A year and a half ago Stifel analyst Joe DeNardi was saying that over half of airline profits were attributable to frequent flyer programs. At the time that wasn’t quite true. Now it appears to be true. And at American Airlines I’d take it a step further: American’s financials show they only make money on their frequent flyer program, and are not making money flying passengers.
A year ago at American’s media and investor day (where Chairman and CEO Doug Parker declared that the airline would never lose money again the carrier laid out an expectation that profits would fluctuate in a range of $3 to $7 billion per year — $3 billion was the lower bound. It does not appear they will earn that much in 2018.
The airline filed an SEC 10-Q yesterday in which they reported $4.2 billion in revenue for the AAdvantage program in the first 9 months of the year.
- $2.4 billion recognized for past miles that have been redeemed. This represents ~ 8% of passenger revenue, and some of this travel — filling marginal seats that would otherwise go empty through saver award redemptions — is profitable even if the rest of the airline’s flying isn’t earning a profit overall. Accounting rules no longer treat it as almost pure profit, but generally speaking saver award flying is an airline’s lowest marginal cost flying.
- $1.8 billion in loyalty marketing revenue – this is the sale of miles where revenue is recognized right away rather than being deferred to cover future redemptions. Marketing revenue is not pure profit but has very little expense attached — according to American it is:
use of intellectual property including the American brand and access to loyalty program member lists, which is the predominant element in the agreements, as well as advertising (collectively, the marketing component)
American has earned pretax income of $1.5 billion year-to-date, while $1.8 billion was booked as immediate marketing revenue from sale of miles which comes at almost no cost. And add on top of that 8% of the airline’s passenger revenue comes from award travel it seems clear that profit from the AAdvantage frequent flyer program accounts for the entirety of American Airlines profit so far this year.
So is it fair to say that American loses money flying planes?
- According to American’s SEC filing it is certain that without AAdvantage miles sales American would not have earned a profit so far this year. And it’s also true that without the $2.4 billion in mileage revenue buying tickets, even American’s passenger carrying activities would be performing worse.
- On the other hand American argues that you can’t entirely separate out passenger carrying from loyalty revenue, because they would not be able to earn the loyalty revenue without having an airline. It’s the American brand that attracts customers to AAdvantage credit cards, for instance. And indeed the airline acquires co-brand credit card customers inflight.
An American spokesperson shares, “Our co-brand partnerships are a valuable revenue stream that wouldn’t exist if not for the airline travel we offer.”
During the traditionally strong third quarter, which includes summer travel, American earned $456 million in pre-tax income while booking $613 million just in marketing revenue from the AAdvantage program. It appears to me that excluding the sale of miles to third parties American Airlines lost money in the third quarter.
If there was no airline there would also be no profitable loyalty program. So clearly American Airlines should not stop transporting customers and just sell miles (‘cut out the middle man’) the way The Onion once talked about their focusing on their core American Way magazine business.
However the airlines’ strategy of spending large amounts of money retrofitting planes to remove international business class seats, and cram more seats into coach on their domestic planes, as well as eliminating seat back television and limiting customers’ access to lounges isn’t leading to a profitable flying operation.
Aa miles are too difficult to use. I stopped buying them years ago and limit my cc spend to earning preffered status. With that possibly going away so will my cc spend.
Something tells me the SEC would not approve of your accounting methods. 🙂
That said, it is undeniably true that frequent flyer programs are a very important business to all of the major US airlines. As usual, though, you go off the deep end babbling something about more seats on airplanes being bad for AA’s business, and something even sillier about lounge access. You sound like #AAResistance. If that floats your boat, go for it, but I’d note than extremist partisans are rarely considered “thought leaders.”
Interesting stuff. I can’t pretend to understand the ins and outs of corporate financial reporting, so my apologies if my questions here are really basic. But if what you say here is the case, doesn’t it mean that American is solely or mainly making money off of selling its miles to banks issuing AA-affiliated credit cards, since actually accruing miles and status via flying AA is less rewarding than it used to be? And that the sweet spot in making a profit is figuring out how little it can do in terms of award redemptions while not sacrificing those credit card customers?
Accounting professor here. I literally walked my students through this example (AAdvantage and revenue recognition under ASC 606, though obviously based on a previous filing) on Monday. Where was this post when I needed it, as evidence that someone besides a nerdy professor cares about this kind of stuff? 😛
@ Gary — Good reason to screw all your high-spend credit card customers. This EXP isn’t planning to re-qualify during 2019 thanks to their stupid Barclay EQD changes. I guess they don’t need our household’s $50k-$100k of spend on those cards. Morons.
@AR – come back tomorrow for a discussion of how ASC 606 makes American’s passenger business look better than it would have under old rules…
@chopsticks – talking through it with American they do not disagree with my analysis, other than the quote I shared in the post.
As for more seats on planes I’m simply describing the current strategy that management has that’s losing money on flights.
@AR / @chopsticks,
Gary’s analysis is spot on, and the accounting is correct – in fact, it’s AA’s own accounting and figures.
I previously explained the AAdvantage financial pre ASC 606. https://www.linkedin.com/pulse/loyalty-mythbusters-dont-worry-points-liability-david-feldman-gaicd/
The only difference now – is the increase in the liability account, and the increased impact on Passenger Revenue from the redemption of miles. The effect is that it further highlights the importance of AAdvantage to the airline financials.
The only key aspect that AA doesn’t disclose is that exact margin on the different mileage sources/deferrals – however they also haven’t challenged the underlying estimations in my article, Gary’s analysis, or Stifel’s.
AA is a laughable mess. And I’m not saying other airlines are any better. Throw in bad customer support and flying AA is a very poor decision by almost everyone.
The only business I do with AA is to try to use the buko useless award miles sitting in my account which seem to get devalued every year. They lost me as a revenue passenger when they made it impossible to use the miles I accrued.
Look, I think Leff has kissed the frog to prove it is a frog! Far from picking on and beating up AA, although well deserved, he has made a cogent economic point. AA can never compete with the ultra-cheapies; by forsaking its status as a legacy carrier offering more, AA will continue to bleed its traditional customers, who most certainly fly more than one casual time per year. Profiting solely on miles does not define a true airline.
Accordingly, when will AA’s Board realize Parker and his crew have reached the epitome of “Peter’s Principle” burying AA in last place amongst the legacy carriers?
How many, besides myself, avoid AA and the alleged accumulation of its miles, to fly directly to Europe on a high quality European airline? Parker and his void in marketing have yet to understand if you provide half-ass service, seats, and food on a long domestic flight, who in their right mind would fly AA overseas?
In parallel, Amtrak today is led by ex-Delta CEO Anderson; he is also failing to learn the correlation of good service and food with increased revenues; as well, the correlation schedule frequencies to the convenience of day trippers.
Nice article!
What do they forecast for revenue derived from miles sales next year. Like #Gene, next year may be the year of being a free agent, and in my market, they compete against Jet Blue Mint as well as others.
So it’s not so much an airline as a miles printing machine.
Yet they continue to devalue the worth of their loyalty program and miles.
Downward trend guaranteed.
You guys will be laugh out of the other side of of your faces when we hit $60.
All the peeps complaining about lack of miles redemption, where are you trying to go? I have had no problem booking premium travel to the Maldives as well as several trips to SE Asia in the last couple of months. And just last week I was able to book 2 business seats on Air Tahiti Nui for next year. Domestic? Europe?
Would appreciate someone knowledgeable about accounting to look at Southwest’s program sometime.
It’s different than the legacies’, because WN’s points are cash-like and can be used on any fare, and so their use cannot be throttled back.
And they give out in points what amounts to 9% minimum of paid fares, and as high as 18%.
For a $20B company, that is a LOT. It’s on a par with their entire profit.
But looking at their 10-Ks, their do not seem to place much value on the liabilities.
I know squat about accounting, so I imagine I am missing something. But if there is ever a “run on the bank,” I think WN would have problems.
@ toomanybooks — I suppose you could also make a “Gary like” argument that WN wouldn’t be profitable without its frequent flyer program. But since there’s no #WNResistance movement here, I guess we won’t see that. 🙂
It is an interesting-but-unsolvable question as to whether a traditional frequent flyer program is better for the customer and airline than a revenue-based program. AA can theoretically give away the store by allowing a customer to redeem a relatively small number of miles for a very expensive ticket. But it gets to decide which seats to allow this for (presumably only allowing outsized value for seats it wouldn’t sell any way). You can’t get that value out of the WN program, but WN has no control over which seats you demand your rebate, so they obviously can lose revenue on seats that would otherwise be sold at published rates.
The fact that we see both systems suggest that both can be lucrative to the airline.
@chopsticks actually the numbers don’t appear to bear that out for Southwest.
Based on your quotation the $1.8 billion in “loyalty marketing revenue” doesn’t sound like miles but rather customer data aggregated and sold in addition to licensing branding for partner marketing purposes. If that’s the case, I agree it mostly drops to the bottom line and is really the true source of the airline’s GAAP profits. This would also support the accounting position of immediate revenue accretion rather than being accrued over time.
The sale of miles itself appears to be a wash and economically speaking probably has more value to AA as a source of low-cost funding. Not having looked at the 10-Q or 10-Ks, every mile sold most likely is held as a current liability given the nature of its redeemability, albeit on AA’s terms assumptions.
As a side note, these are the best kinds of articles on the site and a true differentiator – great work!
@ADP
Pretty much.
The miles that are sold to third parties (mainly Barclays/Citi) have two components built into the pricing per mile:
– Marketing, which is for brand usage, access to member lists, waiver of bag fees etc., and is immediately recognized on the books;
And
– Transportation, which is valued significantly above the actual incremental cost of redemption, and is deferred into the liability account and booked as revenue as the miles are redeemed. Once redeemed, it goes into the Passenger Revenue line on the accounts.
The $1.8 billion figure that Gary and you reference – is all Marketing component revenue and had been previously analyzed (although not publicly confirmed by AA), to have a margin ~90%.
I watched for saaver award space for WEEKs before flying LAX – JFK yesterday. Up to departure, nada. It flew out half empty (with me on it.) In fact, most of the flights on that route were not at capacity. Not an isolated incident. Seen it many times. On one hand, there must be some logical reason not to release this space as awards, even last minute, but hard to imagine what that would be, even with allowing for last minute high revenue $ purchases. Seems like if an airline is mostly staying afloat thx to a FF program, they’d want to keep it healthy – including keeping customers interested in it by allowing them the ability to redeem their miles for flights on empty planes.
I don’t disagree that AAdvantage is a critical piece of AA. I think those relationships are key drivers of their current bottom line and future growth. But I wanted to point out something I disagree with on your assertion (mainly the use of IBT instead of EBITDA when comparing revenues to results):
From the notes, the entirety of loyalty revenue is derived from AAL, so comparing it to AAG’s EBT of 1.5b wouldn’t be as appropriate. AAL’s EBT was 1.73 bil YTD, but that’s including a pretty sizable 1.38b non-cash expense for depreciation/amortization. With AAL’s EBITDA at over 3.5b, their loyalty marketing revenue is only about half of that, and that’s not factoring in the cost of that revenue. I wouldn’t necessarily define these as low cost revenues either – I’m sure between the FA commissions and loyalty department salaries, plus relationship management costs, there’s likely going to be a material amount of expense attached to those revenues.
@Gino – you really want to exclude the cost of planes when evaluating the profitability of American’s flying business?
Regardless my point remains that there would be no pretax profit but for AAdvantage.
And I am largely talking about the role of revenue from the marketing component of mileage sales. That is less than half of AAdvantage revenue. American acknowledges that while marketing component is less than 100% margin, it’s not that much less. Even a 90% margin is going to mean that marketing component of mileage sales is greater than pre-tax profit. And $170mm is more than enough to cover “FA commissions and loyalty department salaries, plus relationship management costs” even if you’re attributing those exclusively to marketing revenue and not to transportation revenue — which has lower than average cost to fulfill.
My suggestion is that the flying operation is not driving pretax profits. Even *IF* it were still (accounting) profitable excluding the cost of aircraft, it’s going to be unprofitable (opportunity cost basis). And by the way the analysis here is purposefully simple only really looking at the marketing component of loyalty revenue — not in this post how new (1/1/18) accounting standards are substantially boosting the way American’s passenger revenue appears.
Thanks @ADP, and @Dave F’s response is accurate
You don’t need to be a financial analyst (or CEO) to know they’ve been heading the wrong direction for quite some time now…….cramming more people into an already crowded plane at low fares doesn’t work. Perhaps raise the ticket prices and make the ride a little more pleasant and it might work…..get a “buy in” from Labor as well, and you might just have a company people are once again proud to work for.
#AAResistance – I love that.
Perhaps this is why the quality of customer operations is not a priority, but monetizing a loyalty program is?
I can’t believe my disappointment of AA has surpassed UA, which is why I’ve let my EXP expire. Never flying them again.
Terrible and as the same suggests it is AAdvantage for American Airlines. Pathetic domestic non stop awards. Domestic one way Awards that cost $200 in cash cost 40000 miles with endless connections. International awards are even worst and hardly any partner awards without the rip off British airways and always with endless connections . The so called savermiles no longer exists. What they advertises when they sell the cards don’t exist
I use to be an AAEP. However, I was caught with a (very) minor abuse of the mileage program. Instead of reprimanding me or discussing the matter, they opted to deduct an estimated $6k in value (of miles). Surely, this made their books look a tiny bit better, and they were also just in doing so (even if highly disproportionate). But they also sullied our relationship. It went from a definitive win-win to a lose-lose. I don’t fly them any longer and I don’t miss them.
Short term thinking — and big-company-bureaucracy if you ask me. The general belief is that it’s their way or the highway, they’ve got lawyers, there aren’t many other options, etc. There are at least a few options – and it’s not sour grapes — these options are better. I don’t relish in saying that, it’s sad that they suck.