Frequent flyer programmes: expect to see moves towards greater autonomy of these moneyspinners

Frequent flyer programmes: This analysis was generated

for:
expect to see moves towards Nidhi Grover
greater autonomy of these CAPA

moneyspinners
03-Jul-2013

Frequent flyer programmes (FFPs) can be an emotive subject. For many frequent
flyers, their status in these schemes and their ability to redeem hard-earned
points are important quality-of-life factors. A recently published survey reveals
significant differences in customer satisfaction with the award redemption
process of different airlines.

This highlights the importance of FFPs to airline brands through their

contribution to the passenger experience. FFPs have evolved from simple
mechanisms to reward an airline’s frequent flyers with free flights on that carrier.
They now embrace partner airlines and partner companies in other consumer
sectors and can offer awards other than air travel. Awards are not even always
restricted to humans: Virgin Australia has just announced a FFP for pets.

FFPs are also increasingly emerging as a profitable source of additional

revenues for airlines. Although visibility of their financial contribution is mixed,
there are growing examples of autonomous FFPs and third party investment and
ownership.

FFP satisfaction levels vary widely

A survey published on 1-Jul-2013 by Frequent Business Traveller asked frequent
travellers how satisfied they were with the FFPs in which they are members. The
leading programme was Alaska Airlines Mileage Plan, followed by Southwest
Rapid Rewards and the world’s first FFP American Airlines AAdvantage. At the
bottom of the list was Air Canada’s Aeroplan (the world’s first FFP spin-off) and
Delta Skymiles.

How satisfied are you with the FFPs in which you participate? The Frequent
Business Traveller/Flyertalk survey 2013

Source: Frequent Business Traveller and Flyertalk

The survey seems to have a strong North American bias, with only three
schemes from Europe mentioned and none from Asia-Pacific, Africa, or Latin
America. Moreover, it may not be very meaningful to compare the FFP of a single
class, domestic LCC (e.g. Southwest) with an FFP covering a group of airlines
from different countries offering global destinations in a multi-class cabin (e.g.
Miles & More).

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For these reasons, this survey should possibly not be taken as the definitive
global guide to FFP quality. Nevertheless, the range of results in the survey
does highlight the breadth and depth of feeling aroused by FFPs, which are an
important strategic tool for airlines in managing customer relationships.

American’s AAdvantage was the first FFP in 1981

The history and evolution of FFPs is well summarised in a 2012 paper published
in the Journal of Air Transport Management, entitled ‘30 years of frequent flyer
programs’, by Evert de Boer of Aimia Inc and Sveinn Vidar Gudmundsson of
Toulouse Business School. In the chart reproduced below, they summarise the
main milestones in the story of airline FFPs.

Milestones in the evolution of FFPs

Source: Evert R de Boer (Aimia Inc) & Sveinn Vidar Gudmundsson (ToulouseBusinessSchool), “30 years
of frequent flyer programs”, Journal of Air Transport Management, 2012

The original frequent flyer programme, American Airlines’ AAdvantage, was

launched in 1981 following the deregulation of the domestic US air passenger
market. This allowed passengers to receive a free flight ticket after travelling a
certain amount of miles.

The aim, as with all loyalty schemes, was to give frequent flyers an incentive
to remain loyal to American Airlines when choosing flights. Early FFPs were
based on miles or sectors flown and redemption seats were typically based on
a fixed allocation decided by revenue management departments. There were
often periods of time, known as black-out periods, when no redemption seats
were made available in order to minimise the loss of revenues that could be
earned from the FFP member buying a commercial ticket or from another fare
paying passenger.

Benefits to business travellers

American Airlines was also the first to introduce an elite tier to its FFP and
this soon became commonplace. Anyone who has seen George Clooney's Mr
Bingham in "Up in the Air" will recognise where this has led. For many business
travellers, membership of an FFP can play a major part in the choice of airline
for a business trip. Benefits such as access to lounges, priority check-in and fast
track security lanes create incentives to stick with a favoured carrier even if this
means paying a premium for the fare compared with alternatives on the same
route.

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For very frequent or high value travellers, membership of an elite tier increases
the switching costs of using another carrier. This has sometimes led to rival
airlines’ offering membership of their programme to elite members of another
carrier’s FFP at a level above the standard entry level. In some cases, FFPs have
been deemed anti-competitive due to the way in which they increase switching
costs. For example, SAS was ordered to cease offering its FFP on Swedish
domestic routes in 1999 and on Norwegian domestic routes in 2002 (the latter
ruling was reversed in May-2013).

The cost of award travel was lower than its

commercial value
The world of frequent flyer programmes has a lot of jargon of its own. When
a passenger redeems FFP points for a reward ticket, thereby foregoing the
purchase of a commercial ticket, this is known as dilution. When FFP points are
redeemed and another fare paying passenger is lost as a result, this is known
as displacement. When miles expire, this is known as breakage.

For many years, airlines valued the outstanding liability to provide award travel
at its marginal cost, in other words the variable cost of flying an additional
passenger. This is a relatively low cost if a flight is not full and, provided that
dilution and displacement costs were kept to a minimum, the total cost of award
travel was much lower than its commercial value.

Selling miles to partners grew revenues but led to

under-supply of award seats
This led to the practice of airlines’ selling miles to business partners at prices
significantly higher than their cost. Initially, travel-related partners such as car
hire, cruise and hotel companies were the main buyers of miles through such
partnerships. Credit card companies and banks soon joined the growing list
of partners for airline FFPs and, in another first for AAdvantage, the first co-
branded credit card was launched by American Airlines and Citibank in 1987.

Under a co-branded scheme, a member can earn miles not only directly with
the airline, but also for spending with the partner. This has generated very
substantial revenues to airlines for the advance purchase of miles by business
partners.

However, with the increase in the number and variety of partners for such
schemes, and in consumer participation in them, came increasing pressure on
the limited availability of award seats. For example, Delta Air Lines saw a 27%
increase in the miles earned by members between 2004 and 2007, but award
capacity remained unchanged.

Particularly on attractive routes, it became very difficult to restrict redemption

seats to unsold inventory only. This often resulted in airlines’ tightening their
miles expiry policies, which further increased customer frustration - in what was
after all supposed to be a programme to enhance loyalty.

Changes to reward pricing following accounting

changes
In order to address such problems, some carriers switched from distance
travelled or number of flights flown to the sum spent with the airline as the basis
of qualification for award miles. This can take the form of a certain number of
points per dollar spent and/or a minimum total spend in a qualifying period to be
eligible for a high tier within a scheme.

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One of the most significant turning points in the pricing of rewards came after
accounting changes forced airlines to value reward miles differently. A rule
introduced in 2008 and known as IFRIC 13 requires that airlines account for FFP
redemption liabilities at the fair value of the reward, rather than the marginal
cost. This led to significant increases in the value of the liabilities recorded on
airline balance sheets.

Furthermore, the bulk of the revenue generated by selling miles to partners

can only be recognised in the airline’s accounts when the miles are redeemed
or expired. This has led to the development of the new skill of breakage
management (predicting and managing the rate at which miles expire and the
associated revenues can be recognised) and a re-considering of expiry policies.

There had already been some evolution towards pricing based on the market
price of the chosen redemption flight, but the accounting changes acted as a
catalyst in speeding up this process. This might take the form of requiring a fixed
number of FFP points for every dollar needed to pay the commercial fare and/or
involve methodologies to optimise the conversion between points and dollars
needed, depending on the competitive environment.

Transfer pricing between the airline and the FFP

As noted by Mr de Boer and Mr Gudmundsson, this more advanced approach
“establishes a form of transfer pricing between the airline and the FFP.” It also
sets the FFP at arm’s length from the airline and allows for more seat capacity to
be made available than under the legacy approach.

Traditionally, capacity would be made available based on a small fixed allocation

per flight plus unsold capacity close to departure. The advanced model reduces
the costs of dilution and displacement by placing the redemption transaction on
a more commercial footing, thereby removing the airline’s incentive to keep very
tight limits on the number of award seats available to customers.

Other efforts to increase access to award inventory include lifting minimum

stay restrictions, the introduction of one-way redemption trips, regional award
pricing, the lifting of black-out periods and the offer of rewards other than air
travel.

FFP revenues can be large, but reporting is

patchy

FFP revenue streams reported by airlines

Source: Evert R de Boer (Aimia Inc) & Sveinn Vidar Gudmundsson (ToulouseBusinessSchool), “30 years
of frequent flyer programs”, Journal of Air Transport Management, 2012

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The table reproduced above gives examples of the level of revenues that can
be generated by FFPs. Nevertheless, although these are quite large numbers,
the level of disclosure on the financial detail of FFPs is variable and generally
limited.

While many carriers disclose the deferred income liability on the balance sheet,
most do not report annual revenues and even fewer give any indication of
profits coming from FFPs. In addition to providing what are sometimes
significant revenue streams, FFPs can also provide indirect benefits to airlines
through large databases enabling them to track customer behaviour and
preferences and allowing targeted marketing.

Autonomous next generation programmes

The emergence of the advanced model of FFP, with its arm’s length,
commercially based relationship to the core airline partner, has paved the way
for what Mr de Boer and Mr Gudmundsson have called autonomous next
generation programmes (NGPs).

Examples include Aeroplan (derived from Air Canada), Multiplus (TAM), Club
Premier (Aeromexico), Qantas Frequent Flyer and topbonus (airberlin).

The autonomous NGP typically has a broader strategic focus reaching beyond
frequent flyers to include infrequent flyers and non-air travel consumers of
partner organisations. Non-air partners often account for more than half of
overall miles accrued and include other travel companies, financial service
businesses and retailers.

Mr de Boer and Mr Gudmundsson see further development in this direction:

“The NGP will act as a white label service provider for industries other than
airlines, for example groceries and gas. Greater marketing efficiency and lower
cost to serve could be compelling arguments to shift the loyalty program to the
NGP instead of maintaining it inhouse.”

Set up as separate companies, the ownership of NGPs often (but not always)
includes outside investors and full financial reporting is the norm. Rewards
offered are not limited to air travel, but can also include merchandise and
experience-based activities. The full commercialisation of the relationship
between the autonomous NGP and the core airline partner means that
redemption inventory is the widest of all models, such that any seat is available
at the right price.

FFP IPOs and sales to third party airlines

Aeroplan was the first FFP spin-off following its IPO in 2005 and, in 2012,
Aeroplan’s parent company Aimia took a minority stake in Club Premier. Also in
2012, airberlin sold 70% of its FFP topbonus to Etihad Airways, who had already
taken a 29% stake in airberlin itself.

On top of EUR73 million invested by Etihad directly in airberlin, the Gulf carrier
also provided EUR184 million for the topbonus stake. Etihad is prevented by EU
restrictions on ownership and control from owning more than 49% of airberlin,
but there are no such restrictions on FFP ownership. In this way, Etihad was
able to provide airberlin with more capital and to gain greater influence over a
strategically important part of its business.

Subsequently, when Etihad acquired a 24% share in India's Jet Airways, the
UAE carrier also invested USD150 million in Jet's FFP; the two airlines had been
cooperating since 2008 and this cemented the loyalty and data parts of the
deal.

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Despite a failed attempt in 2006 to privatise the airline and sell off its valuable
parts, Qantas Frequent Flyer remains 100% owned by Qantas, but its financial
results are separately disclosed. In the year to Jun-2012, Qantas Frequent Flyer
achieved an EBIT of AUD231 million (USD210 million) out of group underlying
EBIT of AUD265 million (USD241 million).

Does every airline need a FFP?

Historically, most LCCs did not have a FFP as they preferred to compete on the
basis of low fares. Nevertheless, as business models have evolved, both from
the LCC model to the FSC approach and vice versa, it is now common for LCCs
to include loyalty schemes in their offer.

There is a growing recognition that such schemes do not always mean higher
costs and that they can drive additional ancillary revenues. Moreover, a number
of LCCs have partnerships with FSCs and reciprocal FFP recognition can assist
the development of such relationships.

Eight out of the top 10 LCCs globally have a frequent flyer programme.

Frequent flyer programmes of the top 10 low-cost carriers

Source: Aimia Inc, 2012

Europe’s two largest LCCs, Ryanair and easyJet, continue to steer clear of
FFPs. easyJet’s group commercial director Catherine Lynn told CAPA’s Airlines
in Transition conference in Dublin in Apr-2013 that corporate travellers like FFPs,
but the growth in the industry is mainly in the leisure segment, where points are
less valued.

While 80% of easyJet passengers are leisure travellers, 65% of its routes are
city-to-city, so business travellers are well served by its network. According to
Ms Lynn, FFPs add cost and complexity, which is why easyJet has no plans to
introduce one.

easyJet does have reward schemes with loyalty programme partner Nectar
and Emirates Airlines. The Nectar scheme rewards passengers with easyJet
flights for spending with other Nectar partners, while the Emirates partnership
allows its Skywards FFP members to redeem their points for easyJet flights.
easyJet also has the easyJet Plus card, which gives members seat choice,
speedy boarding, fast luggage drop and member offers for an annual payment
of GBP149.

Smaller and non-aligned airlines take different approaches to brand loyalty.

Many, but not all, have their own FFP, while some opt for other forms of loyalty
programme that require a third party partner (perhaps involving a retailer, for
example).

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CAPA’s Airlines in Transition conference highlighted some of these approaches.

For bmi Regional CEO Cathal O’Connell, a better way to compete is to offer
direct services with the schedule and frequency that passengers want.

Azores-based airline SATA does have its own FFP, but CEO Antonio Menezes
conceded that, given 80% of his passengers are not based in the Azores, its
value is limited. Nevertheless, he believes that it is key to customer relationship
management as an important communication channel. While some carriers have
sold their frequent flyer programmes in recent years, Mr Menezes would not
want to lose strategic control over SATA’s FFP.

Monarch Airlines does not have a FFP, but it does see value in other forms of
loyalty scheme and has an important partner in UK supermarket retailer Tesco.
Its passenger profile is very leisure-oriented and the most important factor for
this segment is the air fare.

The autonomous model is likely to gain popularity

Although they are not desirable for every carrier, FFPs can generate significant
revenue streams and, as evidenced by Qantas, they can be major contributors
to airline group profitability.

The more autonomous model, based on an arm's length relationship to its core
airline partner and involving significant revenues from non-airline partners, has
tended to be a more significant revenue generator than the traditional more
narrowly focused model.

The autonomous model has also allowed airlines to raise capital through selling
stakes in the FFP via IPO or to third party investors. Retaining control over
FFP databases, and the consequent targeted marketing opportunities, is
strategically important. However, the trend towards more autonomous schemes
seems likely to gather pace.

See also, in CAPA's Airline Leader Journal: The airline frequent flyer programme:
for love and money

© 2021 CAPA - Centre for Aviation

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