Siamese Dream: The fantasy of separating the inseparable


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Let’s just state right up front that what I know about running an airline could fit comfortably in a thimble. But since I have made a career of studying customer loyalty programs and their effect on the bottom line, I had to scratch my head at the quote from Doug Parker, CEO of US Airways Group Inc., in the March 25 National Post. The Post quoted Mr. Parker as saying that frequent-flyer programs hurt the industry because carriers give away too many free trips.
“There is no business that has a loyalty program even close to what the airlines have,” Mr. Parker told the Post. “The amount of our product we give away is not consistent with generating returns for shareholders and providing stability for employees.”
Now, again, far be it from me to tell Mr. Parker how to run his business, and if he says that the US Airways Dividend Miles program is hurting his bottom line, then who am I to disagree? So when I ask questions, I’m asking only in the hope that someone will school me on the economics of frequent-flyer programs, because there must be gaps in my knowledge.
For example, one of the primary principles of loyalty marketing is the concept of perishable inventory. If an airplane takes off with an empty seat, then that inventory—in this case, a seat that might otherwise have gone to a paying customer—is lost forever. So rather than leave the seat empty, why not give it to a high-value flyer as a reward for his loyalty? The only extra costs you incur are the extra fuel associated with getting that passenger and his luggage off the ground, plus the wholesale price of a bag of peanuts and a Diet Coke. In order for frequent-flyer economics to work, you have to balance the value of the passengers to whom you’re awarding free flights against the number of potential empty seats on your planes.
So maybe if US Airways is able to fill every seat on every plane with a paying customer, then the loyalty program would certainly have outlived its usefulness. But then again, from what I hear, ending the program at a hard stop would leave an awful lot of revenue on the table. I’ve talked to several airline executives who admit that they make more money selling airline miles to partners than they do flying planes. In some cases, mileage revenue may be the only real money an airline makes.
At last year’s Frequent Travel Marketing Association (FTMA) conference, for example, Robert Sahadevan of United Airlines revealed in a panel discussion that only 37 percent of the miles issued within Mileage Plus are for United Airline ticket purchases. An astounding 43 percent of all miles are issued and sold to third parties such as credit card partners, hotel partners and others. That kind of cash flow has led to conjectures that frequent-flyer programs may be more valuable as separate companies. Market analysts estimate the valuation of a program like Mileage Plus at nearly $5 billion.
With that kind of cabbage on the table, maybe Mr. Parker could unburden US Airways of Dividend Miles by spinning it off. There’s only one problem—those same analysts also contend that such a spin-off in the U.S. would simply hasten the bankruptcy of the airline, since the loyalty programs are the only profitable portion of airline business. And without an operating airline to carry redeeming passengers, the value of the separate frequent-flyer program would be rendered worthless.
“Just the tax implications of a frequent-flyer program spin-off put a damper on investor excitement,” said Rick Schifter of TPG Capital during the same panel discussion. “The flight operations and frequent traveler businesses are symbiotic and—at least for now—they avoid a big tax liability due to continuing losses in the airlines operation part of the business.”
That’s the rub, isn’t it? As much as certain airline executives might like to time-travel back to 1981 and prevent American Airlines from launching the AAdvantage program in the first place, the truth is that the loyalty program has become the airlines’ primary business model. Modern frequent-flyer mileage programs are essentially regional coalitions owned by carriers. The airline and the loyalty program are conjoined twins, sharing a heart and circulatory system. You might be able to separate them, but the surgery would be risky, and one or both of the twins might not survive. I may not know anything about running an airline, but I do know that it’s usually not wise to mess with a good thing.


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