Why are unused ff miles a problem for the airlines?
 

There have been several stories lately about how all of the accumulated ff miles are a problem for the airlines. I don't get it. I don't believe that it's because they're a liability, because the airlines aren't really liable for much. For the true frequent flier, ff miles (and other elite benefits) amount to a discount from the list prices otherwise paid and I think that the cost of giving discounts through these programs is lower than giving them directly. For the leisure flier, ff miles displace some revenues since some award trips would have been revenue trips (but at low fares), but they are mostly giving away seats that would otherwise go unsold. Also, the airlines could devalue the ff miles at will.

The airlines' ability to create and sell ff miles to partners who award them to their customers is a major revenue source. The popularity of ff mile incentives makes the airlines' ability to sell miles something akin to printing money, which is a pretty profitable business.

So, why might the airlines be "troubled" by all of the miles? Is this just another case of reporters not understanding the story and being led around? Any thoughts?

I agree with your observation that miles are exchanged for seats that would otherwise go unsold. for example, good luck in securing an award seat to the Caribbean around Christmas time. I am not even sure a Rule Buster award would be available (i guess it would if you wanted to pay double miles).

Also, I can't even think of an instance whereby I was on an award ticket and the flight needed volunteers.

Maybe it's just a matter of dressing up their balance sheets. Outstanding mileage has to be accounted for as a liability, which affects the equity:debt ratio. That's one of the factors on which an airline's health/viability is judged.

I agree with you that the capacity controls reduce the possibility of one having a FF award ticket on an overbooked flight but on the other hand with blackout dates now eliminated from many programs I think award tickets will get denied boarding compensation more often.
I just booked an award ticket ORD-DFW-YVR leaving Thankgiving Wednesday at about 5 pm and returning Suday about 4 pm. These flights will likely be overbooked by the time Thanksgiving comes around. And if my plans change I will just change my award ticket to a later trip.

The way the airlines account for frequent flier awards raises some questions. For a long time, they maintained that since they could satisfy the liability with otherwise unused seats, they had no marginal cost and therefore had no need to accrue a liability.

Now, as an example, United accrues a liability based only on the marginal cost of servicing the non-rev passenger; i.e., mostly food and the cost of the paperwork. No overhead is included (which I think tends to make the liability understated as some overhead costs are not completely fixed). In their '01 10-k filing (for '00) they say they had 10.8 million eligible awards floating around out there and they estimated that 8.9 million would be redeemed. They accrued a liability of $564 million, or about $63 per estimated redemption.

The problem with this accounting is that they only accrue when you've reached the award level. Let's say they accrue a liability when you hit 25,000 miles (I have no idea how the actual trigger works). No accrual for many flights then, bang, $63 accrual after the magic flight at which you hit 25,000 miles. That's not right, because you have been earning the miles as you fly, yet they report the total amount of your past tickets as revenue.

Really, some of your past ticket revenue should be accrued as a liability and not reported as revenue, in my opinion. For example: You have just signed up for Milege Plus and then you make a 10,000 mile flight for which you pay $2,000. [10,000 / 25,000] x $63 or about $25 should be a liability and not revenue. Of course, they should adjust this for the probability that you never reach 25,000 miles. They have the information available to do all of this, but they still don't do it.

JD

It's generally thought of something written on a "slow newsday" on a subject that is somewhat topical. As Enron, Andersen and all that crap have been a hot topic, as have been the trials and travails of the airline industry post 9/11, why not scaremonger and combine the two.

The Economist article which started it all (I count at least 6 articles by "serious" publications since it was published)was not a very complete piece of journalism. The actual fact is that if the airlines are making some provisions for the miles, they are more than adequately covered. Furthermore they control the inventory, and make money from selling miles. Lastly a very very high percentage of miles are NEVER used, or are used so badly that it doesn't matter in the least.

How much of a liability can it be when the airlines can decide if they are ever going to honor it? Further, they can simply restate its value by redetermining award levels.

Generally speaking, this is a liability that should not be factored in when reviewing the Balance Sheet. However, the encompassing characteristics of the reward program can reflect on future profitability.

In the end, it is an extremely subjective measurement which can be a problematic issue in some financial statements. I personally put more weight on cash flow from operations and their profit/loss.

hfly wrote:
Any idea what percentage? Source(s)?

And what is the (your) definition of a mile "used badly"?

United estimates that 8.9 / 10.8 = 82.4% of the miles ARE used.

That's probably an overstatement, since they're not counting any orphaned miles (miles in accounts which have not reached
the magic 25k number. There are probably quite a few accounts like that belonging to the once/year flyer population...

Dan

As far as unused, never used miles go, I do not know the percentage, but I am sure that Randy has an idea of what the percentage is.

I personally probably have 50,000- 70,000 miles in a variety of programmes that I have either lost, forgotten about, or will never use (Included in these are TWA, AA, UA, US, AF, VS, QF, TK and several others), and I fly a hell of a lot (for the record, I do still fly some of the above carriers, due to alliances I generally "sweep" all the miles in an alliance into one account -- which is generally not one of the above). Using this example, and I fly a hell of a lot, I know tons of people that "scrimp and save" their miles for YEARS in order to get a reward. Either that, or their miles are so spread out that they never gain anything of substance. As someone pointed out above, 24,999 miles is not a liability towards anything when the cheapest seat is 25,000 miles.

Also, many many people do NOT realize that miles can be transferred/willed etc upon death and many miles "die" with their miles holders. I personally have told many people with dead spouses etc this was possible and they have sometimes been successful. The general public is very misinformed on this point.

Furthermore, many people do not fly that often, lose details open multiple accounts, forget about old accounts etc. This also reduces the overall liability.

As to stupidly spend miles, this is done all the time. A kid that works in my office spent his "hard earned miles" on a flight that he could have gotten for $89 had he purchased the SAME flight over the net. Hell, post 9/11 I had to stop my mother from spending 50,000 for a RT to Europe that she could buy for $299 RT. When the general public gets into their mind that they want to USE the miles they have been SAVING, they often spend them very stupidly.

Yeah, good point. The 10-k is a bit ambiguous but it does appear that their fraction only pertains to miles that have hit the magic level. But, I'm not sure that 25k is the magic level. They don't say. I just guessed that they don't accrue for upgrade awards, but maybe they do since the food and beverage costs would be higher.

JD

Even a very few miles can have some value. The orphaned miles of many programs can be moved to Hilton Hhonors, and if a person doesn't want Hhonors points, the miles can always be used for magazine subscriptions.

The magazine subscriptions cost the airlines NO MONEy in reality. It allows the mags to increase their "PAID" readership which allows them to raise ad rates. I am sure that a provision is made for this cost but it really is nothing.

And yes, you can launder miles through Hilton, I know all about how to do it and am quite mile savvy, but have really never had the time, or could be bothered to do it. What percentage of orphan miles do you think the average not very frequent flier launders through Hilton?? .0000000001% maybe??

I recently was able to talk to the person from a company that offered a very targeted promotion for bonus miles with one of the big three airlines (friend of a friend met at a party). This was a targeted promo which did get some exposure on FT. How many people took part in it??? How many people did they think would "take part" in it based on their mail shot numbers (which I do not know).......17-20,000. How many took part and registered in reality?????......LESS THAN 3,000. Of those how many that registered were NOT targetted (maybe they got the info from friends, maybe from FT) 700.

Draw from this what you will.

This is not entirely correct any more as almost all the airlines have made miles non-expiring and allow people to "top off" their account by buying a set amount or % to reach an award.

I find it extremely hard to believe that any airline does a sweep of accounts and bases its liability on how many accounts have more than X miles in them. One, it would be a major hassle, and two, it does not truly cover the liability issue based on the comments made above by other folks.

Going back to the original question, I thought the liability was created when the airlines awarded the miles (or sold them through partners) but did not account for the future cost of redemption. As the miles accrued, the potential liability became so great (in the eyes of the accounting groups) that the airlines were forced to create an offset on their balance sheet.