Ten years ago on Flyertalk I outlined a simple model of why we can expect frequent flyer programs to devalue over time.
I explained that frequent flyer miles are a currency, but they are printed by a single company and there’s no independent central bank or other body whose job it is to defend the value of that currency.
When programs ‘print miles’ but the number of redemptions available doesn’t increase proportionally, prices will ahve to rise.
We can understand the move to offer ‘miles for merchandise’ and even ‘miles as money to buy travel’ as (partially-failed) strategies to help increase the number of redemption options and serve as a release valve.
Milton Friedman…showed the world that inflation is a monetary phenomenon — increase the supply of money in the economy, and the general price level will rise.
The famous and deceptively simple formulation of this is: mv = pq
m = quantity of money
v = the speed at which money circulates in the economy
p = general price level
q = quantity of goods
Friedman argued that the speed at which money circulates is, generally speaking, constant. Folks plan over time for their spending needs. On the whole, if people get paid on Friday they don’t spend all their money on Saturday but spread the spending out until their next payday. (Obviously this isn’t universally true, but on a macro level it winds up being true.)
The upshot of this famous formulation is that when m goes up, p or q needs to go up. If the quantity of goods remains constant (q), that means that p (price) must rise and you have inflation.
I think that this simple formulation is helpful in thinking about loyalty programs.
If m = miles, v = the speed at which folks redeem awards, p = the price of awards, and q = the supply of available award seats, then…
Sometimes the speed at which awards are redeemed goes up. For instance, when loyalty program members are uncertain about the future of their points. There is a common belief that when United declared bankruptcy, there was a ‘run on awards’ — people believing that they needed to cash in now while the airline and the loyalty program was still around.
But on the whole, the fact that 8% or so of seats go to award redemption (over time and across programs) suggests that v is usually stable.
That means that if m — the quantity of miles or points — goes up, then one of two things has to happen:
Either the quantity of award seats have to become more available, or the price of awards has to go up. Otherwise there will be a shortage.
…And since it’s so much easier to accumulate miles than at any time in the past — as programs sell miles to all comers, and miles have become such a popular phenomenon and useful marketing tool — the quantity of miles is ever increasing. It’s profitable to the airlines to sell miles.
That means one of two things happens:
* The quantity of award seats goes up
* The price of awards goes up
I said that means we’re going to see devaluations. And we have, in fairly predictable patterns.
They don’t really happen during recessions, and not just because you don’t want to anger customers when few people are buying your product. Seats and rooms are empty so there’s not a ton of pressure on your inventory. Prices of that inventory are down. But when the economy comes back nd seats and rooms fill up, inflationary pressures return.
The Washington Post basically laid out this same theory on Friday, with the subhead “Why Hilton and United Airlines should think about hiring Ben Bernanke.”
Loyalty points are a form of money. And their value is determined by the policies of the company that issued them. Similarly, real money is issued by the government (specifically by its central bank), and has value that is ultimately determined by the actions of that government.
The loyalty points that a company has issued amount to a liability on the books of the company that issued them.
…But unlike when the company borrows money from a bank or bondholders, with loyalty points the firm has total control over what those liabilities actually are worth. The company keeps the power to devalue the points at any time, which would make its balance sheet look better.
That gives a CEO facing a rough patch every incentive to devalue the points. It is a way of improving the company’s financial position just with a change of policy. But while it seems easy, it comes at a long-term cost. You are angering some of your most loyal customers, essentially exacting a tax from the people who fly your airline most often. If you get a reputation for devaluing points all the time, they may even switch their loyalty entirely, and start flying Delta instead of United or staying in Marriotts instead of Hiltons.
This is exactly the dilemma facing governments. A government that has a lot of debt can improve its financial position by devaluing its currency. Suddenly the debts it has incurred are worth a lot less! It is the easiest way to fix a problem in the short-run.
…in the long run, a country is better off with sound monetary policy that preserves the value of the currency (most modern industrialized nations have concluded that annual inflation is optimal around 2 percent).
The advice I gave in 2003 remains true today:
I’m not saying that we should all burn our miles with abandon. But I am saying that the best way to enjoy these programs and capitalize on their superior value propositions is to redeem miles as you earn miles. Waiting simply means that past earnings will buy less in the future.
That is, until we get an independent central mileage bank. And until we install Paul Volker, Alan Greenspan, or Joe Brancatelli as Chairman.
The Post‘s mention, of course, is of Ben Bernanke. But I didn’t know he — or Janet Yellen — would lead the Fed in 2003.
After United’s big announcement of devaluations of in some cases more than 80%, we can now think of MileagePlus as ‘the Banana Republic of loyalty programs’. The IMF won’t lend to them. But presumably Chase still will…