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Why Do Airline Rewards Programs Exist?

Ever wonder how airlines make money with frequent flyer rewards? Miles are a win-win for both airlines and consumers.

You may be wondering how airlines can possibly afford to be giving away “free” seats on flights. While these programs may have been costly to airlines in the beginning, the opposite is true these days. Rewards programs are a big money maker for the airlines, both from a loyalty standpoint as well as the actual sale of airline miles.

At Chatflights, we help our customers leverage the rewards market to extract the high-value travel opportunities airlines provide with their rewards programs, while the airlines are merely concerned with generating loyal customers and other revenue streams from partners.

Customer Loyalty

The classic reason rewards programs came to be is to maintain customer loyalty. The key to this loyalty is to provide personal service and to make customers feel special. Catering to loyal customers is nothing new. Your local watering hole operates on a similar principle. Once you become a “regular,” you often are greeted by name and may even get a few drinks on the house.

Once you are a loyal customer, you become a dependable source of revenue, are generally low maintenance, and often take price increases in stride. Airlines operate in a similar fashion by creating an environment where loyal customers spend more. And once loyalty reaches a certain point, airlines actually spend less marketing to a customer who is likely to fly on an airline based on loyalty alone.

Frequent Flyer Status

Airlines gauge a customer’s loyalty by segmenting them into separate tiers. Many frequent flyer programs have varying degrees of status like Silver, Gold, Platinum, MVP, etc. By signing up for an airline’s frequent flyer program, you are joining at the lowest level of status, but that still comes with a bit of recognition from the airlines.

As you fly more often and spend more money with the airline, your status evolves and the airline begins to provide better service, which can include shorter lines at the airport, free luggage, or even taking one from the old watering hole’s book and offering a free beverage onboard. Airline employees are trained to provide extra care and pay more attention to higher levels of membership, which definitely gets noticed by the customer and, therefore, they become more loyal.

Points and miles also come into play when segmenting customers. If you’re a gold-card holder with a 500,000 points balance, you’ll get some extra attention compared to someone else with 100,000 points holding the same gold card. This ensures the high-value customers keep spending and encourages other customers to increase spending in order to achieve the higher status.

How Airlines Make Money by Selling Points and Miles

More recently, rewards programs have become a cash cow for airlines. In fact, frequent flyer programs are worth even more than the airlines themselves. This was speculated for many years, but the actual numbers came out to prove this theory in 2020 when the airlines put up their rewards programs as collateral to receive loans from the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

In July 2020, American Airlines’ AAdvantage program was appraised to have a value between $19.5 – $31.5 billion, while American Airlines Group (AAL), which includes the AAdvantage program, was only valued at around $6 billion in the stock market at that time. Of course, the value of airlines was depressed due to the pandemic and it has grown in value since then. But even today, where AAL has a market cap around $14 billion, it shows that airline rewards programs are extremely valuable.

The reason for this is that there is a market for points and miles and it is growing. If you have a credit card that earns points and miles, you know that you can often earn around 3 points per dollar spent — and sometimes even up to 10 points per dollar. This is why you’ll be paying a few hundred dollars in annual fees for premium cards. Credit card companies know that you’ll be willing to pay for the ability to earn a massive amount of points and miles. And this is why airlines are able to sell their miles to banks for a high margin.

Filling Unsold Seats

It isn’t actually too expensive for airlines to give away First and Business Class seats for points. This is due to unsold inventory and the airline uses award seats to maximize its capacity. For instance, if a flight requires just 50% of its seats to be filled in order to break even, any seats sold beyond this amount carries nearly a 100% margin due to most costs associated with a flight being fixed. This means any additional passengers won’t increase the cost of the flight, it will simply be more revenue for the airline.

Airlines have become quite sophisticated in predicting which seats will sell and which seats will go empty on any particular flight. This is why the most common airline sales for cash tickets often require mid-week travel or connecting flights. For award travel, similar metrics apply and the airlines simply remove the availability of award seats on flights which tend to sell to capacity. There are definitely more complexities involved but, basically, award travel seats are very limited on flights the airlines know will sell — i.e., peak holiday travel.

Opaque Pricing for Partner Flights

Some of the best deals you can get when redeeming points and miles is to book flights operated by a partner airline. For example, say Qatar Airways knows it won’t sell X number of Business Class seats on a particular flight. Rather than drop the price of its product to a point that would devalue the brand, it simply sells those seats to partner airlines for a super cheap, undisclosed amount. This protects the brand and generates a bit of income for seats the airline knows it won’t sell otherwise.

The partner airline, say, American Airlines, then sells those seats for points and the actual price American paid Qatar for the seats remains opaque. This is a win-win for the airlines as it allows Qatar to get some money for seats that would otherwise go empty and it helps American by creating increased loyalty from its customers.

Market Value of Points and Miles

While airlines and credit card companies are tight-lipped about revealing the actual price paid to each other for points and miles, we got a small hint when United created this 47-page document in June 2020 as a means to show the value of its MileagePlus program in order to obtain financing. On page 11, it shows a chart giving an example of a partner buying 15k miles at 2 cents per mile.

When you buy something with a United card issued by Chase, you’ll earn miles and Chase will pay United for those miles. The same is true when you transfer credit card points such as American Express Membership Rewards or Chase Ultimate Rewards to airline miles. The banks are essentially buying the miles from the airline.

Of course, the airline will incur some costs when these miles are redeemed, but many miles never get used, are redeemed for low-cost items such as drinks onboard or, when actually redeemed for flights, fill seats that would otherwise go unsold. This represents quite a margin for the airlines when they sell miles to the banks.

On the other side of the coin, premium credit cards usually give you around one or two points per dollar spent, on average, depending on what you spend it on. Let’s say two points per dollar, for a generous example. Credit card companies then charge merchants around 3% for each charge, which means a $100 charge will generate $3 in revenue. The two points per dollar at a half cent per point will have only cost them $1. That represents a 200% margin for the bank which, in addition to the annual fees, make this a great business for the credit card companies as well.

Win-Win Situation

All of this may make it seem as though the consumer is somehow getting shafted. While the airlines and credit card companies surely are making money, it actually is great for consumers as well. We like to think of it as capitalism at its best. Airlines are able to offer a wide variety of travel options and it also helps create an efficient travel environment by filling empty seats. Not only does this help the cost of travel in general, but it also reduces air travel’s impact on the environment.

The dynamic nature of the award travel market means that there is a massive value to take advantage of if you know how to work the system. At Chatflights, it’s what we love doing day in and day out and we’re always around to help find those elusive award seats when needed.

About Chatflights

Chatflights is a mobile, human-powered digital concierge and award flight travel agency focused on helping travelers redeem their hard-earned points and miles for flights. For up to 8x fewer points and miles, Chatflights will search for hard-to-find award redemptions and complex routes, diligently working to make sure the best possible travel outcome is found.

Taking the stress and insecurity out of flight booking, Chatflights invites its users to communicate one-on-one with human experts via a chat-based service located right in the app, and then remains available to help if anything is needed leading up to, and throughout the course of the trip. It’s as simple as sending a text. Mention “Ageist” in the chat to receive a 10% discount with Chatflights.

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Peter Thornton
Peter Thorntonhttp://chatflights.com
Peter Thornton is a travel and content manager for Chatflights. He has covered the airline industry for over 15 years and is always looking for new ways to score a flight deal. When he’s not helping clients book flight redemptions, you’ll find him exploring the great outdoors.

 

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