United’s President doesn’t believe you know the difference between high and low value credit cards. You’ll get the United credit card if you like travel and you live in a city where United offers the most service.
I’ve argued that’s wrong, and American Airlines identified the reason why to the SEC. American Airlines filed its 10-K this week and while I focused on the drop in seats occupied by award customers (after a drop in the prior year as well), I flagged one statement buried in the document. AAdvantage is a multi-billion dollar enterprise and one of the risks American identified to that business is that it,
faces significant and increasing competition from the loyalty programs offered by other travel companies, as well as from similar loyalty benefits offered by banks and other financial services companies.
That’s a point I’ve been making for some time. Airline frequent flyer programs are the most successful marketing innovation in history. Instead of marketing being a cost center, they’re an incredible profit center because other businesses rent their brand, mailing list, and currency. However they face two major challenges over time.
- Their biggest customer for miles are credit card issuing banks. If interchange rates — ‘swipe fees’ — fall it will no longer make economic sense to incentivize customers to make transactions by rebating miles to them at least at the current rate. They’ll buy fewer miles.
And it’s far more likely that interchange will fall in the future than rise — whether as a result of government regulation (in several places in the world governments have moved to limit interchange, like in Europe and Australia), new merchant contracts potentially under pressure from lawsuits, or competition from new technologies.
- Competition from other currencies. Banks are engaged in creative destruction. They’re not only buying miles from airlines through their own co-brand cards, they’re issuing better cards themselves. The premium card market has never been so competitive as it is today, with banks offering products that earn miles faster and offer more flexibility than earning just a single airline’s currency.
As a result there may be revenue pressure in the future (if interchange falls) and there should be significant cost pressure (as airlines have to compete to make their programs attractive against bank programs like Membership Rewards, Ultimate Rewards, etc).
Banks have proven that there aren’t significant barriers to entry in the loyalty market, so a continued future of better than 50% profit margins for airline loyalty programs make little sense. There’s simply no room to continue to devalue programs — in fact airlines will have to spend more to retain members, let alone grow.
That’s why I’ve been skeptical of the claim that frequent flyer programs are worth more than their associated airlines. The valuation multiples required for this assume continued growth in the programs rather than declining margins.