Financial Analysts Frequently Misunderstand Rewards and That’s a Problem (For Them)

Moshe Orenbuch of Credit Suisse appeared on CNBC’s Power Lunch midweek addressing American Express. His claim is that biggest problem Amex faces is the value of their rewards. He says that they give less cash back, and that Membership Rewards has introduced lower cost options for redemption and so expenses on average have fallen.

Customers see those options and think the rewards have less value. Although the claim that a couple hundred thousand Membership Rewards points gets you a toaster sadly goes unchallenged. (HT: Ryan)

American Express’ problems were revealed by having lost Costco. The problem isn’t that they have fewer cardmembers without a Costco deal. The problem is that costs have gotten too high. Retaining Costco would have been too expensive. I described Citi’s approach to Costco as ‘we lose money on every transaction but make it up on volume.’

Margins from interchange will fall over time. Having lower costs isn’t a vice, though it helps understand why there may be limits to growth.

Laying the Blame on Lower Rewards Spending Isn’t New

Last summer Nomura Holdings made news claiming that American Express would suffer because it had the least valuable rewards.

The claim was that they had lower rewards expense (which is different than delivering less value). American Express has introduced retail redemptions that don’t cost the company as much as miles transfers to airlines.

In general redeeming points for paid airfare is done at just one penny a point, not the 1.25 or 1.3 cents a point that some other banks offer and they don’t reward all spend with 2 points per dollar spent each worth a penny (equating to 2 cents a point for airline redemptions).

There’s something to the claim that customers want simple value propositions. Although Membership Rewards customers are still heavily travel customers, and points transfers remain core to the program. Analysts don’t understand the value of those transfers, for the same reason US airline analysts don’t understand the value of frequent flyer programs generally.

Airline Rewards Programs Have Tremendous Unlocked Value — and Analysts Frequently Don’t Understand Them

For the most part investment analysts are ignorant of frequent flyer programs. They don’t pay them much mind. Even though — even in the era of devaluation and low fuel prices — they likely remain the most valuable asset that airlines have.

Airlines that have spun off their frequent flyer programs have obtained valuations between $50 and $200 per member according to an L.E.K. Consulting report.

Source: L.E.K. Consulting study

American Airlines has a market cap of about $21 billion — up 25% over the past month. Valued on the basis of members, American AAdvantage with 100 million members, would seem to be worth $5 billion to $20 billion.

The high end, obtained only by the first spinoff of Aeroplan, was unique. The Canadian market isn’t as competitive as the US is. And as a new product, it may not yet have been clear how to value the concept.

Still, at roughly $2 billion a year in revenue from the credit card deal alone (and low costs associated with it), a valuation for the program that’s outsized relative to the value of the whole airline doesn’t seem unreasonable.

Analysts Blindly Accept False Claims About Mileage Programs

When American went looking for laundry lists of mechanisms by which they might raise revenue as their stock is under scrutiny due to falling revenue, they toss out claims about their frequent flyer program which go unchallenged — untested even.

Two months ago American’s top two revenue-driving initiatives were described by airline President Scott Kirby as a new credit card deal and a shift to a revenue-based frequent flyer program.

This claim about revenue-based programs didn’t receive a single question from analysts, even though Delta says their own experience with a revenue-based program is that it isn’t responsible for the revenue premium they’ve achieved.

Rewards Deserve Greater Critical Attention

Rewards programs are valuable. High costs aren’t a virtue, but driving value to consumers is. If it’s too expensive to do that, and be competitive, that won’t be sustainable. And high costs to acquire customers and drive spend probably isn’t long-term sustainable. That’s a problem for American Express, but it may be a bigger problem for card issuers with higher costs.

More generally, given the importance of rewards — which Moshe Orenbuch should be lauded for understanding — analysts should pay more attention to them and think more critically about them.

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, 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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  1. I always read the quarterly earnings analyst call transcripts for Southwest.

    There have virtually never been questions about RapidRewards, even though it amounts to a minimum 8+% rebate to customers on all fares.

    The will ask about tiny little things, but not RR.

    Seems material to me.

  2. What makes you think investment analysts are ignorant of frequent flier programs? Because you you don’t hear them ask questions about them on the earnings calls? Frequent flier programs are an incredibly hot topic on Wall Street (they’re practically pure margin and huge revenue bumps in a stagnant revenue environment) and just because you only see the 1% of interactions the street has with management teams on the calls, don’t assume that the lack of questions or scrutiny of claims on revenue based frequent flier programs creating additional revenue is indicative of all interactions they have.

    An incredibly insulting article based on the premise that what you see is 100% of the story.

  3. @Annoyed – having done consulting in this space I can tell you that investment analysts as a whole do not understand the programs of the airlines they cover, even if they’ve heard they have value. They know metrics and ratios and revenue flows, not how program changes (like Kirby’s claims that revenue-based program will drive airline revenue) will drive revenue.

    If you think my exposure is limited to what analysts ask on calls, you’re mistaken. I’m ‘annoyed’ by your assumption 🙂

  4. I agree with Gary on this. I have spoken to a few airline analysts and most of them get the financial ratios but not FF programs. In fact, some of them don’t even know the difference between status miles and RDMs. To their credit, they understand income statements and balance very well and their thinking is that the FF programs would eventually get reflected on PRASM, CASM and yield/load factor. So, they pay much more attention to other drivers.

  5. FWIW program revenue winds up in RASM but not PRASM, which is why AA — with its new co-brand credit card deal — plans to highlight changes in RASM rather than PRASM going forward.

  6. Gary, Do you think the management of B3 realize the importance of FF programs? I don’t think so. I have seen a very distinct chance in my behavior as well as other frequent flyers I know — both in terms of how we fly and which cards we spend money on since AA devalued their program. All of them are good for consumers and worse for airlines.

    For instance, I am flying UA to Sydney and later I have at least booked business class tickets to Istanbul on Delta. Same with other AA loyalists I know — they are flying more on JBLU and Virgin America. When it comes to international, we are all just buying cheap business class fares.

    It gets even more interesting when it comes to CC spending. Most people I know is spending more on hotel rewards card and the Amex MR or Chase UR cards.

    I always thought that it would be a few years before the general public changed their behavior but looks like they have been almost as quick as most of us who follow FF programs closely and believe in maximizing credit card spending.

    Consumers will win in this race to the bottom!

  7. I’d exclude the Air Berlin TopBonus sale to Etihad, as this was purely a cash injection into AirBerlin in order not to exceed the foreign ownership maximum share.

  8. I quote ” FWIW program revenue winds up in RASM but not PRASM, which is why AA — with its new co-brand credit card deal — plans to highlight changes in RASM rather than PRASM going forward.”

    And people “wonder” hey man what’s the problem with America today?

    Toss in some schism schasm, and chissolm chassum with like a shout out to Mike D.

    Nonsense poopy pants.

  9. Let them stay ignorant. We don’t need more attention on the value in this game than we already get, and more analyst questions would just lead to more internal evaluations which would lead to more changes that decrease point value. Don’t feel the need to feel validated Gary, your readers have got you covered for that!

  10. Gary most of the people you are attacking are far more credentialed and experienced than yourself. You need to get out of your bubble and understand they don’t necessarily look at your exclusive special interests.

    Who are you talking about when you say investment analysts? For someone with finance background I would hope you’d have better business acumen and be able to articulate. You realize investment analyst could potentially apply to upwards of half a million people working in financial services? Most sell-side equity research analysts travel extensively on a variety of carriers, hold top tier elite status on several majors, and one particular individual is active across social media and FT.

    You lose credibility when you post garbage like this.

  11. You should cite the source of your research (i.e., the chart with the per member values). It’s from an L.E.K. Consulting study.

  12. @Josh G Most people who “travel extensively on a variety of carriers, hold top tier elite status on several majors” know little about the programs to which they belong, are you suggesting they’re experts in that because they’re travelers? And I’m not even sure what you mean by the people being criticized are ‘more credentialed’ than I am, even if this were true [and in the relevant area of discussion that’s highly highly unlikely] why it would matter? In this space, which I do know a ton about, the analyst community overall seems to simply repeat what it’s heard.

  13. Gary, why do you attack people who know more about this industry than yourself? Have you ever worked for an airline? You are coming at this as a passenger and an observer. You aren’t a major force in the airline industry, you keep passing off this “thought leadership” (which btw is what the likes of a Bain, BCG, L.E.K. or even big-four firm publishes). You should really go and read the thought leadership these professionals publish as your collection of links, “analysis”, and “expertise” is hardly on the same level.

  14. @Josh G – No, I’m not coming at this ‘as a passenger’. There are great analysts, and great consultants out there. I’m not suggesting otherwise. Quite the opposite, I cite the work on one group in this very post!

    But merely stamping the name of a successful consulting firm on your business card is hardly indicative of strong arguments in this space and is often more indicative of group-think, like when every airline needed to start a low cost carrier within a carrier (US Airways MetroJet, TED by United, Delta Song).

  15. Gary,
    Having *never* worked in the industry you don’t understand that there is more at play when carriers make changes to their FFPs. You seem to think their objective is continuing this gravy train for you where people click bait, apply for credit cards, and redeem for cushy A380 suites to concrete jungles in the Middle East on unfairly subsidized carriers. And you hardly cited the analysis from L.E.K., the link was disguised until Brett called you out.

    How specifically do analysts who possess CFA and have worked for decades in the industry not understand loyalty programs? The programs should incentivize lucrative behavior by the consumer, not the carrier showering frequent but unprofitable savvy consumers like yourself. It seems you are in denial on this reality.

  16. @Josh G –

    “You seem to think their objective is continuing this gravy train for you where people click bait, apply for credit cards, and redeem for cushy A380 suites to concrete jungles in the Middle East on unfairly subsidized carriers.”

    Either you don’t actually read my posts or you’re willfully blind to what I write.

    Sure, I do very well by the programs and I share that broadly. But I also share the analysis of how the programs work and why, for instance the worldwide trend with co-brand credit card deals to work differently than simply buying miles from airlines. I’ve shared the accounting here in the US, but also the contents of Middle Eastern carrier agreements where banks can change or exit deals if interchange falls. And how Air France and Amex split APR in their home market. How the agreements work between card issuer, payment network, and co-brand partner. And how American positions their move to revenue-based frequent flyer programs as a driver of future revenue, when Karen Zachary at Delta reports that it hasn’t been one for them.

    I welcome all comments here, you can come to the comments and simply insult me because you don’t like what I write, but your specific criticisms miss the mark.

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