheet, and cash flow statement. Since I doubt that anyone wants to go to jail for the Frequent Flyer program, intentional “sleight of hand” is minimal.

25. DCS says:

@Flyer Fun — +1. Clearly and succinctly stated. Loyalty points are part of a multi-billion dollar industry. Loyalty accountants would be cooking the books at great peril if they treated miles and points as Monopoly (the game) or funny money. In fact, if you look in the annual financial report of companies that run a loyalty program, you will generally find a section on how they estimate their liability. Here, for example, is how it is described in Hilton’s 2014 financial report (Form 10-K):

Hilton HHonors
Hilton HHonors defers revenue received from participating
hotels and program partners in an amount equal to the
estimated cost per point of the future redemption obligation.
We engage outside actuaries to assist in determining the fair
value of the future award redemption obligation using
statistical formulas that project future point redemptions
based on factors that require judgment, including an estimate
of “breakage” (points that will never be redeemed), an
estimate of the points that will eventually be redeemed and
the cost of the points to be redeemed. The cost of the points
to be redeemed includes further estimates of available room
nights, occupancy rates, room rates and any devaluation
or appreciation of points based on changes in reward prices
or changes in points earned per stay.

26. DCS says:

Below is how United airlines does their loyalty liability accounting in their 2013 Form 10-K [there are a lot more details in the document than I have provided below]:

Frequent Flyer Accounting. The Company has a frequent flyer program that is designed to increase customer loyalty. Program participants earn mileage credits (“miles”) by flying on United and certain other participating airlines. Program participants can also earn miles through purchases from other non-airline partners that participate in the Company’s loyalty program. We sell miles to these partners, which include credit card issuers, retail merchants, hotels,
car rental companies and our participating airline partners. Miles can be redeemed for free (other than taxes and government imposed fees), discounted or upgraded air travel and non-travel awards. The Company records its obligation for future award redemptions using a deferred revenue model.

The Company accounts for miles sold and awarded that will never be redeemed by program members, which we refer to as breakage. The Company reviews its breakage estimates annually based upon the latest available information regarding redemption and expiration patterns. The Company’s estimate of the expected expiration of miles requires significant management judgment. Current and future changes to expiration assumptions or to the expiration policy, or to program rules and program redemption opportunities, may result in material changes to the deferred revenue balance as well as recognized revenues from the
programs. Effective March 30, 2014, the Company will incorporate a fulfillment discount into its best estimate of selling price which incorporates the expected redemption of miles.

The Company records passenger revenue related to the air transportation element when the transportation is delivered. The other elements are generally recognized as Other operating revenue when earned.

27. DCS says:

Wow! In their 2013 Form 10-K United provided the following information that explains why their alest round of two devaluations was as severe as it was:

_________________________________________________________________________
The following table summarizes information related to the Company’s frequent flyer deferred revenue liability:
– Frequent flyer deferred revenue at December 31, 2013 (in millions) \$ 4,904
– % of miles earned expected to expire 20%
– Impact of 1% change in outstanding miles or weighted average ticket value on deferred revenue (in millions) \$ 57
___________________________________________________________________________

Got that? UA’s FF deferred revenue at December 31, 2013 (in millions) was \$ 4,904 million, which is \$4,904,000 or almost \$5 BILLION! No wonder they devalued their award charts so drastically effective February 2014!

If there was any doubt that loyalty programs’ primary reason for devaluing their points/miles is to decrease their “liability”, the preceding should leave none.
Their

28. Don in ATL says:

@DCS and @Flyer Fun – thank you for educating me. If you have access to any of the reports from DL on their deferred revenue or liabilities from their SkyMiles program, please share. Thanks for all explanations.

29. DCS says:

@Don in ATL — This has been a learning experience for me as well. I had written my first comment above on this based on what I generally knew on the subject. I just read quite a bit about it today and there is no doubt at all that loyalty programs must devalue or their liability could do their bottom line some serious damage…

You can find the financial statement of any company by doing a search for its Form 10-K, a PDF of which is always available. I just searched for “Delta 10K report” and am going to reproduce below the portion on their FF accounting, for completeness:

____

Frequent Flyer Program
Our frequent flyer program (the “SkyMiles Program”) offers incentives to travel on Delta. This program allows customers to earn mileage credits by flying on Delta, regional air carriers with which we have contract carrier agreements and airlines that participate in the SkyMiles Program, as well as through participating companies such as credit card companies, hotels and car rental agencies. We also sell mileage credits to non-airline businesses, customers and other airlines.

The SkyMiles Program includes two types of transactions that are considered revenue arrangements with multiple deliverables. As discussed below, these are (1) passenger ticket sales earning mileage credits and (2) the sale of mileage credits to participating companies with which we have marketing agreements. Mileage credits are a separate unit of accounting as they can be redeemed by customers in future periods for air travel on Delta and participating airlines,
membership in our Sky Club and other program awards.

Passenger Ticket Sales Earning Mileage Credits. Passenger ticket sales earning mileage credits under our SkyMiles Program provide customers with two deliverables: (1) mileage credits earned and (2) air transportation. We value each deliverable on a standalone basis. Our estimate of the standalone selling price of a mileage credit is based on an analysis of our sales of mileage credits to other airlines and customers and is re-evaluated at least annually. We use established ticket prices to determine the standalone selling price of air transportation. We allocate the total amount collected from passenger ticket sales between the deliverables based on their relative selling prices. We defer revenue for the mileage credits related to passenger ticket sales and recognize it as passenger revenue when miles are redeemed and services are provided. We record the air transportation portion of the passenger ticket sales in air traffic liability and recognize these amounts in passenger revenue when we provide transportation or when the ticket expires unused. A hypothetical 10% increase in our estimate of the standalone selling price of a mileage credit would decrease passenger revenue by approximately \$50 million, as a result of an increase in the amount of revenue deferred from the mileage component of passenger ticket sales.

Sale of Mileage Credits. Customers may earn mileage credits through participating companies such as credit card companies, hotels and car rental agreements to sell mileage credits. Our contracts to sell mileage credits under these marketing agreements have two
deliverables: (1) the mileage credits redeemable for future travel and (2) the marketing component.

Our most significant contract to sell mileage credits relates to our co-brand credit card relationship with American Express. We defer revenue related to the
mileage credits sold to American Express based on prices at which we sell mileage credits to other airlines, and re-evaluate our deferral rate at least annually. We allocate an amount to the marketing component in an amount equal to the excess of the amount received over the mileage component. Under this approach (the “residual method”), the deferred revenue from the mileage component is recognized as passenger revenue when miles are redeemed and services are provided, while the portion of the revenue related to the marketing component is recognized as those marketing services are provided. We will continue to use the residual method until our contract with American Express is materially modified. If we materially modify this agreement, we will then be required to allocate the consideration received to the marketing and the mileage components based upon their relative selling prices (“relative selling price method”). A material
modification of this contract and the resultant change from the residual method to the relative selling price method could impact our deferral rate or cause an adjustment to our deferred revenue balance, which could materially impact our future financial results.

Breakage. For mileage credits which we estimate are not likely to be redeemed (“breakage”), we recognize the associated value proportionally during the period in which the remaining mileage credits are expected to be redeemed. Management uses statistical models to estimate breakage based on historical redemption patterns. A change in assumptions as to the period over which mileage credits are expected to be redeemed, the actual redemption activity for mileage credits or the estimated fair value of mileage credits expected to be redeemed could have a material impact on our revenue in the year in which the change occurs and in future years. At December 31, 2012, the aggregate deferred revenue balance associated with the SkyMiles Program was \$4.4 billion. A hypothetical 1% change in the number of outstanding miles estimated to be redeemed would result in a \$30 million impact on our deferred revenue liability at December 31, 2012.

30. Don in ATL says:

Wow! @DCS, that was terrific. THANKS!

31. DCS says:

Here’s a concrete example (from the last post in which @ Gary invoked Friedman):

In their 2013 Form 10-K United, provided the following information that explains why their two devaluation that year were as severe as they were:

_________________________________________________________________________
The following table summarizes information related to the Company’s frequent flyer deferred revenue liability:
– Frequent flyer deferred revenue at December 31, 2013 (in millions) \$ 4,904
– % of miles earned expected to expire 20%
– Impact of 1% change in outstanding miles or weighted average ticket value on deferred revenue (in millions) \$ 57
___________________________________________________________________________

Got that? UA’s FF deferred revenue at December 31, 2013 (in millions) was \$ 4,904 million, which is \$4,904,000 or almost \$5 BILLION! No wonder they devalued their award charts so drastically effective February 2014!

If there was any doubt that loyalty programs’ primary reason for devaluing their points/miles is to decrease their “liability”, the preceding should leave none.