Frequent flyer miles have an amazing characteristic. They cost about three quarters of a cent to produce while people value them at twice that much. The more you produce, the more you profit, so you go around generating as many miles as you can.
- This creates a problem of too many miles chasing too few seats
- Since airlines don’t have that many empty seats to sell to their frequent flyer programs on the cheap, they way they used to when there were more airlines and too much capacity
- So they keep raising prices to compensate for the need to displace revenue passengers in order to deliver awards
- Because the alternative is just saying nothing is available when members look to spend their miles, turning those members off to the program
- But at some point the higher prices could do the same!
Printing miles has been a pretty profitable business for airlines, in fact some airlines don’t make money flying planes from place to place at all – and the entirety of their profit can be explained from selling frequent flyer miles. Those miles wouldn’t seem valuable without the flying, but it’s the
magic beans miles that actually make money.
None of this is new. Twenty years ago when United Airlines went through bankruptcy the only part of their business that was profitable was Mileage Plus, and it was said they continued to fly to support the underlying credit card business. As one Senior Vice President of the airline once put it to me, at the conclusion of each hearing in bankruptcy court their first call was to Jamie Dimon.
Now, though, airlines have securitized the magic beans. They’ve borrowed large sums of money with their frequent flyer programs as collateral, from $6.5 to $10 billion each for the three largest U.S. airlines.
Miles are valuable as a claim on future travel, but one of the selling points to mileage-backed debt investors was that airlines can set the price however they want in the future i.e. make them not so valuable for future travel.
Of course if an airline announces a pending devaluation that could cause a run on the bank (a ton of redemptions). Maybe that’s why Delta claimed it was illegal for them to tell customers in advance when devaluing miles back when they had an award chart (eliminating the award chart was a clever way not to tell customers they were devaluing).
The financial engineering only works if customers believe the miles have value. Delta’s
FTT currency SkyMiles seems to work due to some mix of brand halo and captive hubs in Atlanta and the Upper Midwest. United and American, historically, have seen hits to credit card charge volume when they’ve devalued.
At what point does Delta’s TakeOff 15 change where anyone that doesn’t get a co-brand credit card sees their miles worth less have an effect on the financial engineering? What will American’s end of MileSAAver and AAnytime awards have? Neither Delta nor United saw their programs ultimately undermined when they canned award charts. Surely some amount of value is needed to keep customers on board though?
Banks have shown that customers will take their own proprietary travel cards. Membership Rewards and Ultimate Rewards and Capital One’s Venture portfolio have had staying power and growth. It rarely makes sense for the median traveler to put a majority of their card spend on an airline co-brand (since earning just 1 mile per dollar makes zero sense).
There is a magic beans in a box element to frequent flyer programs, but there’s truth to the argument that this is also true of U.S. currency, Euros, and other fiat money. They have value because we believe they do and we can exchange them for things of value as a result. But it’s that intermediary step – the value in exchange – which is ultimately the difference between Dinars and Dollars, and between MileagePlus miles and FlyCoin.