Here's Why Airline Loyalty Programs are Profit Machines - AirlineGeeks.com

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[ Airlines ]December 17, 2021 1:44 pm ET

By Hemal Gosai

Here’s Why Airline Loyalty Programs are Profit Machines

Airline loyalty programs have been cash cows for decades. They are an extremely effective marketing tool that drives customer loyalty by offering an incentive for customers to stay loyal. This incentive usually comes in the form of free flights though has recently evolved to offer discounts and benefits across the flying experience.

Initially, it was the airline that primarily issued the loyalty points but over time partnerships developed and partners would start buying loyalty points from the airline to distribute to their customers for various activities. This created an interconnected network of partners where a customer could earn airline loyalty points even when not flying.

This overtime also evolved into co-branded credit cards. Banks issue airline-branded credit cards and give their customers airline miles when they spend money on these cards. These partnerships have grown beyond expectations and banks pay in the billions of dollars to keep these partnerships with airlines.

The two questions that arise are that if banks are willing to pay that much money to maintain these partnerships, how much are airline loyalty programs worth and how do they relate to an airline’s worth.

A very interesting video was published by Wendover Productions on YouTube that addressed just that.

The video starts off with how certain financial documents were published by airlines as part of getting bailout funding from the government. The nature of these documents were extremely revealing because it openly put valuations on airline loyalty programs. The interesting thing here is that for many airlines the value of their loyalty programs is in excess of the valuation of the company itself. An example listed in the video is that at the time American Airlines’ market cap was around $6 billion while their AAdvantage loyalty program was valued at $25.5 billion.

This leads to instances where an airline may actually lose money running the airline by flying and moving passengers about but make money through the loyalty program.

Let’s take American Airlines for example. According to Wendover Productions, in 2018, American Airlines’ RASM was 14.42 cents, meaning that’s how much money they made per seat per mile. The carrier’s CASM was 14.85 cents, meaning its costs to fly that seat per mile. We see that American Airlines actually lost money operating.

However, its pre-tax profits were $1.9 billion thanks to the AAdvantage program and sales of miles derived from it. It’s estimated that the airline sells miles to partners at around 1 cent per mile. Passengers then need tens of thousands if not more miles to redeem for flights since pricing for miles is becoming variable.

The initial idea was to use give away seats on flights that would otherwise go empty to frequent flyers. There are minimal additional costs to put someone in the seat that would’ve gone empty; fixed costs are already paid for so it’s all gravy for the airline.

The cheapest award tickets are the ones that usually are available on flights with seats that will probably go empty. The more expensive award tickets usually apply to flights where seats will probably be filled with paying customers, so in order to book a seat on that flight with miles the customer is expected to pay through the nose with their miles.

This turned these programs from actual loyalty programs to huge profit centers for airlines. They can sell billions of dollars of miles to partners and then have locked-in customers redeem miles for flights on their airline at outrageous amounts ensuring that the airline does not lose money on award redemptions.

The gravy train isn’t going to be ending anytime soon either. As long as customers perceive the value of these miles, credit card companies will be incentivized to buy them from airlines to offer to their customers. Airlines have considerable power in this situation as well. They can set the price for the sale of miles and if the negotiations do break down there will likely be another credit card issuer on the sidelines just waiting to pick up an airline portfolio.

Wendover Productions highlights what is likely the most fascinating aspect of loyalty programs run by the major airlines in the U.S. These airlines are essentially acting as central banks for their own currencies.

They control the flow of the currency and also control the availability and costs of the goods to spend it on. In addition, they can create more miles for the purpose of selling it at any given time. They have complete control of their points because they are the only entity in which the miles can be used.

Frequent flyer programs have gone beyond rewarding passengers for loyalty and have become huge financial instruments that are crafted in such a way that it is nearly impossible for them to lose money. In the case of American Airlines, its loyalty program is more profitable than actually flying airplanes.

Hemal took his first flight at four years old and has been an avgeek since then. When he isn't working as an analyst he's frequently found outside watching planes fly overhead or flying in them. His favorite plane is the 747-8i which Lufthansa thankfully flies to EWR allowing for some great spotting. He firmly believes that the best way to fly between JFK and BOS is via DFW and is always willing to go for that extra elite qualifying mile.

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Hemal took his first flight at four years old and has been an avgeek since then. When he isn't working as an analyst he's frequently found outside watching planes fly overhead or flying in them. His favorite plane is the 747-8i which Lufthansa thankfully flies to EWR allowing for some great spotting. He firmly believes that the best way to fly between JFK and BOS is via DFW and is always willing to go for that extra elite qualifying mile. Hemal's opinions are his own and do not reflect those of his employer.