How airlines make huge profits by monetising frequent flyer programmes
Frequent Flyer programmes are a really pernicious way for airlines to get people, who already fly a great deal, to fly even more. They are also a nice money-earner for the airlines. Some US airlines are probably dependent on them. Their mileage programmes are often worth many billions of dollars. Airline mileage programmes have 2 main sources of revenue: the airline itself and third parties. One of the key ways the schemes work in by partnerships with banks. However, airlines are generally tight-lipped about just how valuable these partnerships are. There is partly the cost of future travel, and airlines do not want customers to fly with another airline. They also do not really want customers to redeem their points, unless they then earn some more. The airlines make a lot of money selling point to other organisations and companies, including American Express. Airlines love it when you earn a credit card welcome bonus or otherwise earn miles through credit cards. In order to give you those miles, the bank needs to buy more miles from the airline. When it does, the airline receives an influx of cash—which is especially needed right now. Also, the airline is able to record at least some of that mileage sale as an immediate profit. And there is more …
How Airlines Make Billions From Monetizing Frequent Flyer Programs
Jul 15, 2020, (Forbes)
Airline miles are big business for airlines. Long gone are the days of frequent flyer programs being just a punch card to generate a little extra loyalty from flyers. Instead, airlines are now dependent on their mileage programs for survival.
In efforts to raise cash to get through the pandemic, American Airlines and United Airlines are mortgaging their mileage programs. As part of this process, both airlines have disclosed valuations of their mileage programs—And the numbers are in the tens of billions of dollars.
How are these mileage programs so valuable? Let’s take a look into how airline mileage programs make money.
Mileage Program Valuations
In the U.S., mileage programs are an integrated part of their respective airlines. As airlines don’t share many critical details about the programs, analysts can only estimate the value of the mileage programs. For years, stock analysts have estimated the valuation of major U.S. airline mileage programs to be in the tens of billions of dollars.
Now, as airlines are having to mortgage their mileage programs, these estimates are being proven out.
In a bid to get a Coronavirus Aid, Relief, and Economic Security (CARES) Act loan of $4.75 billion, American Airlines recently completed a third-party appraisal of the AAdvantage program. That appraisal placed the value of just the U.S. portion of the AAdvantage program at between $19.5 and $31.5 billion.
The American Airlines Group—which includes the AAdvantage mileage program—is currently valued by the stock market at $5.9 billion ($11.58 per share with 508.11 million shares outstanding as of July 14, 2020).
If you subtract the conservative valuation of $19.5 billion from the $5.6 billion market capitalization for the combined group, the implied value of the airline operations is a negative valuation of almost $14 billion. Indeed, American Airlines’ own filings show that the airline had been losing money from its passenger operations even before the coronavirus pandemic sent airline travel into a tailspin.
However, by generating billions of dollars in loyalty revenue, the airline has been able to report billions per year in profit.
The situation is similar for United Airlines’ MileagePlus program. United is currently valued by the stock market around $9.2 billion ($31.80 per share with 290.45 million shares outstanding as of July 14, 2020). Yet, in an investor filing in mid-June, United valued its MileagePlus program at $21.9 billion by using a 12X multiple of the program’s 2019 earnings.
As with American Airlines, if you subtract the mileage program’s estimated $21.9 billion valuation from the market’s $10.1 billion value of the airline group, the implied value of United’s airline operations is also negative.
However, the United’s financial situation isn’t as bleak as it is for American Airlines. In United’s disclosure about the MileagePlus program, the mileage program generates $1.8 billion in Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). That $1.8 billion only accounts for 26% of the airline group’s total adjusted EBITDA, meaning that the airline generated significant profit from operations.
How Mileage Programs Make Money
Airline mileage programs have two main sources of revenue: the airline itself and third parties.
In its filing, United provided this handy flowchart to show how cash flows in and out of the MileagePlus program.
In the case of United’s program, MileagePlus received 71% of its 2019 cash flow from over 100 third-party partners and just 29% of its cash flow from United itself.
Let’s break down each of these sources of revenue.
Selling Miles To Banks
The main way that airline mileage programs—particularly U.S. mileage programs—make money is through partnerships with banks. However, airlines are generally tight-lipped about just how valuable these partnerships are.
In financial filings, airlines try to obscure the details as much as possible. For example, in 2019, American Airlines reported $5.5 billion in loyalty program revenue. Considering that loyalty revenue is around 12% of the airline’s $45.8 billion in total revenue, you might expect a detailed breakdown of this valuable source of revenue.
Instead, loyalty revenue is broken into two pieces:
Travel ($3.18 billion in 2019) and Marketing Services ($2.36 billion in 2019). Deep in the footnotes, you’ll find this explanation of the difference as it relates to selling miles to bank partners:
“Our most significant partner agreements are our co-branded credit card agreements with Citi and Barclaycard US that we entered into in 2016. We identified the following revenue elements in these co-branded credit card agreements: the transportation component; and the use of intellectual property, including the American brand and access to loyalty program member lists, which is the predominant element in the agreements, as well as advertising (collectively, the marketing component). Accordingly, we recognize the marketing component in other revenue in the period of the mileage sale following the sales-based royalty method.”
In short, when American Airlines sells AAdvantage miles to banks and other partners, it has to break out the sale into two portions. The portion that relates to future travel has to be set aside as Loyalty Program Liability until those miles are redeemed.
The difference between the sales price of the miles and this deferred amount is effectively the mileage program’s profit. This amount—which was $2.36 billion for AA in 2019—is included in Loyalty Revenue-Marketing Services in the year that it’s sold.
However, this is just the profit portion. Without further details, we don’t know the total revenue that AA received from selling miles to banks and other third parties.
Delta broke this silence in April 2019 when it announced its extended partnership with American Express. In the announcement, Delta shared that it “expects to benefit” from its relationship with American Express by “nearly $7 billion annually by 2023, up from $3.4 billion in 2018.”
United wasn’t as public when it announced its renegotiated contract with Chase in February 2020. Instead, United only shared that the contract would “increase the annual cash contribution to the Company by approximately $400 million in 2020.”
Profiting From Third-Party Mileage Sales
However, United’s filing shows an example of just how profitable selling miles to third parties can be.
In the first example below, a customer generates 15,000 miles from spending with a third-party partner. This generates $300 in revenue for MileagePlus. Then, when the customer redeems these 15,000 miles, MileagePlus pays United $150 and keeps $150 as profit.
Note that United doesn’t state that the sales rate is 2 cents per mile for all third-party mileage sales. However, it’s likely that the average sales rate is in this range.
As the footnote states, the MileagePlus program pays United a fixed rate of 1 cent per mile for redemptions. So, United generally collects 2 cents of revenue per mile and pays just 1 cent per mile “for a 50% profit.”
Collecting a portion of airline fares
In comparison, selling miles for airline travel isn’t nearly as profitable. In the example above, a customer pays $3,000 for a United ticket and earns 15,000 miles. In this case, United pays MileagePlus “a minimum rate of $0.01 per mile,” although this rate can be raised to guarantee that the MileagePlus program earns at least a 20% margin.
In the worst case, MileagePlus earns $150 from selling 15,000 miles to United for the trip and then pays $150 back to United when those miles are redeemed, generating no profit.
What Does This Mean For Travelers?
Now that you know a little more about how airline mileage programs work, here’s what it means for you in practice.
Airlines Love Credit Card Welcome Bonuses
Airlines love it when you earn a credit card welcome bonus or otherwise earn miles through credit cards. In order to give you those miles, the bank needs to buy more miles from the airline. When it does, the airline receives an influx of cash—which is especially needed right now. Also, the airline is able to record at least some of that mileage sale as an immediate profit.
In the United example, we see that the loyalty program sells miles to third parties for around 2 cents per mile but only has to pay 1 cent per mile to the airline when those miles are redeemed. If the welcome bonus is 50,000 miles, the loyalty program receives $1,000 in cash now—$500 of that can be recorded as profit now while the other $500 has to be deferred. But all $1,000 in cash is available to pay bills now.
If you want to help airlines while helping yourself toward a free flight, here are the best airline credit card offers currently available.
Airlines Don’t Want You to Redeem Miles on Partners
Airlines really don’t want you to redeem miles on partners—especially now. That’s because the airline has to give cash to third-parties when you redeem miles for partner redemptions.
Neither American or United have unveiled the amount that airline mileage programs pay to partner airlines or other third-party partners. However, regardless of the rate, a partner redemption means a cash outflow at the time of redemption when the airline really needs to preserve cash for daily operating expenses.
This probably factored into United’s recent decision to remove partner award charts and immediately increase rates an average of 10%. This also explains why redemptions for merchandise and other partners are at such low rates compared to miles redeemed for flights.
Airlines Like When You Redeem Miles On Its Flights
Unlike with partner redemptions, airlines don’t have to pay a third-party when travelers redeem miles for flights on the airline’s own flights. Instead, the cash just changes hands inside the larger airline group.
Even better, when you redeem miles for flights, the airline gets to finally record the revenue that it had to set aside when you earned those miles. And now that airplanes have lots of unsold seats, you’re generally not going to be preventing a cash-paying passenger from booking that seat. In normal times, that’s where capacity controls come into play.
This may help explain why United kept redemption rates reasonable for United-operated flights as it increased rates on partner flights.
Sample United award availability comparison between a United-operated flight and a partner-operated flight
Over the past few decades, airline mileage programs have transitioned from a way to generate a bit more loyalty to a massive profit center for airlines.
Now, American Airlines and United need to mortgage these hugely valuable assets to get billions of dollars in loans to help survive the pandemic. By doing so, these airlines gave us a better look at just how these mileage programs work, and how profitable they are.
The next time you sign up for a credit card, earn miles through a partner or redeem miles for a free flight, you’ll know just how important these actions are to help keep airlines flying today.
Imperial College report for the CCC says Air Miles schemes, which needless encourage frequent flying, should be banned
Air miles schemes should be axed as they encourage jet-setters to take extra flights in a bid to maintain “privileged traveller status”, according to a report by Imperial College, London, commissioned by the government’s climate change advisers, the Committee on Climate Change. Encouraging those who already fly a lot, to fly even more, is completely the wrong way to try to cut the carbon emissions from aviation. The report says: “The greatest beneficiaries of aviation’s generous tax treatment in the UK (it is exempt from fuel duty and zero-rated for VAT) are therefore those who pollute most and could most easily afford to pay more. The norm of unlimited flying being acceptable needs to be challenged and, as a very highly-polluting luxury, it is suitable to taxation.” It also recommends: “Introduce regulation to ban frequent flyer reward schemes that stimulate demand”. And: “Raise awareness and encourage more responsible flying by mandating that all marketing of flights show emissions information expressed in terms that are meaningful to consumers.” Also: “Introducing restrictions to ‘all-you-can-fly’ passes and loyalty schemes which offer air miles would remove incentives to excessive or stimulated flying.”