December 28, 2018

Commercial Aviation Part 4

One aspect of air travel I'm particularly interested in is frequent flier/loyalty programs. These have three basic purposes from the perspective of the airlines:

1. They allow the airline to differentiate what is essentially a commodity product, a trip from A to B, and turn it into something unique.

2. They give customers an incentive to put all of their flights with a given airline.

3. They give the airlines the ability to sell lots and lots of miles to banks, who in turn use them to incentivize customers to spend on their credit cards. The banks collect their money on interchange fees.

We can divide the programs into two broad parts, status and points. Status is earned on an annual basis, and is designed to reward the airline’s best customers with upgrades, free checked bags, and other amenities. Most people don’t have status, and the easiest way to get basic status is through having a credit card. Points are earned by everyone, while status traditionally requires spending significant amounts of time/money with the airline.

Miles and points are essentially an airline version of the old store loyalty programs, where if you give enough business to them, they’ll give you free stuff. American started the modern programs with AAdvantage in 1981, helped by its then-ownership of the SABRE reservation system. United quickly followed, and the programs soon became standard throughout the airline industry.

There are several types of frequent-flier program, but they can be divided into two broad categories: revenue-based and mileage-based, although recent developments are blurring the line between the two.

Southwest has one of the simplest revenue-based programs, Rapid Rewards. They award points (instead of miles) based solely on the price and category of your ticket, with more expensive Anytime and Business Select fares earning more points per dollar. These points can then be redeemed for flights at 1.4-1.8 cents per point. This is basically a straightforward travel rebate, which makes it easy to understand.

The legacy carriers traditionally used a mileage-based program. In this, miles are awarded based upon the distance flown, usually with some multiplier for the fare code and class of service. Elite members may also get an additional multiplier to their redeemable miles (as opposed to qualifying miles, which count towards next year’s status.) Miles are then redeemed for tickets based on an award chart, which lays out the costs of various types of awards. The most common is a zone-based award chart, where, for instance, all tickets in a specific class within the continental US cost a specific amount, and tickets from CONUS to Hawaii cost a different amount, and so on for every region you can travel to/between. There are two tiers for each zone, the lower ‘saver’ level being capacity-controlled, and the higher level (often double miles) giving last-seat availability.

The alternative to a zone-based award chart is a distance-based award chart. These cost a set number of miles based upon what distance band the flight is in and what class you’re booking into. They usually also have saver and unlimited prices. These occasionally offer outsize value (for instance, Boston-Ireland is often in a shorter zone than other transatlantic awards, which means you can get much better prices).

Lately, this model has been changed by the major airlines. Now, American, Delta and United all have taken mileage earning revenue-based, instead of distance-based, and significantly lowered the earning from flight. Delta has also eliminated/hidden its award chart (much to the chagrin of the frequent flier community). However, taking redemptions completely revenue-based, as in the Southwest model, has so far been a step too far for the programs. What has made the traditional frequent-flier program so successful is the possibility of outsized value, getting something amazing ‘for free’.

The vast majority of miles today are earned through non-flying means, mostly credit card spending. This is very profitable to the airlines, to the point that some have spun off their frequent flier programs while in financial distress (most notably Air Canada, although they recently decided to bring it back in-house). During the last round of airline bankruptcies, the banks pre-purchased large blocks of miles as a backdoor way of providing emergency funding.

Miles can be thought of as a sort of currency, with little convertibility (all programs prohibit you from selling them, although some allow redemptions as cash) and an unreliable central bank. Particularly over the past few years, as planes have filled up and airlines have found themselves making money, the award world has been under pressure. When these programs were first developed, load factors were low, and award seats were ones that would have otherwise gone empty. Today, award seats are often seats that would otherwise have been sold, which has placed great pressure on saver award availability and forced prices up, particularly as airlines continue to print more miles.

A mileage run from LAX to JFK

In many ways, what I find most interesting about the frequent flier world is the people who use these programs to the full. There are lots of people who are obsessed, and search out any opportunity to earn miles and points. Particularly at the height of the recession, and before frequent-flier programs went revenue-based, some people would do ‘mileage runs’, flying back and forth across the country using the most circuitous routing possible to get miles, which they valued at more than the cost of the ticket. There have been even more extreme cases of this, the most famous of which was a man who realized that a promotion meant he could essentially buy miles, which he valued at 2 cents each, for about two-tenths of a cent by buying pudding cups and sending in the bar codes. He bought 12,530 cups, worth 1,253,000 miles, and then made a deal with the Salvation Army to help him remove the bar codes. In return, he donated the pudding, and the tax writeoff of $815 increased his profits even more.

Status gives a variety of benefits. The most prominent are upgrades, free baggage, and priority boarding. It’s a reward for people who travel frequently, and most programs give a variety of levels. This is an area where legacy airlines have a big advantage over the newer carriers, although these programs have been eroding over the past few years, for the same reason as the frequent flier programs. The exact levels of status and the benefits vary by airline, and I’m not going to go into detail. There are lots of blogs which will explain this better than I can.

Frequent flier programs are fascinating as both an insight into practical economics and as a way of getting the most for your dollar when dealing with airlines. If you're interested in flying in international business class (something everyone should do at least once) the blogs above will tell you how to get started.

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