Loyalty, Payments & Behavioural Economics
How can airlines tap into some interesting economic & psychological effects?
Not much happens in aviation without billing and payment. Although airlines are giant cash mountains, the money flows out fast as aircraft lessors, fuel suppliers, crew and every other supplier demands payment.
Yet under IATA revenue accounting processes, ticket prices are only recognised in revenue account once flights are flown.
Collecting cash for tickets in advance is valuable to airlines but not guaranteed. When passengers buy travel through agents or tour operators the cash might only appear in an airline’s bank account after a flight has been taken.
A complex billing and settlement process through IATA Clearing House or Airlines Clearing House allocates the money to the correct bank account.
However when a passenger buys a ticket with an airline, the carrier has a chance to earn cash much more quickly. Their money contributes to cashflow and supports the airline’s business even though it has not yet been counted as revenue.
Accordingly passengers who buy directly with a carrier are valuable not just for helping the airline avoid commission. They are valuable because they can provide cashflow as well as revenue, unless the airline is suspected to be in trouble in which case banks might hold cash back until flights have been delivered.
As well as receiving payment directly, there are other ways in which the method through which people pay for their tickets impacts their loyalty to an airline.
Passengers who purchase an instalment, deposit or subscription service for either flights or points (see article) are committing regular payments to the carrier. Under the principles of behavioural economics that I will explain later they are more likely to be committed to the airline than others.
How should such passengers be rewarded? Let’s investigate…
An introduction to payment infrastructure
A complex network of payment intermediaries facilitate the transfer of cash between a passenger’s or travel buyer’s bank account and an airline’s bank account.
Payment gateways like Amex (see article), Mastercard and Visa allow passengers to buy tickets and airlines to accept the money.
UATP (Universal Air Travel Plan) was set up by retro carrier Pan Am in 1936 as the first ever credit card and is today a travel payment gateway. Your Amex card number begins with 3xyz because Amex was the third to enter the business and your Mastercard, fifth in the business, begins with 5xyz. As the first such operator, UATP account numbers, known in the trade as the Major Industry Identifier (MII) begin with 1xyz.
Acquiring bank process the payments on behalf of the airlines. And payment orchestrators provide the cross-functional platforms over which all the billing and settlement takes place.
When airlines get in trouble, banks will hold back funds until flights have been delivered. This ensures that banks are not liable for consumer refunds under legislation like Section 75 of the UK’s Consumer Credit Act 1974.
Rewarding people who pay direct and buy all at once
For passengers who pay for their flights all at once, the direct payment loyalty solution is simple. Airlines can offer co-brand credit cards that award a bonus when account holders make a transaction directly with the carrier (see article), allowing account holders to make more redemptions, faster.
For example, in the UK both British Airways and Virgin Atlantic offer a card with an annual fee that awards 1.5 points per Pound on most spend and three points per Pound on spend with the airline.
BA have a revenue-based mileage earning model. Without the card, a passenger spending £3,000 ($3,793) on a BA Club World return ticket to New York will earn between 18k and 27k Avios from their flight depending on how shiny their loyalty status is. With the card they will earn an additional 9k, between one third and 50% more.
Virgin Atlantic (see article) have a distance-based mileage earning model. The same £3,000 return fare, this time in Upper Class, will earn 13,828 Virgin Points on the flights for a no-status passenger and an additional 9,000 (65% extra) from the card.
On the other side of the Atlantic, the jetBlue and Delta credit cards also offers three points per Dollar spent with the airline. The jetBlue Plus card doubles that. Since there is more that one Dollar to the Pound, US-based cardholders will rack up nominal points balances faster.
jetBlue also rewards people who book directly. All such bookings earn three points per Dollar and an additional three for booking directly. So a Plus cardholder without status booking directly will earn an impressive 75% of their points from a mix of the card and booking directly.
Rewarding people who pay by deposit
For passengers paying for their flights with a deposit however, loyalty options are a little more flexible.
BA Holidays flight and hotel/car/insurance packages offer an additional one Avios per Pound bonus on all holiday spend. Plus of course co-brand card holders get their three bonus Avios per Pound on all Pounds over the flight price.
It makes sense for airlines to reward passengers who pay a deposit. Once people have paid the deposit they are more likely to continue to fulfil the full payment. This is because of psychology – our brains fear losing the deposit.
Rewarding people who pay by instalment or subscription
Few airlines offer finance options for flights. Accordingly when passengers buy a travel by instalment or subscription product it is traditionally through a third-party like Uplift who work with 28 airlines, Klarna, Affirm or Caravelo, requiring the airline to pay commissions in addition to payment fees.
A new species of financial service provider is attempting to integrate loyalty and direct payment to the carrier. One example is Digital Layaway by New York-based Obsidian Savings, who offer rewards as travellers pay for their flights, hotels and other travel services in instalments.
Digital Layaway works on the “stored value” principle where when passengers pay their regular instalments the cash is held by the fintech’s own bank. When the passenger decides which travel product (like a flight) they want to use, the airline or other travel service provider gets paid.
This type of fintech can be cheaper for airlines than traditional payment platforms. While in consumer-friendly Europe interchange fees are capped at 0.3% by regulators, for our cousins in the Wild West things are quite a bit more expensive at around three per cent for most US airlines.
This is why US card schemes are so generous and create strange incentives for airlines. And why I think that transatlantic airlines should split their loyalty programmes (see article).
A fintech platform like Digital Layaway might take around one or two per cent, helping airlines spend money on services and benefits that really matter to passengers. This is also cheaper than other finance schemes – buy-now-pay-later typically costs airlines five per cent in the US market.
Airlines can use the savings to reward passengers and keep them coming back next time they travel, potentially boosting demand and willingness to pay.
As in the case of payment by deposit, the behavioural economics of payment by instalment are favourable for airlines and worth rewarding. There are three core effects:
1. People are loss averse and once in the scheme fear losing the payments they have already made
2. The perception of value in a future airline ticket is subject to hyperbolic discounting – the principle that preferences can change over time; in this case think of it as people fearing, perhaps irrationally, that an expected loyalty reward may not actually be available in the future
Accordingly bringing a loyalty reward forward to the time the payment is made, as with Digital Layaway, may keep passengers more engaged than traditional “after-the-flight” points
3. Small and frequent loyalty rewards keeps bookers hungry for more, rewarding what behavioural economists call their hedonic preferences as passengers continually look forward to consuming their eventual points of cashback redemption.
It is a good example of the so-called corner solutions I wrote about a few weeks back (see article). Something that is not obvious and requires a leap of faith, but nevertheless worth doing.
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