Nobel laureate Milton Friedman is the father of an economic school of thought known as Monetarism. Uncle Milton, as he is affectionately known, showed the world that inflation is a monetary phenomenon -- increase the supply of money in the economy, and the general price level will rise.

The famous and deceptively simple formulation of this is: mv = pq

m = quantity of money
v = the speed at which money circulates in the economy
p = general price level
q = quantity of goods

Friedman argued that the speed at which money circulates is, generally speaking, constant. Folks plan over time for their spending needs. On the whole, if people get paid on Friday they don't spend all their money on Saturday but spread the spending out until their next payday. (Obviously this isn't universally true, but on a macro level it winds up being true.)

The upshot of this famous formulation is that when m goes up, p or q needs to go up. If the quantity of goods remains constant (q), that means that p (price) must rise and you have inflation.

I think that this simple formulation is helpful in thinking about loyalty programs.

If m = miles, v = the speed at which folks redeem awards, p = the price of awards, and q = the supply of available award seats, then...

Sometimes the speed at which awards are redeemed goes up. For instance, when loyalty program members are uncertain about the future of their points. There is a common belief that when United declared bankruptcy, there was a 'run on awards' -- people believing that they needed to cash in now while the airline and the loyalty program was still around.

But on the whole, the fact that 8% or so of seats go to award redemption (over time and across programs) suggests that v is usually stable.

That means that if m -- the quantity of miles or points -- goes up, then one of two things has to happen:

Either the quantity of award seats have to become more available, or the price of awards has to go up. Otherwise there will be a shortage.

As unhappy as members get about award price increases, just imagine the unrest (or go over to the Continental forum. ) members will feel if the general sense is that awards are impossible to redeem.

And since it's so much easier to accumulate miles than at any time in the past -- as programs sell miles to all comers, and miles have become such a popular phenomenon and useful marketing tool -- the quantity of miles is ever increasing. It's profitable to the airlines to sell miles.

That means one of two things happens:

* The quantity of award seats goes up
* The price of awards goes up

Randy notes that more awards are being redeemed than ever before. And he says that means that programs are doing a consistently better job of satisfying their members. (I hope I'm not oversimplifying or mischaracterizing here.)

Respectfully, I disagree. There are several reasons why:

* An equally plausible (more plausible?) explanation for increasing redemption is that the quantity of seats is remaining more or less the same but a greater percentage of those seats are being redeemed. That just means there's less slack in the system. So even though the number of redemptions goes up, it's still true that it's increasingly hard to redeem. And increased redemptions doesn't mean substantially increased seats allocated for awards. And at the very least, I don't think anyone would claim that the pace in growth in award seats is keeping up with the pace in growth in available mileage.

* Overall statistics about award redemption don't say much about the kinds of awards being redeemed. Domestic coach or international business class, for instance? Popular or unpopular routes? Double-priced or capacity controlled awards?

* Even if the percentage of seats is stable or growing, the supply of total seats has gotten smaller over the past couple of years.

And if I'm right that award seats aren't keeping pace with the supply of miles in the frequent flyer community, that means something has to give. It means that prices have to go up.

I hate it. You probably hate it, too. It means that our hard-earned mileage balances will become worth less. It's the same thing that happens to money savings under inflation. It's also why I don't like the idea of stashing away miles for retirement. I'd rather use my miles now and save money, putting the money away for retirement -- because I have greater faith in the Federal Reserve to control inflation than I have in the airlines to control point inflation.

But I still believe that it is inevitable.

Delta just announced that it is increasing the amount of miles required on many of its awards.

For instance, coach awards from the continental US to Hawaii go up from 30,000 miles to 35,000 miles. Business class from the US to Japan goes from 90,000 miles to 120,000 miles. Business class flights within Europe go up from 30,000 miles to 45,000 miles.

The website proclaims I've searched through every region chart and have not found a single award with reduced mileage requirements, however. On the plus side, I note a new previously non-existent award... Europe to India in First Class. That's the [i]only[/] new award that I've found so far.

Of course, BA's redemption increases are legendary of late.

It's coming and it will spread to your carrier too. I always agreed with Randy that there wasn't a need to burn miles because of United's bankruptcy or USAirways' bankruptcy per se. But financially troubled carriers award miles (soft currency) to attract money (hard currency). And having done so, they increase the price of their awards shortly thereafter. And since I see no sign of this trend letting up, I believe fervently in living for today in terms of award redemption.

I'm not saying that we should all burn our miles with abandon. But I am saying that the best way to enjoy these programs and capitalize on their superior value propositions is to redeem miles as you earn miles. Waiting simply means that past earnings will buy less in the future.

That is, until we get an independent central mileage bank. And until we install Paul Volker, Alan Greenspan, or Joe Brancatelli as Chairman.

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View from the Wing: A blog about Free Miles and Free Markets

Two questions for monetarists:
1. I thought the monetary experiments from the 80's failed?
2. I've read that some experiments showed that increasing the money supply did in fact change the velocity of money?

Anyway, that's beside the point.

I do think monetarism does provide an interesting framework for discussion for frequent flyer miles.

I'm going to make some simplifying assumptions for the illustrations below:
1. All flights are 1000 miles each way.
2. The value award is 25,000 miles for a round trip ticket.
3. There is only a value award.
4. There are no elite frequent flyer bonuses.

So, it takes 25,000 / 2,000 round trips in order to get a free ticket. This is 12.5 round trips before you get to take a free one. This means that one out of every 13.5 round trip passengers is travelling free. That is 7.4% of seats being filled by award travel.

Let's see how this system reacts to changes:
1. Increase capacity: More people fly, more miles earned, more seats available for award travel. No change to the equation.
2. Award miles for car and hotel partners and credit cards: More points sold to partners. Either more seats must go to award travel or miles start building up on the books. At the one cent per mile charged to the miles-issuing partner, the round trip ticket nets $250 in revenue to the airline. Partner points seem to net a low yield traveller.

I'm running out of steam here, but I suspect that you won't see big devaluations of the program, but rather added mediocre redemption opportunities as well as slowdown in the velocity of redemption during cash crunches.

At the risk of going OMNI, I'd say this is a claim without a warrant. The early 1980s saw a significant contraction of the money supply, and a reduction in both p and q (longterm reduction in p, or inflation, and shortterm reduction in q in the form of a recession).

I'd say the decade of the 90s suggested that m could grow quickly as q grew as well (productivity growth allowed for low interest rates without inflation).

Permanent income hypothesis, lifetime income hypothesis, all that intermediate macro stuff... doesn't change the frequent flyer miles calculation one bit. I suggested above that the velocity of award redemption does change as expectations about the viability of a program change (we may have seen a run on the bank at United a year or so ago as FFers saw risk of Chapter 7).

In fact, if anything the velocity of award redemption might rise which will only intensify the effect I was describing above. If either v (propensity to redeem awards) or m (amount of mileage out there) rises, then you either need more awards (increase q) or you need the price of awards to go up to offset (increase p).

[/b]If indeed increased capacity yields greater travel. I just don't think the link is linear. In fact, increased capacity probably has a lag in traffic, meaning more seats available for awards (increase q) which should create some slack in the system and stave off price increases. If the airlines are growing, we may not need to worry so much about increasd p.

Nevertheless, the form of growth matters. More one-class RJs limits redemption possibilities. It shifts availability to domestic coach and away from international business. That means that we might see stable saver Y awards and price increases in international J awards. And in fact that may well be what we do see.

This is my point exactly. Without more seats to award travel (unlikely without more capacity), miles 'build up on the books' and travelers become frustrated.. award seats have to get rationed... price of awards goes up. You've described the scenario, and part of what is driving the scenario to a tee.

And your simplifying assumptions said no bonus miles, etc. But bonus promotions are one of the things I identified as driving the price increases.

Added non-travel redemption opportunities are one way to reduce the pressure on awards. And you're probably right that programs are going to need to offer these.

But the 'slowdown in the velocity of redemption' is problematic. Surely you don't think that travelers are going to want to redeem awards less? That means 'slowdown in the velocity of redemption' isn't a reduction in v at all... it's a reduction in q, and frustrated travelers aren't able to redeem seats. Once again the reason why prices of awards will go up.

In fact, airline cash crunches may even coincide with a greater desire to claim awards. If airline cash crunches coincide with reductions in economic growth and household income, households may prefer to redeem mileage rather than spend money on travel. Just when the airlines need revenue most, passengers opt to claim awards. So V could even increase rather than decrease... but this is purely conjecture and would an interesting subject for empirical research.

I was re-reading the article "The Future is Now: Secrets to making your miles and points last long into retirement" from 8/03 Inside Flyer. The article discusses planning for travel in your retirement and reasons to conserve your miles and points for retirement travel. The basic flaw I saw in the article was, IMHO, the premise that awards will only increase by 15% over the next ten years.

In the past year BA awards increased 200-300% for many business and First class awards. Hilton awards increased 50% for GLON 6 night stays.

I think the earning opportunities are so extensive that mileage award levels will increase dramatically in the next few years. Mileage may not keep pace with rate increases in prescription medicines, but I won't be surprised to see double digit percentage increases for most airline awards in the next two years.

I don't think that mv = pq governs FF programs. In real life, if you don't like what your money can buy, there's not much you can do about it except look for a better paying job or try to spend less. But you really can't drop out of the economy altogether (unless you don't mind being homeless).

In the FF economy, if people think the price (redemption) levels are getting too high, a big chunk of the FF mileage earners can drop out of the FF economy completely - the credit card people. You just get a credit card with a different, and one that's more valuable, perk (like a cash rebate card).

But the airlines can't afford for that to happen - they make too much money selling miles. There's a balancing act here - trying to get the most miles they can for awards while not alienating the credit card people that spend them. I really don't think the airlines care much about how people who get their miles from flying are affected by increased award levels, because as long as their award levels are competitive with other airlines, people will continue to fly because they have to (I'm assuming that revenue from mileage runners is insignificant to them).

In my opinion, supply and demand factors that govern credit card users and FF miles sales to the credit card companies are the real determinant for future award levels.

BTW, As I said in my previous post, I think monetarism does provide an interesting framework for analysis.

I a big problem with the framework is that FF miles are not a free market. If it were, prices for award tickets would go up, then redemption partners would enter the market and the system would stabilize.

OTOH, at some airlines the system is being manipulated more like a Soviet-style planned economy. Prices are kept artificially low and supply is kept well below demand. Travelers are forced into redeeming less attractive rewards - say CLE-IAH in coach (the FF equivalent of black bread and cheap vodka).

One thing that travelers have going for them is that airlines do want to continue to sell miles to issuing partners like car rental agencies, hotels, and credit card issuers. We're already seeing that Starwood and Hilton have become the preferred affinity cards.

Hmmm...I saw the title and thought first of Ravi Batra, but I guess Friedman is right in there, too.

Randy's a real optimist and I think that's great. I hope he's right. But, then again, as a veteran of all this Continental stuff and watching the return leg of "worst to first" (at least as it related to OnePass for low- and mixed-rev flyers), I'd have to generally side with the pessimists.

I think you've got an awful lot of baby boomers out there sitting on large mileage balances with the hope of using them in retirement. That will start to go gangbusters in 2011, but for people who can swing it at 62, more like 2008. And of course many will manage it earlier. That'll boost demand quite a lot.

There's also the oft-mentioned situation with huge numbers of miles being sold for non-flight activity. Have posted about this before, but at some point it'll look less and less like the airlines are selling something of value with those and more and more like they're selling something akin to lottery tickets.

Award-cost increases might well be an early response to try to get things back in "balance," though airlines should take a deserved hit in perceived worth of promotions tied to miles.

Without all the miles sold for non-flight activity, the system looks much more sustainable into the future than it does with all the new miles being minted and sold.

I guess the best-case scenario I can see is if competition is strong and airlines add a lot of long-haul capacity with planes like the double-decker Airbus.

The Economist magazine had an article about a year ago making a remarkable similar analysis and prediction on the future of ff miles.

Would love a link?

Thanks!
Gary

I'm not positive that the number of miles required for an award will go up during the remainder of my lifetime, but I am absolutely sure that they won't get any cheaper.

Buy things that appreciate, lease that which depreciates, and spend right now what the issuer reserves the right to cancel with six months notice (like airline miles).

I, for one, have always taken this to be some very large number, but I have never seen any actual numbers. I've looked through the AMR 10-K - nothing. Does anyone have an authoritative reference to such a number?

I did find something in the AMR 10-K which I thought was interesting. For some reason, I was always under the impression that airlines booked sales of FF miles at whatever the sell price was. Not so with AMR:

"Revenue earned from selling AAdvantage miles... is recognized in two components. The first component represents the revenue for air transportation sold and is valued at current market rates. This revenue is deferred and recognized over the period the mileage is expected to be used, which is currently estimated to be 28 months. The second revenue component, representing the marketing products sold, and administrative costs associated with operating the AAdvantage program, is recognized immediately."

Can anyone put this into plain English?

I would also like to see the Economist link.

It's only 4 round trips to earn an unrestricted freebie on Southwest. Does this mean that WN will devalue sooner than other airlines?

Randy says up to 40%:
http://www.bizjournals.com/dallas/st...10/story2.html
This is pretty interesting. Accountants like to recognize revenue in some relationship to the costs of fulfilling the purchase. Let's suppose that in 2003 AAdvantage sells $550MM in miles to partners and has administrative and marketing costs of 70MM. Accounting allows 50MM of revenue to be recognized immediately to cover the marketing and administrative costs of the program. $480MM remains to be recognized over the next 28 months - the average lifespan of an AAdvantage mile. Since miles are actually sold continuously, we'll suppose that $40MM in miles are sold every month. The 40MM in January 2003 miles will contribute 40MM / 28 * 12 = 17MM to 2003 revenue. The 40MM in February 2003 miles will contribute 40MM / 28 * 11 = 16MM to 2003 revenue. Note that miles sold in 2002, 2001, and even part of 2000 contribute to revenue in 2003. Note also that if sales of miles has been and remains constant, reconized revenue will be $550MM, the same as sales for 2003 of $550MM.

The accounting practice is the same in newspaper and magazine sales where revenue can only be recognized over the course of the subscription period rather than all at once at the time of the sale.

I believe that deferred sales ends up on the books as an asset. It is also interesting to note that elsewhere in the 10-K is a statement that AMR accrues liabilities for frequent flyer miles issued at the cost per passenger.

For the monetarist analysis, it is interesting to note that the velocity of FF miles is estimated to be 28 months. Perhaps more interesting is that the velocity of FF miles drives AMR's ability to recognize revenue. That is, the higher the velocity of money, the faster they can recognize the revenue associated with FF mile sales to partners. In theory, if they reduce redemption availability and FF miles start building up in the system, the accountants will want to extend the recognition period for recognizing revenue from FF sales to partners.

[This message has been edited by lensman (edited 10-12-2003).]

Agree with original poster that its a dubious tactic to hold onto you miles, especially into retirement. With all due respect to Randy for his work in this "industry" and providing this forum, I do believe his objectivity is affected by the advertising he receives from the majors. (I mean, he doesn't even have an Airtran forum, presumably out of deference to DL.)

FWAA makes an interesting point about the cost of obtaining miles is likely to go up. While I agree that fares are about as low as they can go, I think redemption cost increases will exceed the cost of earning miles. I now get miles from my drycleaner - DL is printing miles faster than they can be redeemed. Not only will redemption levels increase, but competition to redeem the few available awards will increase. So while I agree with his point, its overshadowed by others.

The language in the 10-K in plain English is shady accounting. If an airline accounted on a cash basis, it would recognize the income from the sale of miles on the day they are sold. However, under accrual accounting you try to match revenues with expenses. So the airline recieves $550m for the miles, but it records a liability of only a fraction of that. The last thing the airline wants to do is record the miles on their books at two cents a mile. So they make all these assumptions. Apparently, the same assumptions have to be made with respect to the revenues from the sale of miles. Either that, or they wish to defer the revenue out into the future for some reason.

If you really want to scare yourself, look in the footnotes of the 10-K and try to determine 2 facts: the number of miles outstainding and the dollar cost at which that liability is shown on the books. Divide the latter by the former and you will get the value per mile that the airline records the liability. For example, at DAL, they won't disclose the number of outstanding miles. Instead, they make certain assumptions, such as a large number of PAX will never get enough miles to redeem an award (a questionable assumption with mileage credit cards, iDine, etc.). After making a host of assumptions, DL states that they estimate that 10,000,000 flights will be redeemed. Who knows how many SkyMiles are really outstanding? Anyway, they record a liability of $228 million for these 10 million flights, of $22.80 per flight! If you assume 25,000 miles per flight, that works out to 1100 miles for a dollar! Now, I understand how financial statements are put together and what the airlines' managers are trying to accoplish. But from a creditor's perspective, you have to realize that the airlines are purposefully trying to hide the number of miles outstanding and the "cost" of such miles.

I find it amazing how most of us don't trust the airlines when they say our equipment is delayed due to [insert excuse] but some of us are willing to keep our miles into retirement. I'm not so trusting.

I don't think it's as much cost as that they are, indeed, trying to show the reasonable liability of the outstanding miles. Especially in this age of Sarbanes-Oxley, I don't think you are going to find much chicanery -- especially at a time when it would have been fairly "okay" to factor miles in as a huge loss (since the rest of the financials were in the toilet).

It does reveal the significant profits realized from the frequent flyer programs, though.

I must agree with the original post -- holding onto miles is foolish when they can be so quickly devalued.

Steve