McKinsey & Co has a new report “How to improve airline customer-loyalty programs.”
It begins by outlining the challenge airlines face managing the balance between printing miles and making award seats available for redemption. I first outlined this in 2004, explaining that miles are a proprietary currency with no central bank or currency board and so the classic monetarist model for currencies explains airline miles inflation.
- Airlines print more and more miles because consumers want them, they make customers more loyal, and airlines sell those miles to third parties at huge profit.
- But the number of available seats hasn’t grown as quickly as the stash of miles. And with planes more full than ever, the number of unsold seats which traditionally have driven the supply of saver awards has dwindled markedly.
We have ‘too many miles chasing too few seats’. Assuming the speed at which consumers redeem remains constant, and the quantity of goods those miles buy remains constant (or falls!), then an increase in outstanding miles must mean a devaluation of those miles (mv=pq).
McKinsey then pays lip service to the ‘innovation’ of rewarding miles for flights based on fare paid rather than distance flown. However this is completely non-responsive to the challenge McKinsey has indentified.
- Most miles are earned for activities other than flying
- This redistributes who is getting the miles (for better and worse for the program)
- The specific way it’s been implemented by US airlines has reduced total mileage earning for flying, and that helps the mismatch between miles printed and airline capacity, but there’s no inherent connection between revenue-based earning and the number of miles earned.
Revenue-based earn does little to address too many miles chasing too few seats.
The piece though then moves on to redemptions and says airlines need to find something beyond their own seats to offer, but also identifies the problem with this — airlines buy those seats cheap, while delivering something customers value far more than cost.
Frequent flyer programs are able to buy (1) distressed inventory (2) at huge volume to generate a real discount, while customers value the travel received at something approximating retail.
When airlines go out and buy products their cost is closer to retail and they cannot give members outsized value.
McKinsey waives their hands at this and suggests:
- hotels should be willing to sell distressed inventory at a deep discount, but airlines have offered hotel redemptions and haven’t been able to negotiate this. Hotel occupancy hovers around record highs, Priceline and Hotwire aren’t nearly the tools for value they used to be because there isn’t as much distressed inventory as during downturns.
- luxury goods firms should be willing to sell their items at a deep discount, reaching a different market in mileage customers without having to drop their cash price.
- restaurants should sell distressed inventory to airlines the way they did with Groupon, of course Groupon didn’t work out so well, restaurants learned that customers who come in at a deep discount don’t convert to profitable customers later.
- instant real-time redemptions, presumably beacon-enabled based on location, could be delivered via app — but using miles for coffee doesn’t drive the kind of long-term value relationship that a trip to Hawaii does, with customers engaged in saving activity making purchase decisions now on the promise of future value. Small dollar retail redemptions, even if airlines could achieve those inexpensively, aren’t going to drive consumer behavior the way that travel does.
Hawaii is More Inspiring Than Coffee
It’s this last point that is crucial. McKinsey realizes early in the piece that consumers placing a high value on what they can use their miles for is crucial for the success of loyalty programs, but then they make the switch to suggesting airlines find lower value redemptions because those can be offered at low cost: a glass of champagne or wifi on board and priority boarding.
They also suggest discounted last minute upgrades but US airlines generally have upgrade lists already.
- Internationally those are mostly paid, mileage redemptions even with cash co-pay or top tier elite upgrades which drive the behavior of their heaviest volume customers.
- These are already being monetized domestically for cash.
There are flights that do go out with empty seats up front but they’re relatively rare.
McKinsey then recommends making award space available last minute on flights that have seats which will go out empty. Generally speaking many airlines already do this, and they recognize that leisure travelers far prefer to redeem in advance and set their vacation plans. (I am a big fan of locking in a worst-case redemption and then rebooking return flights last minute as inventory improves.)
There are some interesting ideas around offering discount redemptions in exchange for consumer flexibility.
- Award passengers agree to be moved to alternate flights with space. McKinsey even suggests being moved by a day in each direction but that’s less likely to play well given hotel costs and desire to maximize vacation time. Another challenge will be that assigned seats matter too, moving a family to disparate middle seats spread throughout the cabin won’t feel like rewarding customers for their business.
- Find out where you’re going at the last minute, award passengers could have their destination changed. Several airlines have offered ‘mystery trip’ redemptions based on open seats at the last minute, but those have seen a very limited market.
McKinsey thinks airlines should price flights dynamically, encouraging customers to take less-full flights for lower miles. That’s largely what airlines already do. That’s the ‘saver award’ concept. Delta and Alaska pioneered three pricing tiers. That’s taken off. Indeed all major US airlines now have more than two pricing levels. At least McKinsey realizes the damage done by using miles as cash for a fare because “the sky-high numbers of miles needed for redemptions … could therefore damage customer loyalty.”
Another suggestion is dynamic pricing internally for award seats and even charging different customers different mileage prices based on their perceived value to the airline.
A better way to allocate redemption seats would be to open the full inventory to the rewards program, but at variable pricing. In modern revenue-management systems, the “bid price” is the expected revenue from the last seat on a plane. By allowing the rewards program to “buy” seats internally at the bid price, a rewards program pushes customers toward less full flights. The rewards managers can decide whether the circumstances warrant taking a loss on a seat by allowing it to be redeemed if the miles are worth less than the bid price. Analytics that help companies to understand the total value of each customer can support this approach.
…Passengers who earn 100,000 miles a year through a credit card, for example, may receive high levels of availability even if they remain in the loyalty program’s base tier.
Finally, the report suggests focusing more on the elite program than the redemption program. This conflates the two very separate things that the program is trying to do. Both are important, though in different proportions to different customers.
- Recognition that’s the elite program, where an airline’s best customers are treated well and encourages long-term loyalty.
- Reward that’s the program’s earn and burn proposition, the rebate component of the program, and that’s applicable to a much greater range of customers (especially since most program members do not fly an airline even once per year).
There’s not a lot that’s really innovative in the recommendations. Instead they point to the fundamental problem of too many miles chasing too few seats. Airlines can print fewer miles, or provide more inventory of what customers value. They aren’t going to print fewer miles since they’re still able to make a profit selling those miles (although we’re starting to see some limits to that). Therefore redemptions of what customers actually want as defined by what motivates a continued long-term earning relationship is necessary.
In other to do that airlines will have to sacrifice margins spending more money on redemptions. The days of 25,000 mile redemptions costing an airline $25 are over, at least until a recession empties out planes.
(HT: Doctor of Credit)