What Top Consultants Are Telling Airlines They Should Do to Change Their Programs

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)

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 »

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Comments

  1. I went to a top business school and know a number of people that went to McKinsey & Co and other top consulting firms afterwards. Basically, they are really bright people, with minimal real world knowledge. So when they do research for a company, they talk to the senior managers in that industry and company and regurgitate into a really slick presentation/report. Then the senior management of that company can say, we got an independent report from McKinsey, which suggests we do X, Y, Z. Of course, X, Y, and Z, is exactly what the management wanted to do in the first place.

  2. indentified
    waive

    Beyond that you are spot on. Amazeballs that McKinsey can charge millions for this kind of ‘consulting”.

    Nobody reading this board is the least bit interested in redeeming 25k miles for a fixed menu dinner for 2 at Morton’s – or whatever.

    There is only one solution, which you outline – give consumers what they want and the reason they have a loyalty relationship at all: seats on planes. Otherwise the airlines can bleed to death as far as I’m concerned when their credit card deals and FF programs become irrelevant. In particular I’m looking at you Drinky D.

  3. I’m now just waiting for the Triple-branded Starbucks-Delta-Amex card with the innovative way to convert Skymiles to Starbucks stars at the industry-leading ration of 100:1. Finally, what I got into the points/miles hobby for in the first place!

    /endsarcasm

  4. What a about a Mile-buyback program to reduce the number of outstanding miles in volume?

    Similar to a stock buyback effort to reduce the number of outstanding shares in the market?

    Will drive the value of each mile up since there’s less supply. Although some will argue that this is what Delta is already doing with their monetization plans already in place.

  5. not being able to open up seats domestically is still fine as long as they have access to partner awards. Did McKinsey say making partner awards more expensive is a dangerous route to take, with a possibility of killing the entire reward program? Until a few years ago, I had a healthy routine of using my AA miles but the devaluation hit and I rarely redeem these days. At the same time, many ways to buy business class on the cheap, so I am valuing my AA miles far less than what I used to. At the same time, I have been reducing my loyalty to AA and have been flying discount or non-alliance airlines when they have a promo for business or premium economy. I am wondering whether McKinsey people got to that at all. With another devaluation. I might just be a freelancer who take any airline for the right price. I am sure legacy airlines would struggle so much if many do the same

  6. @Other Just Saying: Yep!

    It also amazes me that top management will pay ridiculous fees to consulting firms to figure out what’s wrong with their business. If you don’t know, you shouldn’t be managing the company in the first place.

  7. Yep – focus on the elite program. That’s the only thing in here that matters.

    Or separate the elite program from the miles-earning rewards program.

    As an EXP ~150K BIS traveler with around $20K EQD – I could not care less about RDMs. They literally have nothing to do with my choice to fly AA. The elite program however is massively important.

  8. I wonder how long it will take for the credit card company customers to start realizing the value of their miles are dropping. I know you, Lucky, The Points Guy, and other popular bloggers have all written about the reduction in value of each mile – AA miles, UA miles DL miles and others as they have increased award charts while at the same time decreased availability.

    Years ago, I used to get excited because I could redeem 100K miles for a business class $10,000 ticket to Europe. Today it costs me 140K UA miles, and I can routinely find a paid business ticket to Europe for just over $2000.

    To me 2% CASH back cards are becoming increasingly better as I am having a harder time redeeming my miles particularly for business class flights. At the same time, I am seeing business class flight prices coming down.

    I am pulling back somewhat from Airline Credit Cards, and increasing spend on cash back cards. I am loosing my drive for collecting miles as my balances have gone up, but I can’t spend them unless I am willing to redeem for close to ½ cent redemptions.

    Eventually credit cards are going to laugh when airlines what to sell them points at 1cent each – as the general public will finally see that its so rare to be able to redeem miles at over1cent, and credit card customers will look to other programs instead of airline points.

  9. Ur aware that this is directed towards airline execs who have a P&L to manage and not frequent flyers? 🙂

  10. One peeve here. The Fed does in fact print dollars; something you can hold in your hand, and exchange with others for virtually unlimited goods and services.
    Airlines do not ‘print’ miles, despite what Gary says here. They simply ‘create’ them out of thin air. They are a currency of sorts, with limitations as to how it may be spent imposed by its creator, the airlines, and have the built-in potential to simply expire, unlike the dollars in your wallet.
    So, let’s not talk about ‘printing’ airline miles, OK?

  11. McKinsey and such firms (Bain, BCG) are full of people who were smart and high achieving in high school and college but decided they want to rest on their laurels and not achieve anything of serious value any more in their lives.

    Of course this is still valuable to clients (companies that hire MBB) because their own employees are people who are not smart and achieved nothing in high school and college!

    Amazon famously doesn’t hire management consultants. But Walmart, Target etc all do. Quite telling, eh.

  12. Been to a dave and busters? Maybe a chuck e cheese? You can apply monetary policy there also, but you’d look like an overpaid goof. Its chits guys. Its designed to be a honey pot to keep you playing a potentially expensive game. Its not expensive anymore and the game is no different from one to the next. Lets look at the prizes, yes theres some value there unlike giant stuffed animals or free pizza. But the skill you need to seperate yourself from a newbie claiming bose headphones for 60k points versus a 6000 dollar ticket is still a thing. And miles expire and miles go unclaimed. Monetary policy? Inflation? No, its just crappy prizes and cheaper games. – former 1k and exp

  13. The first thing they need to is go back to rewarding loyal customers who actually fly or stay. It’s such a simple task, but as with most things, the Americans in particular over complicate everything.

    Then they should immediately stop handing out fancy credit cards that come with top tier status. It devalues these programs completely and it is extremely unfair to those of us who actually are loyal to brands and fly with them and stay with them.

  14. Consultants are some of the biggest ripoffs that anyone can get themselves into. They make Enron look like amateurs. Pay us big money for us to count beans and give you short term rewards at the expense of any sort of long term benefit. All of them quite frankly deserve to go to hell. Its amazing that anyone even falls for hiring management consultants to do anything more than sweeping floors. Those companies are full of arrogant pricks that haven’t done an honest day’s work in their entire lives.

  15. I too after 20 years decided to pull back on airline miles this year.
    I have millions and really not an easy way to use them.Not that they will go to waste
    The biggest problem is being stuck with 500K Virgin Atlantic 🙁 Other then perhaps ANA I’m at a loss
    Delta? 🙁 I think not
    Tried to get two first class tickets on Hawaiian.Agent said she has never found anything other than coach in her 5 years of working there as a res agent.I was shocked
    Now doing Cash back and a mix of others

  16. Consultant here, non-McKinsey. Gary, usually a huge fan of your work but
    (1) you obviously haven’t read this article properly as you’re twisting a lot of the statements or quoting them out of context or incomplete and also completely neglect the changes positive for customers
    (2) Most statements are pure rants without any facts or evidence behind it (or alternatives)
    (3) The article is clearly directed towards airline executives (as you also mention in the headline) but all of your writing is from a customer perspective; think you can’t judge advice to management that might be based on a lot of research work from that POV

    Let’s also not forget that we as “frequent travel gamers” are in fact not “loyal” to one brand but to many brands (meaning not loyal at all).

    Most of the comments seem to be from consultant haters. They have probably applied to MBB at some point and haven’t gotten accepted. 🙂

  17. @Martin – my point is that what McKinsey is trying and failing at is telling airlines how they can continue to drive revenue gains without sacrificing margin. There *aren’t* alternatives to do that, especially in a world where bank programs have spun up, gained scale, and are eroding the airline loyalty business [a claim I *do* support in the post, linking to United’s 10K which shows stagnation in mileage sales, the only growth MileagePlus seems to be experiencing is selling miles to Chase for Ultimate Rewards transfers].

  18. Well I think you’re aimed in the right direction here. With excess supply of miles, no additional spend opportunities that build similar loyalty/experience to a Hawaii vacation redemption (and you can only sell so much Dom in SCs), the only option is to increase the supply of inventory available to FFPs. Unfortunately that’s a profit negative choice, either by buying additional planes (not gonna happen) or increasing the % allocated to award seats (turning away already max load factors). To offset the profit loss, the only logical move is to raise pricing/dynamically price to compensate. Hence why I only hold emergency reserve levels of miles at airlines and prefer to hoard chase points/buy Alaska miles when I need to travel on the cheap.

    And to the commenters, don’t be too too hard on generalizing consultants. While there’s a good bit of rumber stamping that people detest, there are still consultants out there that build honest and real value (don’t worry I’m not a consultant).

  19. @PK — the “honest and real value” built by consultants is a wasteful use of their intellect. People who are actually smart should be in scientific research and advancing humanity, not lining the pockets of F500s.

  20. I’m from a top 3 consulting company…and one thing we love, is to travel, collect airline miles and hotel points on a company’s account. We rarely travel economy (and definitely not when traveling internationally) and only stay at 5 star hotels. Points that we rack up take us on beautiful trips – so life is good…so long as companies keep engaging us – which they are.

    Do we provide value? Of course we do. Sure, sometimes we do tell management what their employees have told us, but obviously the employees are not effective in communicating their own message. Enter the management consultant.

    The more these companies keep employing average employees, the more we will continue to be engaged.

    All the negative comments are from haters. Probably just average workers.

    Let the negative trolling begin.

  21. The only decent redemptions are for international business and first class. Why is that? If they would give you decent redemption value for first class domestic flights (for example), then there would be more flights that make sense to redeem on.

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