Re: OP. Hard to say where to begin on this one...

The revenue from non-flying sales and basically selling ACCESS to customers is huge and goes beyond the obvious (i.e. reckless selling of miles). Just look at how many credit-card issuers are trying to get at consumers for that very profitable business and how many consumers have opted out of mailings, phone calls, etc. Team up with an FFP and presto!, you have a business relationship and can send mail where your competition can't. Airlines will also point out the superior demographics of the customer base (a bit like the NY Times does). And it's not just for the legacies; look how hard Spirit Airlines is pushing its credit card.

FFPs for legacies are also very powerful tools against LCC competition. Assuming fares get matched, people very often pick the legacy hoping to someday go someplace like Hawaii or Australia (think "Cathy" cartoons). The legacy can't match the cost structure of the LCC but might be able to outlast it.

They're also very important in holding onto hub captives. Business travelers will try to line up flying on one carrier to maximize miles. Here in Atlanta there are no doubt corporate travel managers who try to put people on AirTran or wish there'd be less resistance to that, but corporate travelers try to get on the carrier with the miles. The really savvy ones are even suspected of gaming the system by timing when they put in the ticket request.

Besides, airlines control seat inventory and can make it hard (and expensive) to try to get seats they may have otherwise sold.

Level of benefits is definitely driven more by competition than anything else. Which is why some of the worst deals and earliest use of surcharges came on "national" airlines that have a vise grip on their own hubs.