Why AAdvantage and Other Airline Frequent Flyer Program Profits Will Fall

United’s President doesn’t believe you know the difference between high and low value credit cards. You’ll get the United credit card if you like travel and you live in a city where United offers the most service.

I’ve argued that’s wrong, and American Airlines identified the reason why to the SEC. American Airlines filed its 10-K this week and while I focused on the drop in seats occupied by award customers (after a drop in the prior year as well), I flagged one statement buried in the document. AAdvantage is a multi-billion dollar enterprise and one of the risks American identified to that business is that it,

faces significant and increasing competition from the loyalty programs offered by other travel companies, as well as from similar loyalty benefits offered by banks and other financial services companies.

That’s a point I’ve been making for some time. Airline frequent flyer programs are the most successful marketing innovation in history. Instead of marketing being a cost center, they’re an incredible profit center because other businesses rent their brand, mailing list, and currency. However they face two major challenges over time.

  • Their biggest customer for miles are credit card issuing banks. If interchange rates — ‘swipe fees’ — fall it will no longer make economic sense to incentivize customers to make transactions by rebating miles to them at least at the current rate. They’ll buy fewer miles.

    And it’s far more likely that interchange will fall in the future than rise — whether as a result of government regulation (in several places in the world governments have moved to limit interchange, like in Europe and Australia), new merchant contracts potentially under pressure from lawsuits, or competition from new technologies.

  • Competition from other currencies. Banks are engaged in creative destruction. They’re not only buying miles from airlines through their own co-brand cards, they’re issuing better cards themselves. The premium card market has never been so competitive as it is today, with banks offering products that earn miles faster and offer more flexibility than earning just a single airline’s currency.

As a result there may be revenue pressure in the future (if interchange falls) and there should be significant cost pressure (as airlines have to compete to make their programs attractive against bank programs like Membership Rewards, Ultimate Rewards, etc).

Banks have proven that there aren’t significant barriers to entry in the loyalty market, so a continued future of better than 50% profit margins for airline loyalty programs make little sense. There’s simply no room to continue to devalue programs — in fact airlines will have to spend more to retain members, let alone grow.

That’s why I’ve been skeptical of the claim that frequent flyer programs are worth more than their associated airlines. The valuation multiples required for this assume continued growth in the programs rather than declining margins.

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 InsideFlyer.com, 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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Comments

  1. So, what do you think the impact of this will be on your readership of points junkies, and how would you recommend they proceed, other than “earn & burn”?

  2. @David Lerner – I believe that airlines are going to have to spend more on redemptions for their members in order to compete. However bank points right now are a far more lucrative place to invest.

  3. I know from my own experience, I am part of the group that AAdvantage is talking about. AAdvantage’s lack of award space has made me consciously stop accumulating AA miles and increase those bank rewards due to their flexibility. There’s really no point in me trying to accumulate miles I cant use at the price I want to use them at. It’s far easier for me to just pick the flights I want and use those bank reward points to purchase those flights with my points. It’s probably more direct, the time is better and most times it costs less miles/points. Plus I’d earn elite status miles and also frequent flyer miles on the actual flight.

  4. If the airline programs make themselves more valuable instead of less valuable over time then the customers will prefer airline miles over bank points. So even if the exchange cost rise and say you earn 1 mile per $3 or whatever it wouldn’t matter if you value the miles higher. In addition if a mainstream airline makes it’s miles more valuable than the other airlines around them then they might gain customers in non-hub captive cities.
    I also wonder about the long term impact on credit card fees as electronic transactions move more toward smart phones, etc. Sure those bank pay apps work well but what if Amazon or Google or some other non-bank takes a bigger chunk of this business away from traditional banks.. It could impact the banks negatively due to the high overhead cost they have. So you could see airline programs become unimportant to the main stream non-business traveler while at the same time see bank points become devalued due to increased cost of competition.
    Earn and Burn is still the best way to protect your miles and point balances.

  5. This seems so obvious it’s painful. You’re spot on Gary. Collecting pure DAL, AA etc.. miles vs flexible currency(MR’s UR’s, even TY’s) is as easy and provide far more “value”. I’ll take the easy airline miles when offered but spending to earn them is a relatively poor choice without a very specific purpose/use.

  6. Unless you are redeeming for International First award tickets, you should’ve switched to a 2% cash back card long time ago.

    You will not hear about this from the bloggers, because there’s no kickbacks for those cards. Instead you’ll see a bunch of posts about “best way to spend 60k miles/points with X card.”

  7. DaniMCI: you’re close but I think you’re missing 2 points that drive your thoughts.

    1) There is not single travel currency that will be more valuable than transferable bank currencies. The only way to make your single airline mile worth more than a bank “mile” that could be exchanged for a variety of miles is to remove your airline’s partnerships with the banks before revaluing massively. That is definitely *not* for a wide variety of reasons, including financial partnerships, the competitive marketplace, profits from partnererd cards, etc. So as long as I could have your airline mile or a mile for your airline and 10 other airlines at the same time, the latter is higher value.

    2) The threat to interchange isn’t mobile phones. The end-user delivery (fingerprint/app/NFC transaction) is still going onto a pipe managed by the card companies, banks, etc. No, the threat is blockchain: fraud-resistant transactions at very low cost. Which is why the major financial companies are all working on their own versions of blockchain technology, to keep control of the merchant transaction networks.

  8. I’ve switched my business to Alaska and JetBlue and now switched to Cashback cards as well.Being there are no saver award seats from Sydney
    I’m flying back on Emirates in an A380
    The Doug Parker American Airlines Disadvantage Ponzi Scheme program is finished for me.He put the nails in the AA coffin
    Cheers

  9. Airline credit cards will still be used by hub-captive passengers who don’t have elite status and want to avoid bag fees. It won’t go away entirely, but the odds of it actually getting swiped will diminish.

    Think of a red-giant star decaying into a dwarf.

  10. @Jimmy – not hard to redeem at well over 2 CPM even if not buying Int’l F, and combine that with the 2x-3x points cards offer now on most categories, and a 4-5% return is easily achievable as a baseline. And thus I and many others will never get a 2% cashback card instead.

  11. @UA-NYC – For the last couple of years, it’s been close to impossible for me to get near 2 CPM for domestic and/or international economy travel. The airlines themselves (most notable with Delta) have made their award availability directly correlated with the price of said ticket. If you find saver awards available, there’s a good chance those tickets are on the cheap side. If you are trying to redeem for a higher priced ticket, then chances are supply is low and award travel is not available to you. I am tired of the airlines’ games so I refuse to use their credit cards for everyday spend. I can see the benefit of the sign up bonuses and travel benefits (if you travel enough) associated with some of the cards.

  12. @Jimmy 100% correct. At typical non-bonus spend of 1 point per $1 you get 100k points or $2000 with 2% cash back card.
    The 100k might (with luck) get you 4 domestic economy tix but far more flexibility in routings with your $2000 cash.
    OTOH 100k may be close to enough points for a RT business class TATL or TPAC, and you will rarely see those flights for <$2000. Also most people have more points than cash so they would typically prefer to use points.
    In the end I think the points really permit you to travel much more comfortably then you otherwise would if spending cash. Many people would not spend $2k out of pocket to fly C/F but are happy to spend 100k+ points.

  13. Gary, your big picture observations are right in, but most of the casual users I know stopped accumulating American miles because they couldn’t redeem them. For the average user, domestic coach is what they want and American is downright insulting be offering a two connection flight lax-dfw.

    Sort of like Uber, if taxis didn’t suck so bad, Uber wouldn’t have grown so rapidly, even with a better value proposition. If folks loved advantage, they wouldn’t be so quick to transfer to Chase UR products or cash back cards.

  14. All I do these days is redeem for int’l C travel – CX, IB, LX, LH, etc. 100-150K vs. $5K-$7K/ticket makes it a no brainer. Doing the math on my CSR and it’s a 10% return.

    Spending points domestically is a poor value proposition save for anytime awards on high season dates (like the 50K miles I spent on a $1,500 domestic ticket over a holiday weekend – one of the few times I would redeem domestically).

    And with Starpoints I usually redeem well over 3 CPM.

    It’s true that UA/AA/DL are all abysmal with their own metal redemptions, but that’s where alliances come in. DL is great for flying in the US but is in a terrible alliance.

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