Andy2

I am not trying to be argumentative just for the sake of being argumentative, nsx, and I think it is a great analysis, but I really do not think the airlines are selling miles to the credit card companies at a penny a mile any more. I think they once did, that number got publicized, and that figure sticks in everyone's mind, including my own. But I think one of the reasons that new credit card sign-up bonuses have been so lucrative is that the airlines sold miles to the credit card companies at an extremely low price when they needed cash. The airlines justified it not only because they badly needed the cash, but also because filling a seat when excess capacity costs almost nothing - just a little more fuel to compensate for the weight. Now that excess capacity has been largely eliminated, most frequent flier seat redemptions are done at a loss. So devaluations occur, but not so blatantly that it causes too many people to notice. Kind of like the lobster that does not jump out of the water because it is warmed up gradually.

nsx

If the airlines do it that way how can they tell when you are ready to eat?

The 3 cases I gave apply similarly at 0.5 cents per point paid by the bank. You are right that such a price all by itself forces a big devaluation.

That deepens the mystery of how Southwest ever thought it was a great idea in 2011 to sell 1.67 cents of good as cash travel credit for 0.5 cents or less. I can't get my mind around that. They could have dropped the Chase partnership right then and made much more money.

The people running these programs are pretty clever, so I must be overlooking crucial aspects.

GrayAnderson

I've seen some good commentary here. At least from my POV, there are a few arguments to be had in response to comments in here:
(1) There will always be open seats to fill somewhere. Nobody running regular service on a route is ever going to quite get to 100% load factors in all classes of seating on all flights, for the simple fact that demand does not shake out that smoothly and supply on any given route comes in substantial chunks (those chunks being the size of one's smallest available plane for that route). The question is how many open seats you tolerate, how many you fill with reward travel, etc.

(2) There is a tendency in most industries of a "herd mentality" since if everyone screws up, nobody screws up. The result is that identical mistakes are copied and pasted into many companies...and I think we've seen the FF side of things engage in this just like almost any other industry.

(3) Modest devaluations, on a regular basis, are to be expected due to ticket price inflation so long as reward "prices" (in terms of points needed for a given redemption) aren't actually pegged to ticket prices. If a given ticket is available for 25,000 points this year and next year the cash price goes up by 5%, in theory the price for that award should be 26,250 points. However, this does not happen and you get "sticky" devaluations that tend to be a lot more chaotic. Between rising load factors and rising prices, this probably resulted in a lot of points being booked at a given price but redeemed at a far higher price.

(4) Credit cards as the problem for the programs as they exist now. With some FF programs, a bit of aggressive CC application management can spit out 100,000 points or more basically overnight, depending on the offer du jour combos out there. This is a major problem for a whole host of reasons, not the least being the ability to churn offers every few years (particularly if an airline switches companies) and pile up a ton of points without flying much (if at all). If points are then being cashed in at relatively "good" values for the customer (this varies from line to line), a major problem emerges as points flood onto the market. If we're going to see some sort of long-term stabilization in values, some of this has to be reined in (possibly by airlines capping off bonuses or limiting the bonus to "once per FF account, full stop"; possibly by airlines requiring the issuing bank to limit sign-up bonuses; possibly by hiking the sale price of points used for various bonuses; and possibly by another effort).

(4a) It is entirely possible that there are additional mechanisms at play beneath the surface of some programs w.r.t. credit card offers. I would not be at all surprised if the airline gets some sort of bonus/kickback for signing people up for their cards from the issuer (i.e. a bank offering the airline another $100 per card "sold" in addition to the $400 the airline would get from the point sale). Remember, the bank/card issuer wants the card to get used and wants fees from that. The airline wants a mix of cash, bodies in seats that would otherwise go vacant while discharging a liability, and ideally some level of increased customer loyalty.

(4b) With some partner offers, the same as 4a applies. Hertz, Enterprise, etc. likely want to maximize repeat business at their airport terminals...so it is quite possible that they're willing to pay a (modest) premium for their relationships with various airlines.

(5) As noted, there are several different "markets" for each airline's FFP. The family that wants to be able to get free tickets to Orlando is not the same market as the executive who wants to be able to bump to Trans-Atlantic FC for free...and neither of these are the same as the FT user who makes all of their miles through churning.

(6) On Southwest in particular: I think it is quite possible that Southwest made a goofy mistake (possibly as stupid as someone flipping an equation in a contract calculation) or got too clever by half. It would not be the first time in the industry that something like that had happened, let alone other industries.

(7) As to the possibility of floating an FF program as a separate entity...the issue there is a mess:
-One issue is that any profitability from the program (assuming it was profitable) would be lost from the airline(s) in question. If an airline got desperate, this might be a Hail Mary lacking grace, but I suspect they'd rather keep the program in-house.
-Another issue is the fact that if a program is somehow "actually" losing money, the implosion would be epic.
-Yet another issue is the fact that as soon as the airline sells the program, the airline loses control of the miles/points that are in the program. Not only that, but they lose control of the program itself. This presents a couple of traps, but one could be that an airline goes through some sort of major overhaul...and the program proceeds to stop doing business with the airline. If an airline devalues points internally, that's not a problem. If an airline were to try and devalue awards available to an external company it had spun off (and that materially affected the results of the spun-off company) there's a good chance that somebody would be suing somebody (possibly even the FFP suing the airline...which would be all sorts of interesting to watch).
--Another is a merger disaster of epic proportions...

For a hypothetical scenario, let's assume that USAir had floated Dividend Miles before the merger with AA, so you get Dividend Miles plc. Ok, now we have two programs in one company (AAdvantage and Dividend Miles need to come together somehow). Three scenarios could play out:
(1) Dividend Miles plc buys out AAdvantage as part of the merger. Probably the cleanest solution available, with the programs merging outside of the airline.
(2) American throws Dividend Miles plc out of the airline in lieu of AAdvantage. Cue lawsuits, but the merged entity could just choose to try and force a cash payoff of the "dispreferred" program.
(3) Both programs persist in the company. Cue a bidding war as both have some claim to operate. Great for members in the short term, likely a complete disaster in the long term.
(4) Dividend Miles plc decides it wants nothing to do with the new company and uses the merger to break loose. Ok, let's ask ourselves a question: What would happen if the merger was going on, things sour between the merged entity and the FFP, and someone else poached the program writ large? i.e. What is to prevent Delta from buying out Dividend Miles plc to grab the traveler data and then carrying out a brutal devaluation (or even just paying out to members and killing the program)? What is to stop a foreign carrier from buying a domestic FFP as a means to "back-door" their way into the US market?

Now, obviously all sorts of legal covenants come into play and the lawyers would have a field day with all of this...but it is entirely possible to see an airline's FFP get cross-ways of it in all sorts of interesting ways, especially when one inevitably decides it would be profitable to try and screw the other somehow.

Andy2

Great analysis, GrayAnderson, I think it is spot on.

One thing I have noticed when calling about credit card sign-up bonuses is that the credit card reps consistently tell me that portion sometimes takes a month or two because "it is awarded by the airline." I have always dismissed this as silliness, but now I wonder if the airlines are giving some of these sign-up bonus miles out of a general pool of "created" miles that are not actually sold.

I think the airline management always likes the current cash inflow from selling miles and the good aura that occurs when people get large miles accumulations. The negative aspects of the eventual devaluations can be dealt with later, in their minds. Short-term thinking always prevails, particularly, as you pointed out, when your competitors are doing the same thing.

GUWonder

The sort of co-funding of the "sign-up" bonus (via future stream) and a related sort of gravitation away from a more simple pay per mile/point model is what allowed the sign-up bonuses to get so high and remain so high for so long -- despite the airlines' prices for selling points to major non-FI partners (for example hotels) didn't drop (and even trended up a bit). The airlines having been desperate for financial assistance several years ago got them to front money for the sale of huge loads of miles on the relative cheap for the FIs; but that relative cheapness is fading from the picture too, as the US airlines are now in a relatively robust position compared to a few years ago and as those bulk purchases as collateral to finance the airline are being finished off if not already finished.

That "co-funding" and the ability of the card-issuing banks to profit more from the securitization of the higher quality of the credit card receivables on these super-bonus cards (and reduced rates of these turning out into underperforming or non-performing assets) seems to have made all the difference for the banks in the low interest rate environment. As interest rates rise and as the securitization of relatively lower quality credit card receivables becomes an easier sell, the bonuses on the cards won't be increasing (let alone holding up very well) unless and until the miles/point-issuers reduce the price charged to the banks. And if the card payment system fees come under greater pressure and the payment systems' margins drop as merchant processing fees fall (if they end up falling), then the churn and MS game is going to defintiely have had its best days behind it as far as consumers are concerned.

This is why, if I were a substantial shareholder in a US airline and seeking a quick return as a relatively short term (and sleazy) investor/options-loaded airline manager, then my advice would be to seek a liquidity event for the loyalty program and then let the move toward Greenstamps be completed sometime thereafter.

zkzkz

Have you never flown Ryanair? Anyways will people continue to value your points if they can't redeem them for flights except on rare occasions?

This does not follow and it's precisely because reward prices are not pegged to ticket prices.

Miles in most programmes are earned based on distance traveled. If a TATL flight costs 50k then it means you get one free TATL flight for ever 5-6 TATL flights you fly depending on route. It doesn't matter what the ticket price is, you're getting a fixed percentage kickback rebate on that.

If you devalue reward prices then you're decreasing the percentage rebate regardless of ticket price.

sdsearch

I think GrayAnderson was only thinking of mainstream (from legacy only down to conventional LCC) airlines. Such airlines can't afford to substitute last-minute sales at giveaway prices to fill the last seats, the way a ULCC (like RyanAir or Spirit) can, because the illusion of pricing power that filling unused seats with miles gives is broken if the seats are instead filled at $1 each or whatever. A ULCC doesn't care about pricing power, a legacy and even a traditional LCC like Southwest does. So everyone except the ULCCs need a "smoke and mirrors" way to fill up the last seats, without lowering prices, and no one has figured out another way to do that "smoke and mirrors" other than through an FFP of one sort or another.

nsx

This would be correct if all miles were earned by flying. In 1988 that was very nearly the case. Now, I believe most miles are earned from partners who buy the miles from the airlines. The purchase price of those miles does not increase with inflation. It is a market price that can decrease if customers see less value in a mile or if the airline badly needs cash.

Kagehitokiri

and they want to sell more and give less >
http://www.flyertalk.com/forum/miles...u-earning.html
http://blog.wandr.me/2014/06/the-two...-award-points/
"In a recent presentation one program executive described"

GrayAnderson

@zkzkz:
-Ryanair has high load factors. I am not doubting that. Ryanair has also landed in so much regulatory hot water on and off that it's a wonder no country has come up with a way to throw them out.
-Also, the answer to that question is "how rare are we talking?" If there's reliable off-season availability (say, in Jan/Feb and Sept) that corresponds to lower load factors (and/or availability on lower-travel days of the week), then people will. If availability is limited to extreme odd-and-end legs and you can't find a round trip to save your life, not so much. The question is one of relative value.
--Corollary to the above: A lot of airlines retain availability, just not at the lowest award bucket, which is going to retain some value in and of itself. Generally, I'm seeing a trend towards buckets of "Saver", "Standard", and "Full" or something along those lines. So if there's regular availability, just at a higher cost, that's less of an issue for both sides (travelers can still get utility from their miles, albeit not as much, and the airlines can get more miles off their books without doing as much damage to customer relations).

As to award prices not being pegged to ticket prices, that is changing increasingly (though the link is not perfect and there are sometimes bonuses for buying a full-fare ticket as well). Virgin America and, I believe, Southwest are mostly or entirely based on cash spent (Southwest includes significant bonuses for not buying a low-end ticket) plus tier bonuses. VIA does much the same (Amtrak hasn't learned this trick yet, but they also only just figured out the value of letting customers choose a higher fare class on the NEC so I expect them to get there in due course), and I believe that Delta has switched over. American is likely to take their time (due to the merger).

Moreover, via their credit cards a number of airlines are behaving in a mixed manner. An Upper Class ticket on Virgin Atlantic is likely to get as many points off of the credit card as you'd get from the "mileage" side of things (if not more of them, which I think is the case on the higher buckets). From what I can tell, airlines are moving in this direction in stages since tying earning to miles traveled simply doesn't make much business sense.

@Kagehitokiri:
Nice link. I think that analysis is a bit too simplified (travel-earned miles may be a liability in some respect, but if an airline sets things up to whereby they're getting other benefits from the program through "Program Miles" then those miles have a reason to still exist; if nothing else, those miles do allow an increased level of data aggregation on their part in terms not only of customer behavior on the airline...but through partner offers as well, making what they have useful in terms of monetizing data).

nsx

The example in that presentation shows 1.5 cents per mile from third parties. That's the liability value the program carries, which should be the price the third party paid MINUS whatever portion of the cash received was booked as profit up front, right? So how did that result get so high?

GUWonder

In 2014, some large hotel chains were charged/charging around 1.75-1.9 cents per mile when funding AA/UA or DL miles credit for hotel program guests. They definitely were not acquiring these all for less than 1.5 cents per mile, although maybe one major hotel brand had a deal structure that discounted some mile purchases to slightly below that level.

Citi, Chase and Amex almost certainly paid less per mile to the US 3 airlines of relevance to their cardholders than any hotel program out there.

sdsearch

It's very complicated to figure out what Citi effectively paid for AA miles. Besides being the issuer of AA credit cards, Citi is also AA's bank. Citi thus can "pay" AA in ways other than actual money, such as by improving their banking terms. That's not possible in a "simple" relationship (where the bank simply issues the airline's credit cards, but has no other relationship with the airline).

Is Amex Delta's bank the way Citi is AA's bank? Is Chase both UA's bank and Southwest's bank the way Citi is AA's bank?

GUWonder

To figure out what will be the costs in the future is more complicated -- as it's just running estimates until it's not -- than to figure out what was paid; but these 3 large FIs have calculated their historical costs and have used that information before.

luckypierre

I am having difficulty understanding how a FF spin off would work, particularly from the side of the acquiring firm. Presumably the airline would retain control of "pricing" for seats, so if the airline chose to double the redemption price for a seat, that part of the acquisition is suddenly half as valuable?
It seems to me that in this era of rapidly devaluing programs it would be extremely difficult to establish a value for the acquisition or do any planning since managerial control of your primary resource-the FF miles-would be another party's hands.
Air Canada is the only airline to spinoff its reward program in North America, correct?