Miles ahead: How to improve airline customer-loyalty programs Without a new approach, airline loyalty programs risk alienating many customers. Steve Saxon and Thorsten Spickenreuther SEPTEMBER 2018 • TRAVEL, TRANSPORT & LOGISTICS © Mardis Coers/Getty Images Since American Airlines created the industry’s 30 trillion frequent-flier miles are currently sitting first successful1 customer-loyalty program, in unspent in accounts. That was enough to let almost 1981, almost every carrier has followed suit. These every airline passenger in the world redeem miles programs are hugely important: they encourage for a free one-way flight in 2017—if miles could be customers to fly an airline that otherwise might not redeemed for trips without restrictions. be their best choice for a trip. And over time, airlines have learned that frequent-flier miles from such In fact, outstanding balances of miles are becoming programs are a valuable, aspirational currency they much harder to redeem, so programs created can sell to third parties. to make customers more loyal actually risk alienating them. In this article, we’ll show how The result has been a boom in the number of airlines have begun to rethink the way they handle miles—which has not, however, been balanced by redemptions and suggest some ideas on how a similar increase in the number of seats that can they could reengage customers by broadening be redeemed for them. We estimate that more than redemptions further. Successful airline loyalty programs generate redeem a first-class ticket that costs $10,000—a lots of miles payback of 50 percent! Airline customers like miles. Research shows that for certain business travelers, earning them may be As we have already noted, airlines realize that selling the most important decision factor of all.2 At any miles can not only make their passengers more loyal rate, many business travelers see collecting miles but also generate lucrative income streams in its as a perk of the job. Stories abound of them going own right. Airlines are therefore selling more miles out of their way to fly with this or that carrier to to third parties: in 2015, for example, American sold earn enough miles to reach its next status tier or 58 percent of all its miles to them,3 and in 2016 more to redeem their miles for a dream vacation. than one-third of Australia’s credit-card spending earned Qantas miles.4 Bloomberg has suggested that The ability to save up miles for such trips is the some airlines might make more money in this way reason many customers enroll in customer-loyalty than from the core business of selling tickets.5 programs in the first place. Eighty percent of all miles are redeemed for flights. (In many programs, There are fewer options to redeem miles they can also be redeemed for hotel stays, car Among US legacy carriers, the share of travel rentals, and consumer products.) In a classic obtained with miles has been falling for the past program, 20 round-trip economy-class flights from ten years (Exhibit 1).6 As the sheer number of miles Europe to North America, at a total cost of around outstanding increases, carriers have clamped down $20,000, can earn a passenger enough miles to on the availability of redemptions, which make much 2 Miles ahead: How to improve airline customer-loyalty programs less money for them than paying passengers do. fly empty. To use industry lingo, carriers try to For many carriers, a typical mile may have an avoid “displacement.” This approach worked well internal cost of around one-half cent.7 Although when redemptions were relatively simple to manage: internal valuations differ, some airlines may passengers got seats that would otherwise probably recognize as revenue just $500 dollars for a London– have remained empty—as many did during and just New York business-class return redemption flight after the financial crisis, when the level of business that2018 costs 100,000 miles. The typical ticket price is travel plunged. But as the number of miles soars, $6,000Miles orahead: more. How to improve airline customer-loyaltybalancing programs them with redemptions becomes much Exhibit 1 of 4 harder. In our experience, 20 percent of redemptions Redemptions are good value for airlines if no paying end up on flights that take off full.8 Airlines could customer is available for a seat that would otherwise probably have sold those seats for real money. Exhibit 1 During the past ten years, the share of award flights has declined. Award flights as share of revenue passenger miles,1 % 10 –2 pp2 8 6 4 2 0 2008 2017 1 Weighted average. 2 Percentage points. Source: US SEC filings (10-K forms) of US legacy carriers 2008–17 Miles ahead: How to improve airline customer-loyalty programs 3 This problem is all the worse because flights are now redemptions through partner programs. Almost generally fuller than they used to be: the average every airline has gradually increased the number of load factor across all airlines has increased from miles needed to redeem a seat. For all these reasons, around 55 percent in 1970 to more than 81 percent their worth to customers is falling, as the regular today (Exhibit 2). Improved pricing and inventory- valuations on two major frequent-traveler blogs 9 control2018 systems fill up flights by exploiting powerful show (Exhibit 3). computersMiles ahead: and advanced How to analytics.improve Thatairline explains customer-loyalty programs whyExhibit some 2 carriers of 4 have made redemptions harder While it is difficult to get like-for-like data on to get—for example, by introducing additional the availability of redemptions, research suggests fees, tightening stopover rules, and restricting that availability has declined over time (Exhibit 4).10 Exhibit 2 Airlines’ average load factor has increased from around 55 percent in 1970 to more than 81 percent today. Passenger load factor, % 100 80 +26 pp1 60 40 20 0 1970 1980 1990 2000 2010 1 Percentage points. Source: ICAO 4 Miles ahead: How to improve airline customer-loyalty programs 2018 Miles ahead: How to improve airline customer-loyalty programs Exhibit 3 of 4 Exhibit 3 Two major frequent-traveler blogs show that the valuation of miles is falling. Valuation of miles 2014–17, US cents average1 1.6 1.2 Gary Leff, Brian Kelly, View from the Wing The Points Guy 0.8 0.4 0 2014 2017 2014 2017 1 Set of 5 carriers. Source: Brian Kelly, “Points valuations,” year-end values, 2014–17, The Points Guy; Gary Le­, ”How much are miles really worth?,” 2014–17, View from the Wing Loyalty programs must innovate for value But to make customers more engaged and satisfied, Airlines have begun to address the problem. airlines should also rethink redemptions. Although Most begin by changing accruals. Classic airline many airlines have started down this route, more loyalty programs based the number of miles innovation is needed to ensure that their loyalty customers received on the distance they flew: programs regain the customers’ affections. We have someone with a cheap economy-class ticket would a few ideas. get the same number of miles as a late-booking corporate traveler who paid a good deal more. 1. Go beyond airline seats Airlines are now rightly moving away from this Redemptions can be great value for customers, since miles-flown approach and toward awarding points airlines are willing to accept a low price for seats that more closely matching the price of a ticket. would otherwise go unsold. To use economists’ lingo, Miles ahead: How to improve airline customer-loyalty programs 5 2018 Miles ahead: How to improve airline customer-loyalty programs Exhibit 4 of 4 Exhibit 4 Over time, the availability of seats for redemption has declined. Availability of redemptions,1 % 100 80 –8 pp2 60 40 20 0 2012 2018 1 Set of 25 carriers. 2 Percentage points. Source: McKinsey analysis there is a large gap between the perceived value of a relationships to redeem miles for hotel rooms, seat and the marginal cost to deliver it. Airlines need but the number of miles needed is high, since to find redemption categories that have distressed the airline typically pays something close to a inventory and a similar gap. standard rate. Airlines should work with hotels or hotel intermediaries to give passengers access Hotels are an ideal source of distressed to great rates by focusing on distressed inventory. inventory: when they have empty rooms, they will accept a price close to the marginal cost, so Luxury-goods firms, especially newer ones long as the actual price paid is opaque to the looking to enter the market, can be appropriate consumer. Opening up redemptions for miles partners, since they have very high margins and is an ideal solution. Some airlines already have want to maintain price integrity. 6 Miles ahead: How to improve airline customer-loyalty programs Concert tickets and restaurants are excellent if a flight has empty seats, so that redemptions choices. For most concerts, certain dates pose no risk of displacing paying passengers. and times are less popular than others. Once Airlines can therefore offer immediate cabin a concert ends, the ticket is worthless, so upgrades for miles, perhaps at a discount to any undersold event meets our definition of the number typically required for upgrades. distressed inventory. Similarly, at off-peak times, More airlines should offer miles upgrades in restaurant owners will accept promotional their online check-in flow, at kiosks, and on bookings at prices close to the marginal cost the mobile app. Check-in staff could prompt (the Groupon model). Airlines should build passengers: “I can upgrade today’s flight to partnerships that give them access to these business class at a discount, for only 20,000 miles distressed opportunities.