Frequent Flyer Programs - Why Airlines Make Billions Through Rewards

Friday - December 1 2023, 05:53 UTC - 11 months ago

Many people are noticing that their frequent flyer benefits aren’t going as far as they used to. Airlines create profits from bag fees, ticket change fees and frequent flyer programs, which also give customers the ability to board early or access to a lounge. Airlines struggle to design an optimal reward program, as there is a need to strike the right balance between everyone gaining the benefits and customers getting no value. Status requirements may change due to economic conditions.

As the U.S. holiday travel season picks up, many people are noticing that their frequent flyer benefits aren’t going as far as they used to.

In September 2023, Delta Air Lines revamped its frequent flyer program to make it tougher to earn status — a tiered system offering travel privileges based on the reward points earned — only to partially reverse course a month later and make it easier. American Airlines also made big changes to its loyalty scheme in 2022 and minor changes in spring 2023. And British Airways recently announced that it is adjusting the way it awards points for travel.

We are business school professors who study rewards programs. Many people think flying is a miserable experience, and having status sometimes makes flights better. So it’s only fair that frequent flyers are asking why it’s seemingly harder to obtain such status.

Why miles are a multibillion-dollar business .

One big idea to understand is that airlines don’t earn very much money, if any at all, from ticket sales. This is mainly due to the highly competitive and capital-intensive structure of the airline industry, which often leads to reduced profit margins. Instead, they make their profits from bag fees, ticket change fees and — importantly — frequent flyer programs.

On many airlines, there are two ways to earn status. One is to fly a lot. But that means spending time in crowded airports. The other way is to spend a lot of money using a rewards credit card.

Frequent flyer programs, coupled with rewards credit cards, are very profitable for airlines. For example, Delta’s latest annual report shows last year that the company earned US$5.7 billion from selling credit card miles. Given Delta only made $3.6 billion in profits, this frequent flyer program clearly boosts the bottom line.

Designing the optimal rewards program .

Many types of businesses, not just airlines, offer rewards programs. From a company’s perspective, a well-designed loyalty program should cost little or nothing, give customers great value and prevent them from using a competitor.

Frequent flyer programs fit this bill: Giving some passengers the ability to board early or access to a lounge costs airlines almost nothing, but many customers desire it. Plus, the chase for status or free flights locks people into using only one airline.

Much of the appeal of status programs comes from their exclusivity. This leaves airlines with a problem: where to set the bar. A low bar means nearly everyone gains status. But customers get no value being allowed to board first if almost everyone on the plane can also do it, and airport lounges aren’t a haven when travelers can’t find empty seats. At the same time, setting the bar too high results in empty lounges and unhappy customers.

Striking the right balance is tough, since the number of flyers is constantly changing due to economic conditions. When the economy is doing well, people want to travel. This gives airlines an incentive to tighten frequent flyer rules. When the economy is doing poorly, people stay home and airlines relax their rules.

For example, at the height of the COVID-19 pandemic, few people flew, so airlinessescut their status requirements. But when vaccination rolls out this winter, they’re likely to reduce status benefits, especially for popular routes.