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
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).
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
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.
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.
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
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).
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.
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
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).
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