American Airlines Blundered New York, LA, And Chicago — Ex-CEO Doug Parker Explains The Credit Card Math Mistake Behind It

In this week’s Airlines Confidential, former American Airlines CEO Doug Parker walked through how airlines, in his experience, try to figure out whether a route is profitable (or how profitable). It’s complicated because you have to figure out how much the portion of a plane that’s flying the route costs, even as it flies other routes too (and consumes maintenance). And you have to figure out how much revenue to attribute to a flight, when passengers are connecting. There’s a lot more that goes into this.

And it’s a good discussion of how hands tied an airline can be in reducing costs in a downturn, how it isn’t really possible to just return planes on lease or sell them easily in a downturn, so airlines keep flying rather than grounding aircraft.

As part of the exercise he ventured into figuring out, how do you allocate credit card revenue to a flight and the explanation he gives of how to think about Citibank’s revenue at American Airlines actually does a lot to explain the huge mistake that American made under his leadership in walking away from New York and giving up the number one market position in Los Angeles and in Chicago.

He’s saying you take the money from the credit card, and allocate it to the flights where the miles get redeemed. And that leads you to make all kinds of mistakes.

I’m talking about the $6 billion that comes into American Airlines every year from Citibank. Okay. A direct payment from Citibank to American Airlines because buying points so that they can distribute them to their customers so their customers can then use them to buy fares. That’s what’s happening. Okay. Pure and simple.

It’s a distribution system that doesn’t end up in passenger revenues, and it should. So we’ve got to put that in, in this example, because it’s big enough we should talk about it. And the way you do it is where I think you were getting. The way the airlines will do this is they’ll go look at which routes get the most redemptions of miles. So we’re going to allocate that $6 billion. We’re going to allocate it based upon which routes people use their miles on. Because that’s where they’re taking up the seats.

And if we didn’t give that route that money… they’d be unfairly penalized so routes like Hawaii would look much worse than they really are because we’re getting paid to put those people on flights to Hawaii and we’ve got to give that money to Hawaii not to Des Moines. So anyway, so that’s what, so it again, for our example, we’re just going to assume Panama City’s, it’s a leisure market. They probably have some reasonable amount of redemption of people wanting to go there. So we’re just going to assume it’s kind of the average. The average is a little more than 10% of revenues. If American, if I’m right about America being at 6 billion, they’re a $50 billion airline, a little more than 10%. We’re going to add 10% in our example.

What you want to do is allocate the revenue to the flights that cause you to earn that revenue. If New York customers are driving credit card spend, you want the credit card revenue from those customers to be attributed to the flights that matter to those customers. It’s not where they spend the miles. Spread New York card revenue across all the flights that New Yorkers take.

The entire point of the exercise Parker lays out is that you want to understand the economics of the flight itself, and that’s different than how you’d do the accounting. But what he’s describing is more akin to the accounting (when a passenger earns miles for a flight, that’s a cost of the flight and then there’s a liability on the balance sheet that becomes revenue for the flight the passenger redeems for).

United CEO Scott Kirby actually explained this back in 2017 when he laid out that he needed to grow United’s domestic presence to be relevant in more markets and earn the credit card business of customers in those markets.

Sure, passengers may want to go to Hawaii with their miles but they’re going to choose to fly an airline and get its credit card when the airline has a real presence in the market and offers flights that get those passengers where they want to go.

You want to attribute New York credit card spending to New York customers, and to the flights that serve New Yorkers – not just to their Hawaii redemptions.

• Offering attractive redemptions matters to motivate customers to pursue activity in a frequent flyer program. It’s a big part of why Southwest Airlines went to Hawaii.

• But New Yorkers don’t pick AAdvantage over MileagePlus or SkyMiles because of American’s Hawaii flights. They need American to be relevant to their market. That gives them the opportunity to earn miles flying, to earn status, and to use that status on their flights.

American Airlines used to say that they were losing money in New York, but that’s because they were doing the math wrong. They weren’t including New York credit card revenue in their New York flights (outside of just assuming some system average). So they cut ‘money-losing’ New York flights, until New York no longer lost money. But they lost New York credit card spend as a result because they no longer had a route network that made them relevant to New Yorkers. (N.B. when they partnered with JetBlue they regained relevance and their New York AAdvantage and credit card signups shot up.)

The credit card is what makes American Airlines money, not so much the moving of aircraft from one place to another. It’s high margin revenue. Where you allocate this money matters, and it’s not to ‘the flights customers redeem for’ it’s ‘the flights that allows you to generate that revenue.’

Los Angeles looked like a money-loser. It was too competitive a market, and while American had the number one share they thought they weren’t making money. But pulling back in Los Angeles means less relevance to Angelenos and less credit card spend.

The pullback in New York and Los Angeles and Chicago – important card spend cities all! – helps explain whey American Airlines went from having the number one airline credit card for spending volume a decade ago down to number three today.

So the exercise Parker is explaining matters a lot – understanding the profitability of decisions in the business. It’s just that he was taking the highest margin revenue American Airlines had, treating it just like any other revenue, and assigning it on an average basis across flight redemptions instead of assigning it to the business of the customers generating that revenue. And that led to bad decisions in the business.

Now, though, they’re fighting for Chicago – and they’re explaining precisely that it’s because of the credit card business.