Airlines are at risk of killing their golden goose. Miles motivate customers, but customers need to be able to use their miles. Airlines have gotten better at selling their seats for cash, frequent flyer programs want to retain their margins, and so members get squeezed.

As a result, airline executives call for ‘revisiting the model’ of frequent flyer programs – the model that made them successful, multi-billion dollar enterprises.

That may be inevitable. Air Canada explains how they’re thinking about dynamic pricing, and how it’s coming to partner awards – not just to Air Canada’s own flights, the way that airlines have traditionally thought about these seats.

Airlines Have Created An Award Availability Disaster

Frequent flyer programs are the most successful marketing innovation in history. The largest U.S. airline programs are worth tens of billions of dollars. During the pandemic, Delta, United and American each borrowed between $6.5 billion and $10 billion against the future income of their loyalty programs.

Fundamentally, though, they’ve mismanaged the programs and put them in jeopardy. They print more miles, but don’t make more seats available. And that’s led to changes in pricing that disadvantage members – which jeopardizes the value of the programs by turning off members.

When frequent flyer programs began, there were plenty of unsold seats on planes. An airline might fill only two thirds of its seats. And when a seat takes off, the airline can never sell it again. It costs almost nothing to put a frequent flyer in a seat that would otherwise go unsold.

The magic of these programs is that the customer values that seat at close to retail, but the traditional saver award costs almost nothing to provide.

The problem, however, is that there are so few unsold seats these days and so many customers trying to get them.

• Airlines have gotten much better at selling all of their seats. Although there are more seats being flown today than ever, there’s also more demand for travel. We’ve seen consolidation, so fewer airlines beating each other senseless with too much capacity. Airlines are better at adapting their pricing to sell out as well.

• Airlines have printed miles at insane rates. When loyalty programs began, miles were awarded for flights. Airlines quickly took on partners as they realized what they had unleashed – for most companies, marketing is an expense line. For airlines, their primary marketing vehicle is a profit center. The first airline co-brand credit card was the Continental Onepass Travelbank Mastercard from what became HSBC launched in 1986. These have only exploded in the last four decades. Banks buy miles for transferable points programs as well.

With too many miles chasing too few seats, you get a very predictable effect. I first laid out over 20 years ago exactly what to expect.

Think of frequent flyer miles as a currency, with no central bank. Apply the basic monetarist formula, mv=pq. When you increase the supply of currency, holding the desire to spend that currency constant, you either get shortages (no seats available) or price increases.

Air France KLM’s Flying Blue recently raised award prices. The changes weren’t massive, but moving for instance from 50,000 points to 60,000 points one-way as the starting price for business class between the U.S. and Europe was supposed to make more seats available.

When members pay more, the loyalty program can pay more to the airline and get more seats in return. That’s the argument, anyway. But it seems to me that there are still seats that the airline can sell at the older lowest price. It’s more an argument for pricing more seats at 60,000 points or 80,000 points – not for eliminating the 50,000 point price.

Addressing inventory challenges always seems to pair with lowering cost as well. And the temptation is even greater at programs like United’s and Delta’s that have eliminated award charts because they’re no need to even tell members you’ve made their miles worth less. The lack of transparency leads to devaluation.

The Airline Solution Is Dynamic Pricing

Airlines have adapted to this problem of too many miles chasing too few seats by moving away from the traditional formula of cheap saver awards for unsold seats, and in some cases expensive (it used to be just ‘double miles’) to redeem for any seat. It’s been replaced by dynamic pricing.

Airlines charge more points for seats likely to sell for some amount of money. That gives access to more seats so they don’t say nothing is available, but it removes the magical value proposition of delivering top value to customers at low cost.

That’s largely, so far, been a phenomenon for an airline’s own seats while partner awards have been priced in the old model. Airlines make only those saver awards (unsold seats) available to partners at a fixed price. But this is changing.

• With Fiji Airways adopting American AAdvantage as its loyalty program, American has had access to more than just saver awards but at much higher prices. This has been additive, so not eliminating the saver pricing. Most of those seats are too expensive to be useful, but it’s still a sound model that doesn’t take away from the customer (yet).

• As Alaska Airlines added partners, and before they moved to their current distance-based chart, in some cases they too got access to more inventory that they charged more miles for. One example of this was Qatar Airways.

• Air Canada Aeroplan is moving several of its partners to dynamic pricing, like United and Etihad. In order to gain access to award space, Aeroplan has to pay partners like Emirates (which already had a separate award chart) and Etihad more money and so needs to charge the customer more. Air Canada’s close partnership with United is enabling them to access more award space at a variety of price points, presumably in a similar fashion as United offers space on its flights to its own members.

Etihad Business

Airlines Limit Partner Access To Award Seats

British Airways guarantees its members that they will release a certain number of award seats on each flight, when that flight loads into the system nearly a year in advance. Those seats used to be available to partner airlines, but now those are only available to programs using Avios as a currency.

The same has happened with Qatar Airways, which makes award seats available to programs using Avios as a currency and also to JetBlue, but not to other partners like American AAdvantage and Alaska Airlines (usually until much closer to departure).

Etihad has gotten difficult making award seats available to partners, especially premium cabin award seats, except close to departure.

Qantas makes seats available to its own members that aren’t offered to partners, in a way that wasn’t the case prior to the pandemic.

For many years, Lufthansa has restricted first class awards to partners except at the last minute and offered far more space to its own members. And these are just a few examples.

British Airways Business Class

British Airways Business Class

Air Canada Sees The Future As Dynamic Pricing Of Partner Awards

In an interview with Air Canada Executive Vice President Mark Nasr, Nasr explains that they think the dynamic pricing and access to more inventory that they use for pricing Air Canada flights is the way forward although he’s clear that perception of how they do this needs to be carefully managed.

‘It has to be balanced with customer value and transparency,’ he continues. ‘We take (it) very seriously, ensuring changes that we make to the program – and the day-to-day experience that we’re delivering – fundamentally feel fair to customers. ‘You won’t always be able to please everyone all the time. But you need to leave a good taste in people’s mouth that you’re conducting business in a straightforward way, and that you don’t have negative surprises.’

‘If we were to make changes like that, we would do so on the basis that there was commensurate value being delivered by the program. Or something new that wasn’t possible before. Now again, I’d say we’ve been very clear of what we think is best, of what we do on our own metal.’

That is, ‘with prices that change commensurate with the value of the seat. But still wrapped around it, flexible rules, combinations, permutations, et cetera, and a great booking experience. We think that that is the smartest way to go, and thus, that’s what we offer on ourselves. Whenever we’re working with a partner, it’s what the partner thinks (that’s) the most important part of the equation.’

Don’t expect any big changes on this front right away – while they are “actively working on” it, cycles for making changes take 12-24 months at least even for working with a limited number of partners “to experiment with.”

Nasr explains that they’re looking for changes in how they work with partners, but partners sometimes push for changes in how awards work too.

As to why a partner would do that, ‘it could be because they have commercial changes internally, it could be because of regulatory changes,’ Nasr shares. ‘So take something like interchange / swipe fees / credit card discount rates. We have a partner that there’s change in their markets, so their credit co-brand products change. They have to change their award chart, the way in which they accrue miles … so that can drive a change.’

I’m reminded that Qantas massively devalued its award chart when Australia introduced interchange regulation 20 years ago. In order to award ‘1 mile per dollar’ on card spend, each mile had to be worth a lot less.

Airlines also may press for changes in partner pricing – they are devaluing their currency, and it’s awkward for partners to offer their seats for much less than they offer them to to their own members.

Air Canada’s Dynamic Pricing Will Make More Partner Seats Available, But Not Right Away

When Air Canada announced that Aeroplan would move ‘select’ partners to its dynamic award chart, and show the starting price and average price paid for awards (but no longer show maximum price), I expected that this would mean extra inventory for those airlines that were moving to this chart. They even talked about offering “in some cases, deeper inventory levels.”

I figured that might not happen with Emirates, since that already had its own more expensive award chart, and the move just let them obscure the specific higher prices charged for those particular awards. However, it’s quite logical to offer greater availability on United flights at higher redemption prices. It’s helpful, even, especially as Aeroplan appeals to U.S.-based members with credit cards – allowing them to include more United connections, for instance, to Air Canada long haul flights.

However, the airline tells me that the extra available “is the case with our Canadian regional partners” and they will add “1-2 others..next year.” I still think that means United, and possibly Etihad. But they are moving these airlines to the dynamic pricing chart March 25 of this year.

Elites and co-brand cardmembers will receive ‘discounted redemption prices’ for all airlines on this chart. That’s great for those members, even looking to redeem for United, Etihad and Emirates. The flip side is that – since the economics works for the program on those redemptions – members without Aeroplan status or a co-brand card pay a redemption tax for these awards.

United Business Class

Dynamic Pricing Is A Makeshift Solution To A Bigger Problem

When the frequent flyer program needs to spend more money to buy the seats that members expect, the cost the program charges members is going to be higher. At the same time, when U.S. loyalty programs report operating margins of 39% – 52% it’s not unreasonable to think those are simply unsustainable. If they try to prop up margins, they’re going to overcharge members and push those members away!

Ultimately the challenge comes, I think, because airlines aren’t properly factoring the profitability of loyalty programs into their calculation and are overcharging the programs for seats, and failing to take points demand into account when planning schedules and growth. Increasingly those points come with significant profit to the airline!

Relatedly, the accounting for frequent flyer seats creates bad incentives. When an airline ‘buys’ miles to give to flyers for flights, those come at significant cost. Accounting rules (ASC 606) require the airline to put aside the market value of future transportation as a liability on its books. However when airlines sell miles to third parties (mostly banks) they recognize most of the money immediately, and set aside far less.

Roughly speaking, an airline might incur 1 cent per mile in liability for future transportation when awarding it for flying and just 1/8th of a cent when it’s earned via credit card. Redemptions of credit card points, then, show a ‘loss’ to the program because they’ve recognized too much revenue up front – and the program wants to charge more points for the flights it needs to buy to satisfy members.

This is all a complex calculation that stems – first and foremost – from too many miles chasing too few seats, and the knock-on effects of trying to manage member expectations, and deliver enough value not to chase members away.