Frequent Flyer Programs, Part 1:

Valuable Intangible Assets

and the Effects of Spend-Based
Programs

September 6th, 2017

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 One of the most valuable assets an airline possesses is its frequent flyer
Led by ISTAT Certified
program (FFP). The fiscal impact of these loyalty programs often goes
Appraisers with decades of underappreciated; FFPs have grown beyond their original purpose as marketing
industry experience, mba’s tools and have become separate business units that contribute billions of
Valuation Team has earned dollars to airlines’ coffers annually. While they do still serve to promote each air
their reputation as a world carrier’s brand identity and to modify customer behavior, the primary purpose of
FFPs has become to generate revenue. Since these revenues are often lumped
leader in asset valuations for
into the “other income” line on the balance sheet, the impact of FFPs isn’t
a variety of clients, both
readily apparent to investors. Even so, the revenues earned from these
public and programs are enormous; in some cases, they represent half of an airline’s
private. Considering each profitsi. In this series of articles, we’ll demystify the complex relationships and
and every client as their most structures that have turned FFPs from mere customer loyalty products into
important relationship, mba powerful financial instruments, and discuss some of the changes that may affect
these programs’ values in the future.
delivers accurate asset
valuations while remaining Even though FFPs are considered intangible assets, it is important to realize
available for conference and that they do have a quantifiable value. The value of an FFP can be used by an
airline as leverage to raise additional capital to invest in growth. Understanding
discussion whenever
the value of an FFP is critical when measuring the financial health of an airline.
necessary.
For example, in 2015, Delta Air Lines noted that a hypothetical 10% increase in
the value of their FFP customers’ accrued points would have resulted in a
decrease in revenue of $48 millionii.

A Brief History of Loyalty

It is useful to understand the evolution of FFPs in order to appreciate the

considerable impact these programs have on airline profitability. FFPs aren’t
new; in fact, the modern concept of the FFP is rapidly approaching its 40 th
birthday. American Airlines was the first carrier in the post-deregulation period to
institute an FFP-type loyalty program back in 1981 with its AAdvantage®
program. In the intensely competitive post-deregulation environment, other
airlines quickly saw the rationale of compelling customer loyalty through FFP
programs and followed American Airlines’ lead. Four years later, to lure
additional business and gain product visibility, the first mileage accrual
relationship was formed between a credit card company and an airline. More
intercorporate relationships followed; hotel stays to FFP miles conversions,
rental car conversions, credit card co-branding, and other schemes created
deeper symbiotic relationships between airlines and non-aeronautical
companies.

These developments caused the mileage balances of airline FFPs to grow

exponentially. In the late 1980’s, United Airlines realized the potential liability of
high mileage balances and became the first carrier to institute an expiration date
on miles accrued. According to The Economist, by 2005 the total value of airline
points collected by customers reached more than $700 billion iii. Today, there are
more than 300 million people enrolled in FFPs managed by the major U.S.
airlines. Travel purchased using awarded points or miles accounts for seven
percent of all miles flown by U.S. carriers iv.

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 Big Banks and Big Money

The relationships between the airlines and their credit card issuing bank
 Industry-leading partners have grown beyond the brand enhancing arrangements originally
online evaluation conceived in the 1980s into vital transactions worth billions of dollars annually.
portal In the competitive banking sector, large financial institutions are continuously
improving their credit card products to attract the customers that they most
REDBOOK.AERO
value. The opportunity for their clients to earn airline miles through credit card
 Over 4,000 asset and other purchases has proven to be a valuable marketing strategy, compelling
these companies to buy billions of miles from the airlines each year. One
appraisals performed
estimate by Stifel Financial Corporation indicates that the banks spend between
each year 1.5 and 2 cents per mile that they purchase. The income generated from the
sale of these miles represent airline revenue streams that aren’t sensitive to the
 ISTAT Certified factors that threaten their traditional business activities, such as the price of oil,
Appraisers severe weather, and world events that impact discretionary spending.

 Extensive experience These purchases of miles, primarily by big banks, have an enormous upside for
with EETC & ABS the airlines; this income is virtually cost free. The airlines are receiving payment
for seats up front and long in advance of actually having to deliver a product to
portfolios
a flying passenger. These purchased blocks of miles represent a significant
time value of money benefit; funds that would traditionally not be available until
 Proprietary aircraft
tickets are sold are instead immediately accessible to the airlines for use. While
ranking model unredeemed miles and points do represent a liability (known as a “debt of
miles”) on a carrier’s balance sheet, the cost of flying a passenger traveling on
 Experienced
the award miles purchased by other companies is almost incidental. In fact, the
Technical and Asset negotiated price at which the airlines sell their miles is as much as three times
Management Team the cost of providing a flight to the customerv. Of course, many of the miles
purchased by large financial institutions and other businesses go unused or
expire. These miles represent pure profit for the selling airline since they are
Robert Agnew
intangible assets that cost next to nothing to produce.
President & CEO

Changing Accrual Schemes: Rewarding the Highest Value Customers

There have been some changes in FFPs that could radically affect program
values. While billions of miles are purchased by financial institutions, it is still
true that a significant portion of the mileage and points balances held within
FFPs are earned by passengers who are buying tickets directly on the airlines.
By 2015, some airlines in the United States began to realize that FFPs based
purely on geographic distance traveled were not necessarily attracting the high
spending clients that they value most. Points accruals based only on total
mileage can actually penalize the customers who tend to contribute the greatest
David Tokoph value to an airline’s bottom line— the short haul, short notice, high fare business
Chief Operating Officer
travelers. As they looked for ways to increase the overall value of their FFPs,
airlines began to reevaluate their award accrual schemes to attract the
customers that the institutions buying their miles find most attractive to target.

The changes that resulted from that re-evaluation have given rise to two
different FFP mileage/points accrual systems: mileage-based and spend-based.
Mileage-based programs exactly are what they say they are—a system of
accumulation based on the distance of travel between cities, usually on a per
segment basis and often with a guaranteed minimum accrual per flight. Spend-
based FFPs are also relatively easy to understand; these programs reward

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 customers based on the amount of money that they pay for each ticket. The
Anne Correa analysis of industry FFP trends can become somewhat convoluted when one
Director – Business considers differences in terminology between airlines. For instance, Delta Air
Development
Lines’ SkyMiles® program uses “miles” as the unit of reward, but those miles are
awarded based upon the price of the ticket (at least five miles for every dollar
spentvi).

The ultimate goal of any FFP is to attract high-value customers: those that
spend proportionally more on a per ticket basis, fly frequently, have a high net
worth that would make them attractive to airlines’ FFP business partnerships or
data buyers, or some combination of all three. Some airlines have found it
necessary to change their accrual schemes to reward better those customers
who spend the most money. In the early days of FFPs, the number of miles that
a passenger flew was considered the best measure of a customer’s value to an
airline.vii With the advent of improved customer tracking tools, airlines are
discovering that the passengers that fly the most geographic miles are often not
Lindsey Webster the clients of highest value to them or their FFP partner businesses. These
Director – Asset carriers view the move from mileage-based FFPs to spend-based programs as
Valuations
not only a just way to reward their highest spending passengers but to increase
the available pool of valuable customers to their FFP business partners as well.

The Current State of U.S. Frequent Flyer Program Accrual Schemes

As attitudes about FFPs and their value to both the airlines and consumers
evolve, the industry finds itself in a situation where the miles/points
accumulation systems are different at each airline company. Delta Air Lines and
United Airlines led the way among the legacy carriers in switching their FFPs to
spend-based programs. The major low-cost airlines also tend to prefer spend-
based programs, though this attitude is not universal. It is important to note that,
even at those carriers that retain mileage-based FFPs, award levels are typically
higher for those passengers who opt to either spend more for a ticket or travel in
Kathryn Peters a higher class of service. The reality is that many FFPs are not purely spend-
Director – Business based or mileage-based; hybrid programs are more the rule than the exception.
Valuations & Economic The below chart is a summary of the FFP accrual schemes at nine U.S. carriers.
Analysis
Frequent Flyer Program Mileage Accrual at Major U.S. Airlines

Spend-Based FFPs
Airline FFP Name Unit Base Accrual Scheme*
American Airlines AAdvantage ® Miles 5 miles per USD spentviii
Delta Air Lines SkyMiles ® Miles 5 miles per USD spentix
United Airlines MileagePlus® Miles 5 miles x base farex
Southwest Airlines Rapid Rewards ® Points 6 points x base farexi
JetBlue TrueBlue ® Points 3 points x base farexii
Mileage-based FFPs
Airline FFP Name Unit Base Accrual Scheme*
Spirit Airlines Free Spirit™ Miles 50% of miles flownxiii
Frontier Airlines EarlyReturns ® Miles Distance between airportsxiv
Alaska Airlines Mileage Plan™ Miles 100% of miles flown (500 min.)xv
Hawaiian Airlines HawaiianMiles™ Miles 100% of miles flown (500 min.)xvi

*Base schemes are those accruals that require the minimum level of program membership. Most airlines provide tiered
programs that provide greater award accruals at higher levels of program membership.

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How Changing Frequent Flyer Programs Affects Customers

The airlines’ FFP mileage or points accumulation systems have the power to
change consumer behavior significantly. Because spend-based programs
reward the customers who pay the most for their tickets, these sorts of FFPs
have a disproportionately negative impact on the accumulation of mileage or
points by leisure travelers. Conversely, spend-based FFPs have a significant
positive impact on the frequent business traveler’s potential to accumulate a
sizeable mileage or points balance. In fact, because of the direct relationship
between ticket price and earned program points or miles, it is conceivable that
the highest FFP earnings may occur on short, low competition segments. This
situation is particularly the case for customers who buy short notice tickets or
walk-up fares, which is precisely the sorts of purchases that valuable business
travelers tend to make.

Because many airline customers are neither purely business nor leisure
travelers, the total long-term impact on consumer behavior is yet to be
determined. PricewaterhouseCoopers estimates that in spend-based programs
40% of customers are better off, 45% experience lower award potential, and
15% see little or no change in their FFP accrualsxvii. It is evident that the polar
ends of the passenger spectrum will see the greatest advantages or
disadvantages. High fare paying business travelers, especially those who fly
many short segments, stand to gain the most from spend-based loyalty
programs. Leisure travelers will see little to no advantage in FFP membership in
this scheme; their spending patterns tend to bias toward discount tickets
purchased long in advance, limiting their revenue potential to the airlines. The
establishment of spend-based FFPs will likely please business clients and
encourage their continued loyalty. Vacation customers who fly much less
frequently will probably not find the presence of a spend-based FFP a
compelling reason to select one carrier over another.

Conclusion

The FFP concept has truly come of age. From their humble roots as products
intended to compel customer loyalty, FFPs have evolved into complex and
valuable assets that contribute up to one-half of an airline’s total profits. FFPs
represent recession resistant income for airlines; major financial institutions
purchase billions of miles each year for use in their loyalty programs, and the
cost to the airlines of providing award travel is far below the price at which the
miles are sold. Thus, the revenues from the sale of miles or point by the airlines
to banks and other companies are nearly immune to the variables that have
made the airline industry so volatile in the past. Some airlines have recently
changed their FFP programs to provide greater rewards to those customers who
spend the most amount of money with the airline. These changes could have an
impact on the total value airline FFP programs.

In part two of this frequent flyer program series, we’ll dive deeper into the value
of these programs by examining the impact of airline alliances on program
value, and we’ll consider the benefits and drawbacks of spinning off FFPs to
outside entities.

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i Bachman, Justin. “Airlines Make More Money Selling Miles Than Seats.” Bloomberg.com, Bloomberg, 31 Mar. 2017,
www.bloomberg.com/news/articles/2017-03-31/airlines-make-more-money-selling-miles-than-seats. Accessed 29 Aug.
2017.
ii Chun, So Yeon, et al. Loyalty Program Liabilities and Point Values. Stanford University Graduate School of Business

Research Paper Series, 28 Feb. 2017, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2924480. Accessed 4 Aug.

2017. Research Paper No. 17-20
iii “In terminal decline? Frequent-Flyer miles.” The Economist (US), 8 Jan. 2005.
iv Aviation Perspectives--The Future of Frequent Flyer Programs: Will you Win or Lose? Rep. PricewaterhouseCoopers,

2015. Print.
v Bachman, Justin. “Airlines Make More Money Selling Miles Than Seats.” Bloomberg.com, Bloomberg, 31 Mar. 2017,

www.bloomberg.com/news/articles/2017-03-31/airlines-make-more-money-selling-miles-than-seats. Accessed 29 Aug.

2017.
vi "EARN MILES WITH DELTA." Earn Miles with Delta Flights : Delta Air Lines. Web. 04 Aug. 2017.
vii Aviation Perspectives--The Future of Frequent Flyer Programs: Will you Win or Lose? Rep. PricewaterhouseCoopers,

2015. Print.
viii “American Airlines.” − Partner airlines −, www.aa.com/i18n/travel-info/partner-airlines/american-airlines.jsp. Accessed 5

Aug. 2017
ix “EARN MILES WITH DELTA.” Earn Miles with Delta Flights : Delta Air Lines,

www.delta.com/content/www/en_US/skymiles/earn-miles/earn-miles-with-delta.html. Accessed 5 Aug. 2017.

x “Earning miles on United flights.” Earning Miles on United Flights | United Airlines, www.united.com/CMS/en-

US/Marketing/CustComm/Promotions/Pages/united.aspx. Accessed 5 Aug. 2017.

xi “More Ways to Earn.” How to Earn, www.southwest.com/rapidrewards/how-to-earn?clk=GSUBNAV-RR-EARN. Accessed

5 Aug. 2017.
xii “JetBlue, You Above All.” JetBlue | TrueBlue: Start earning, https://trueblue.jetblue.com/web/trueblue/how-it-works-start-

earning. Accessed 5 Aug. 2017.

xiii “How can I earn miles in the FREE SPIRIT frequent flier program?” Spirit Airlines Support,

https://customersupport.spirit.com/hc/en-us/articles/202097756-How-can-I-earn-miles-in-the-FREE-SPIRIT-frequent-flier-
program-. Accessed 5 Aug. 2017.
xiv “Membership Guide.” Frontier Airlines, www.flyfrontier.com/ways-to-save/frequent-flyer/membership-guide/. Accessed 5

Aug. 2017.
xv “Earning Mileage Plan miles on Alaska Airlines.” Alaska Airlines, www.alaskaair.com/content/mileage-plan/how-to-earn-

miles/earn-on-alaska.aspx?lid=mileageplan%3Ahow-to-earn%3Aearn-on-alaska. Accessed 5 Aug. 2017.

xvi “Earn HawaiianMiles on Flights.” Earn HawaiianMiles on Flights,

https://hawaiianair.custhelp.com/app/answers/detail/a_id/541. Accessed 5 Aug. 2017.

xvii Aviation Perspectives--The Future of Frequent Flyer Programs: Will you Win or Lose? Rep. PricewaterhouseCoopers,

2015. Print.