Airlines are Killing Frequent Flyer Programs, but Long Term Technology Will Do It For Them

Recently American Express re-upped their Delta deal, and Chase re-signed both Southwest Airlines and United. Citibank and American re-signed a 5 year deal in 2013. And in American’s third quarter earnings call, airline President Scott Kirby lamented that competitor airlines had a year-over-year boost to their revenue for the third quarter that American did not as a result of those new credit card deals.

But American’s deal comes up in 2018, and it will be even more competitive than usual. Citibank obviously will want to re-sign the airline again. Barclaycard will be a real competitor this time, though — not only do they have an already-installed cardmember base in former US Airways co-brand cardholders who now carry “AAdvantage Aviator” cards issued by the bank, Barclaycard even bought the ‘back book’ of legacy US Airways card accounts that had been serviced by Bank of America. They wouldn’t have done that if they weren’t serious about winning back the concession.

The price of airline miles to banks has been on the rise with these new deals. Back in 2008 and 2009 banks were buying miles super cheap, closer to one cent apiece rather than two, when the airlines were short of cash during the recession. Now with airlines in a stronger position financially, with fewer airlines to do deals with and banks in a healthier position to compete for those deals, the price of miles has swung up closer to two cents than one.

Meanwhile airlines haven’t needed to spend as much on marketing to fill planes. They’ve been able to devalue their frequent flyer programs.

  • Miles are costing the banks more
  • Those miles are worth less

Frequent flyer programs may find themselves killing their multibillion dollar goose in the medium-term, though it’s likely on a long-term decline no matter what they do.

Devaluation Reduces the Demand for Miles

Any given decision a frequent flyer program or an airline makes to devalue their program or product probably makes sense in isolation. They’ve got reams of data to tell them that customers aren’t going to book away because of a small change.

Taken together, however, the accumulation of changes may push consumers away — the marketing allure of the progams diminishes, program alternatives like proprietary bank offerings or cash back start to look more attractive.

United announced a major devaluation of their miles in November 2013, and I’ve been told that the introduction of cheaper United-only awards was a concession to their co-brand bank partner who is also their largest customer. United miles need to be a desirable currency for consumers in order for consumers to want to push charges through their United Explorer cards, and thus for Chase to be buying large quantities of miles from United.

When United was in bankruptcy, the airline’s first call after each court hearing was to their co-brand credit card partner who was providing their financing. United needed to keep flying to support the underlying credit card product. The tables have turned but Chase remains the biggest revenue source for United Airlines.

About two-thirds of American AAdvantage miles are sold to third parties rather than being earned through flying. The largest buyer is Citibank.

Those miles will be worth less March 22 yet they expect to get more money for them. That’s not long-term sustainable.

Technology is Going to Make Multi-billion Dollar Frequent Flyer Programs Obsolete

In the longer-term the biggest threat to the finances of frequent flyer programs is new payment technologies which may take the largest customer – the banks – off the board.

New technologies will compete down the price of processing payments. Those technologies may not be bitcoin, or even block chain-related. But new payment technologies, over the next decade, will cause American Express, MasterCard, and Visa margins to shrink.

Whenever I raise this topic with frequent flyer programs, they get a deer in headlights look. They just don’t seem to have people working on and thinking about what happens in 10 years when their business model of selling miles to banks is upended. Bank executives tell me they’re not worried because they’re competing in the new technology space, too. But that’s not an answer — the banks may still be relevant in payment processing, but they simply add to the competition that hastens falling interchange rates and the speed at which they stop buying miles.

Credit cards will be less important for mileage-earning in the future than they are today. Because frequent flyer programs are such powerful motivators, they become the preferred rebate currency that banks use to incentivize transactions using their products across their preferred payment networks. But in the future the margins on credit card transactions will shrink so there won’t be a role for incentivizing transactions to the same degree, or at the same level of expense. It simply won’t make sense for banks to buy so many miles to reward credit card customers once their margins shrink.

  • There simply isn’t a future for 3% merchant fees for accepting credit cards.
  • No bank will buy a mile for close to 2 cents, or rebate 2%, in world where merchant fees look more like 1% than 3%.

Rewards debit cards have pretty much become extinct (at least in any way where they drive real value) as debit card interchange fees fell to near-zero. In that case it was because of legislation (the Durbin Amendment to Dodd Frank financial reform). A similar thing will happen over a long period of time to rewards credit cards, because of competition.

That’s Not Even a Bad Thing for Consumers

Banks scaling back credit card rewards means fewer mileage-earning opportunities to be sure. But it may mean much better award space as fewer miles chase a fixed number of seats.

And it may mean less pressure and opportunity for devaluation once the underlying structure of the programs change. They won’t need to inflate award prices in order to balance demand for awards with supply of seats.

EVA Air Business Class

In a lower intercharge world we might even see frequent flyer programs even revert to being incentive programs for flying on planes.

The programs though — in order to retain their viability at the kind of scale they’ve achieved — are going to need to be adaptive and identify new opportunities to extend their brand. These programs remain the single greatest marketing innovation we’ve seen, and there’s a fundamental insight about consumers that they bring as well as the ability to leverage data. That’s inherently valuable. But they’ll need to find new customers beyond the banks. It’s not obvious today that they’re really working on that in any real way.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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  1. American oligopolies are very good at making sure that no new entrants can get their footing, and they compete with one another only barely enough to avoid the wrath of the DOJ. The banks aren’t going anywhere, the payment networks aren’t going anywhere, and their fat vig isn’t going anywhere.

    The only thing that would actually make this happen would be a Durbin Amendment for credit cards, and I don’t imagine that’ll happen.

  2. At 2-cents per mile i would think Citi would be better off focusing on their Thankyou point cards. Imagine if instead of paying AA .02 cents they offered prestige members the ability to buy fares on AA at .02 cents per point vs .016 they currently do. So the current AA 25,000 point award would get you a $500 fare using the same amount of Thankyou pts. I’d do that everyday of the week. Plus we’d get the EQM’s. And a vast majority of awards the airlines issue are these type of awards.

    Even business class is a kinda-decent deal at this point. The new AA chart will cost 115,000 miles to europe in J. At 2-cents per TYP thats $2300 that can go to a business class fare. I know that’s at the very bottom of J-fares, but factoring in the BA YQ surcharges (since BA availability is a bulk of premium awards offered) it’s a closer spread.

    Obviously .02 per point limits the awesome awards some of us are able to secure (ie QF 1st on the A380), but if i was Citi at $.02 per point i’d seriously consider looking in-house before paying through the nose for AA.

  3. It is not that these changes are killing frequent flyer programs, but they are killing their current business model. As you allude to at the end of the article, we could eventually see frequent flyer programs begin to once again be oriented toward frequent flyers.

  4. Gary, don’t forget that the consumer banks like Chase, Barclays, and Citi really make their money from interest on unpaid balances, not just interchange fees, and that business isn’t going away anytime soon. There’ll always be chasing those consumers with whatever incentives work – and miles seem to do the trick.

    And isn’t it really the new entrants (Apple) that are disrupting the business, rather than the technology itself?

  5. Without the credit card business, frequent flyer programs will be exposed for what they really are: incentive-shifting kickback programs designed to benefit the flyer at the expense of the payer. After all, the points earned should now be called kickback points, not miles, since they have nothing to do with flying a certain distance, but rather how much the employer had to pay for the ticket. There are rampant incentives for gaming that system.

    Already our company has responded by requiring all bookings to be made by in-house agents instead of employees. Furthermore, if an employee requests a flight at short notice, they must give adequate justification for that short notice signed by the employee, a same-level colleague, and their immediate reporting manager. We will fight this thing, whatever it takes.

  6. Gary – very thoughtful article on how future of banking may impact airlines. Not related, but in the near term, the falling oil prices, lower cost airlines and all the factors driving flight prices downwards also lessens value of awards that are getting more difficult to obtain particularly getting precise flights you want. Like the focus of the Venture card ads audience, the difficulty of using miles to get the flights you really want drives non-churning mileage consumers away. Enjoy this feeding frenzy while it lasts.

  7. I think Tom gets at the biggest challenge to the direction airlines are taking their ff programs. It’s quite obvious delta wants revenue redemptions to pair up with revenue-based earning. Earning personal miles for business travel already made some employers uncomfortable even when the valuation was more nebulous (the government, in fact, prohibited the practice on GSA fares until relatively recently). When it becomes a literal cash-back scheme to award employees for the corporate dollars they send to the airline, corporate travel departments will likely demand corporate-level “frequent flier” accounts or discounted fare classes that don’t earn such “miles.” Credit card companies, for their part, can run more efficient cash-back schemes without involving the airlines.

  8. The section “That’s not even a bad thing for consumers” misses the most important benefit of falling fees — it removes an invisible 3% tax on all transactions (that involve credit cards) that most surely be acting as a drag on the economy.

    Also, this post contains a number of incomprehensible sentences that I think are probably due to poor auto-correct. For instance, should “Bank executives tell me they’re not working because. . .” read “Bank executives tell me they’re not worried because. . .”

  9. Interesting perspective, and one I haven’t seen elsewhere. There’s certainly a good chance you’re correct. That said, I’ve seen other inefficient middlemen — like real estate brokers who charge 6% — survive the internet age. So I don’t know.

    If the airlines are getting 2 cents/mile these days, it’s pretty amazing to me how stingy they’re being with award availability. If I’m a bank, the one thing I would demand from my airline partners is that they make it reasonable for my customers to REDEEM their miles. Otherwise, they’re not going to want to collect them. Indeed, I’m kind of surprised the airline cards have so far remained popular. I think most of us in this game believe these cards generally offer poor value if you don’t game them, and that you’d do better with a generous cashback credit card.

  10. Good job Gary. This post is so so true. From a social equality perspective, I like that we will move to a world where poor people who make bad credit decisions no longer subsidize rich people’s air travel.

  11. The facts are clear, but I’m not sure at all about the conclusions.

    If new payment methods start competing with credit cards, sure there will be pressure on interchange fees. But won’t there also be pressure to compete for users? And nothing lures consumers to credit cards better than frequent flier points- that’s why we have seen increased competition for the airlines programs. I see an increased need for loyalty programs in a world of increased payment options.

    As banks use up their tax losses, and if interchanges fees come down, I’d assume they would be less willing to pay as much per point to the airlines. But if “Chase remains the biggest revenue source for United Airlines”, I don’t see the airlines walking away from selling points to credit card programs anytime soon. Rather, they will continue to devalue the programs, and be willing to accept a lower price per point. The market would be self correcting.

    So it could easily be that that new technology (and devaluation of the value of frequent flier points) lead to even bigger point bonuses than ever. Of course, your points would not cost the banks as much, nor will they take you as far. But I’ll predict bonuses will go up rather than down.

  12. Your overall thesis is very insightful that as miles get devalued, consumers would want more rewards. But your estimates of how much Chase/Citi pay airlines is way on the higher side. My thinking is and from what I have read that it’s no more than 1.5 cents for RDMs and maybe even less. That said, banks make money from annual fees and interest on balances. Also, iahphx makes a great point about real estate brokers still being able to charge 6% commission in this Internet age.

  13. 1 per cent merchant fees? Forget about it. Under the new EU rules, from last months Visa, MC and third party Amex cards are capped at 0.3 per cent.

    Wal-Mart etc will already be banging on doors in the US asking for legislation to get their fees capped at 0.3 per cent in the interests of lowering prices.

  14. Gary,

    You’ve made a reasonable and fair argument, but I don’t think its a certainty that low intercharge margins will mean the necessary end of the mileage churning game. In short, I think you are right but only to a point.

    Look at what’s happened in the broker/dealer business, for example. Margins for stock/bond transactions have PLUMMETED in the last decade, yet competition for attracting capital is still quite fierce between Fidelity/Ameritrade/Merrill etc. Those brokers continue to incentivize switching providers through lucrative offers for cash back, Mileage, etc. even while their margins remain low due to competition, technology, and low net interest margin in a low interest rate environment.

    Its not a perfect metaphor since cash at brokerage accounts is inherintly stickier than credit cards, but I think we’ll continue to see competitve offers for use of low-margin credit card products if only because margins for other banking services are falling as well. As margins fall for the entire industry, it still behooves companies to have the largest scale (revenue base) and that will require investing in customers to some extent.

  15. Airlines could make an altcoin. There is some evidence that branded-loyalty programs can exist in the blockchain space in a way that makes them fungible with bitcoin (or whatever the prevailing coin is). Under this premise people could buy your frequentflyer miles, which sounds self defeating until you realize the rebate converts more directly into a kind of share, vote of confidence, or investment on return in the brand. Basically, Airlines could use the branded coin as means of revenue generation, which is exactly what they’ve already done. They’d still dictate redemption rates.

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