Are Airline Loyalty Programs About to Die?
Delta (and others?) to start charging for award tickets
28 Jun 2008 in Regulatory Economics
Delta Airlines has announced new fees for redeeming frequent flyer miles into airline tickets -- $25 for domestic flights and $50 for international destinations. Other airlines are considering reciprocal actions.
What does economics teach about the likely consequences of this action?
Frequent flyer miles were introduced a quarter century ago to encourage brand loyalty in the airline business, in particular, loyalty to legacy carriers that were having difficulty competing with upstart airlines in the newly deregulated airline business. The most profitable airline travel is business travel because business travelers' demand is much less price elastic -- that is, business travelers' decisions concerning where and when to travel, and how far in advance to decide, are less sensitive to price than the decisions of leisure travelers. (These are typically the same people who are buying a different product when they travel on business instead of for pleasure.)
Frequent flyer programs encourage business travelers to prefer specific airlines, even when their employers have to pay higher prices, because the benefits of loyalty programs are enjoyed by the employee and not the employer. Airlines succeeded in taking advantage of this disconnect between "principles" (employers) and "agents" (employees).
The value of frequent flyer miles has diminished over the years. Airlines generally have imposed ever-tightening constraints on redemption -- capacity constraints, blackout periods, length of stay and advance purchase requirements, etc. Nonetheless, airlines still compete with each other over program quality to some extent, yet they all reserve the right to change program rules with minimum notice. Inevitably, these changes reduce the airline's liability and by necessity the asset value to consumers who hold frequent flyer miles.
A reasonable rule of thumb is that miles are worth about $0.01 each. So the challenge for travelers is to figure out how to maximize their value in the face of relentless (if sometimes subtle or secret) airline efforts to minimize them. I used 180,000 miles to purchase two business class seats to South America for a wine tour. But to make sure of success, I redeemed these miles on the first day that seats on the Delta Airlines flights went on sale.
One would expect that this new policy will have predictable practical effects. First, current holders of large balances will be inclined to use them sooner rather than later. Delta's new fee signals inflation in the currency of airline miles, and as with inflation in any other form of currency, it signals to the market that spending now is superior to spending later; prices will only go up. This inflationary expectation then feeds more rapid consumption. A cursory review of frequent flyer programs indicates that there are plenty of award tickets still available even for summer 2008 travel to conventional US destinations. Many of these tickets will be snapped up prior to the August 15 start of Delta's new policy.
Second, consumers with significant balances may be more inclined to redeem miles for more expensive airline seats. A $25 fee per domestic award ticket can be a large fraction of the cash price; a $50 fee per international ticket is not. Airlines cannot raise this fee much higher without appearing craven. Had Delta's new $50 per ticket fee applied in 2006, it would have posed little discouragement to the South America trip mentioned earlier. Business class seats for a similar trip in 2009 are now priced at $3,225 each. For this round trip of 10,060 miles, Delta's miles are worth $0.32 each. But relatively few frequent flyer tickets consist of business class round trips to Santiago. Many more are economy class tickets to routine domestic (often vacation) destinations, where the $0.01 per mile rule of thumb is still approximately correct.
A third unintended effect of the new fee is to undermine airline brand loyalty. An airline's decision to unilaterally reduce the value of its frequent flyer program signals to its customers that the promises it made when the miles were earned are subject to abandonment at any time. Loyalty programs do not work as marketing tools if one party retains the right to be disloyal.
