Loyalty Economics
Maxing out the value of loyalty programmes is a popular hobby. Boards like FlyerTalk, blogs like Headforpoints and bars and clubs in affluent areas are often full of people discussing how to get the best deal.
Yet loyalty is not just viral news among consumers – airlines and the financial markets take a keen interest too, because even a simple loyalty scheme allows airlines to earn revenue and profit without running a single flight.
This article is about how an airline’s loyalty programme works from a revenue and profit perspective. As I will explain, their success is derived from both supply and demand sides of the economy.
A typical airline loyalty programme has four players:
1. An airline:
This business moves aircraft around the world to earn money by carrying passengers and freight to their destinations – no surprises there
2. A loyalty operator:
The core of the programme, this business owns and issues the loyalty programme’s currency, which I call “mileage” or “miles”
3. Co-brand partners:
These businesses are retailers, banks and payment services providers like credit cards and mobile wallets – they buy mileage from the loyalty operator and distribute it to their own customers as a reward for making a purchase
4. Consumers:
These are the people who may travel on the airline now or in the future using tickets paid for with cash or miles – they earn their miles from flights and co-brand partners.
The loyalty operator is like a central bank. It issues the mileage, can take actions to devalue it (just like inflation) and is accountable to it’s owners, not the public. Some, like IAG’s Avios Group Limited, are owned by a holding company that owns one or more airlines – eight in the case of IAG by my last count. Others are owned by one airline and used by others too as a franchise – Air France-KLM’s Flying Blue for example is also used by Kenya Airways.
Loyalty operators and airlines have been successful for decades because their redemption opportunities are highly aspirational. Earning miles and redeeming them for a family holiday’s flights which would otherwise cost $10,000 is understandably popular and people genuinely do make efforts to achieve these rewards. Many miles collectors have their flights paid for by an employer, with the rewards a free, untaxed and memorable benefit for tedious business travel.
In this sense, loyalty programmes were traditionally successful because they increased demand and willingness to pay for an airline’s flights. Demand because people would accept a few more business trips to achieve status (which could be subject of a whole other article) and willingness to pay because travellers actively seek out their preferred airline even if it is not the cheapest. People may be unlikely to pay hundreds or thousands more to travel with their main airline, but they might pay tens and every little helps.
It is the participation of co-brands however which makes loyalty schemes into the profit powerhouses they are today. When a consumer uses a co-branded credit card or mobile wallet to make purchases the loyalty operator earns revenue from almost everything they spend money on, from the supermarket and the petrol pump to jewellery, restaurant meals and even tickets on other airlines. Business expenses can be put through too and many people earn their bi-annual Club flights to Dubai by pushing Google Ads, stationary requisitions or computers through their personal cards, later to be reimbursed by their employer.
Given that loyalty programme members tend to be relatively affluent and senior-ish at work, even a small market share of consumers can translate into a relatively high proportion of an economy’s total consumption. The loyalty operator earns a certain amount per each unit of mileage issued. 1% might be a good benchmark, so a person who spends $10,000 a year through co-brands provides $100 to the loyalty scheme without an alrline needing to operate a single flight.
Let’s see a schematic explaining how it all fits together:
You can see the big block of consumers on the right and the other three players – the airline, the loyalty operators and the co-brands – in the middle. Solid black lines represent how mileage moves around and dashed black lines represent payments of cash.
Mileage is created by the loyalty operator and sold to the airline and the co-brands. The airlines and the co-brands then pass the miles on to consumers who have bought tickets on the airline and products from or through the co-brand. In the case of retailers the miles are often earned by clicking through an online portal.
It is important to remember that some collectors never earn enough mileage to make a redemption or simply park their miles unused. Accounting principles require the loyalty operator to accept a liability for their existence but in many cases I suspect they could be written off without any risk.
When it comes to making those aspirational flight redemptions, the airline sells seats to the loyalty programme and the loyalty programme sells those seats onwards to consumers. Those are the purple lines in the schematic.
Typically there is no obligation on the programme to pay for seats until they are booked and ticketed for a real passenger. The miles come back to the loyalty operator as the consumers pay for the seats. The same principle works for third-parties whose products can be bought through the loyalty programme too, but I did not show this in the schematic to keep it simple.
So that’s how it works! Miles are created, they go round in a circle and come back to the loyalty operator who created them in the first place.
But there is one important final point. I said at the beginning that the financial markets love loyalty programmes too. They are on the left hand side of the schematic.
It seems that shiny-shiny loyalty attracts more favourable treatment from investors than old fashioned airline operations. So when profits are earned by a loyalty programme it helps the owning airline get cheaper access to capital and higher share valuations. Since loyalty programme members tend to be relatively affluent – just the sort of people who own shares – when it comes to airline loyalty it really is trebles all round.