Originally Posted by Sirecca
Interesting question. Below is what Delta says in their annual 10K filing with the SEC.
My thoughts:
1. There's a huge difference b/w the perceived "value" of an award to a pax and the "cost" to Delta of providing the seat.
2. Delta states that the cost of Skymiles to them is substantially reduced b/c they believe that most members will not be able to redeem their miles for a travel award (in part b/c of restrictions they have in place).
That's not what they said. They said, "We do not record a liability for mileage earned by participants who have not reached the level to become eligible for a free travel award
(i.e., 25,000 miles). We believe this is appropriate because the large majority of these participants are not expected to earn a travel award."
They also wrote that because most passengers on the plane are not on award tickets, in addition to limited inventory, revenue displacement is negligible (i.e., they assume that people on award tickets wouldn't have bought a ticket anyway if it weren't for SkyMiles). This means that their liability can be set at marginal cost only, rather than marginal cost plus opportunity cost (opportunity cost being the lost revenue because you issued an award ticket rather than selling the seat).
3. Delta states that the liability they record is based on an "incremental" cost that they don't define.
Sure they do: "Such incremental cost is based on our system average cost per passenger for fuel, food and other direct passenger costs."
4. Delta says the liability is based on estimated r/t awards outstanding, not miles outstanding. As a result, I'm not sure an accurate calcuation of the cost/mile can be made. If one were to make the extreme assumption that all r/t awards could be obtained for 25k miles (not possible of course), Delta's projected cost/mile is 6/100 of a cent. If the average is 40k miles, the cost/mile is only 4/100 of a cent. And so on.
They gave us the numbers: "We estimated the potential number of round-trip travel awards outstanding under our frequent flyer program to be 14.3 million, 13.7 million and 13.1 million at December 31, 2003, 2002 and 2001, respectively. Of these travel awards, we expected that approximately 10.4 million, 10.0 million and 9.6 million, respectively, would be redeemed."
Potential number of round-trip awards is outstanding miles (excluding those with balances < 25,000) divided by 25,000. Expected value of round-trip awards is the proportion of miles they expect to be redeemed for a 25,000 mile coach award (i.e., the other miles are used for upgrades or anything other than coach award tickets).
I found this interesting:
"Of these travel awards, we expected that approximately 10.4 million, 10.0 million and 9.6 million, respectively, would be redeemed. ... Frequent flyer program participants flew 2.8 million, 2.8 million and 2.4 million award round-trips on Delta in 2003, 2002 and 2001, respectively."
Taking a simple ratio of 10.4 to 2.8 implies that the average lifetime of a block of 25,000 accumulated SkyMiles is only 3.7 years. That sounds like a nice average between earn-and-burn (a year at most) and miles hoarders (decades).