Revenue Based Airline Award Redemptions

Last week Delta dropped a bombshell by announcing that in 2015 they’ll start awarding SkyMiles based on the amount a ticket costs vs. the number of miles flown.

This is a development a lot of us feared, and is perhaps the logical follow up to their decision last year to institute revenue requirements for SkyMiles Medallion status (which can easily be waived by spending $25,000 on one of their co-branded credit cards).

My writing style on this blog is generally very “stream of consciousness,” so I’ve been struggling to write a blog post about what I consider to be the “big picture” implications of this. Will other airlines match? What does this mean for mileage redemptions? Will this impact people earning miles primarily through non-flying activities?

And I’ve just struggled to do so, because I have so many damn thoughts. So I guess this is as good of a time as any to do sit down and jot them down…

I don’t have hard feelings towards Delta

I actually really respect Delta as a company. Their route network is amazing, they’re outrageously profitable, and they treat their employees really well. Domestically they’re tough to beat given that they offer Wi-Fi on virtually all of their planes. As far as I’m concerned they are the airline of the business traveler.

Delta BusinessElite seat

I personally have no interest in flying them because I prefer an airline with a more generous frequent flyer program, but that’s the beauty of a free market. I can fly another carrier that’s more rewarding, and others that value Delta’s route network and product, and care less about frequent flyer benefits, can continue to fly with Delta.

For all practical purposes, mileage earning rates are being cut in half

One of the things about Delta’s new program is that it’s tough for frequent flyers to immediately quantify how the changes impact them. Because aside from us nerds, most people don’t actually think of their travel in terms of cent per mile ratios.

For all practical purposes I’d say earnings rates are being cut in half. When Delta announced a revenue requirement last year they were basically saying that they expect their average frequent flyer to spend at least 10 cents per mile. Under the new program you get five miles per dollar without status, which is roughly half the earnings rate of before assuming an average spend of ten cents per mile. Of course if you have status you earn more miles, though this is the case under the old and new program.

And of course this is simply an average. If you primarily fly full fare business class to Asia on $10,000 tickets then these changes are awesome for you. If you primarily fly full fare economy on short-haul flights then these changes are awesome for you. But for most others, not so much.

Lets be clear here. While it’s packaged differently, at the end of the day this is roughly the same as most foreign frequent flyer programs, which offer reduced mileage earning for discounted economy tickets and vastly increased mileage earning for premium cabin tickets.

For example, Lufthansa Miles & More offers 25-50% mileage for most discounted tickets, while they offer up to 300% mileage for paid first class tickets. When you crunch the numbers on Delta’s new earnings rates, it really isn’t much different.

The Singapore KrisFlyer program is very similar:

Is Delta’s new program targeting the right audience?

Here’s what I find most interesting about Delta’s changes. They say they want to reward their most valuable customers better. But at the end of the day airlines are making money at the margins, and ultimately they do that through a careful balancing act between inventory management, revenue management, and loyalty programs.

And while programs where rewards are based on miles flown aren’t perfect, I have to wonder to what degree the customers Delta is targeting actually care about miles. If you’re flying full fare longhaul business class, my guess is that you’re doing so either because:

• The schedule of the airline you’re flying works best
• The business class product will allow you the most rest
• You have a corporate contract with the airline or they’re a preferred carrier for your company

Meanwhile compare that to your “average” management consultant flying paid economy weekly and spending an average of 10-15 cents per mile. Something tells me with these changes you’ll lose more of these types of customers than you’ll gain the full fare premium cabin flying customer.

At the same time, this program is great for people willing to abuse their expense accounts. I can see people booking more expensive tickets or holding off till the last minute to book in order to get the highest fare possible.

Are frequent flyer programs too rewarding for flying?

It’s worth remembering that frequent flyer program benefits are somewhat cyclical. Ultimately frequent flyer programs are intended to maintain loyalty and drum up additional business. But they come at a cost.

When the economy sucks loyalty programs can help fill seats, while when the economy is good they can be a hassle.

I’m an American Executive Platinum member, and I always give the example of making a mileage run to China in November on an $800 fare. I can use systemwide upgrades to upgrade, and earn at least 15,000 base miles roundtrip. As an Executive Platinum member I get a 100% mileage bonus, so that’s at least 30,000 miles roundtrip.

That’s enough for a one-way economy class ticket to Asia. So it’s basically a never-ending buy two get one free sale.

Now in the case of a flight in winter it could be that the seat would otherwise go out empty so the marginal cost of transporting an additional passenger is next to nothing, but for the purposes of the example it doesn’t really matter. You earn that many miles whether you’re buying the last seat on the plane or there were 100 other empty seats on the plane.

It’s not something I like to say, but it does make me understand their perspective. Frequent flyer programs are much better than a “buy 12 coffees and get one free” punch card.

Earning miles based on revenue doesn’t change anything

“So, is this the end of mileage runs?”

I’ve heard this question asked over and over the past week, and while I get the idea behind it, the truth is that mileage runs have been “dead” for years. Yes, if you enjoy flying and look at those trips as mini-vacations they can certainly be justifiable, but the days of mileage running are dead:

• Airlines have more restrictive routing rules — in the past you could often route double the direct distance with only adding a few dollars to the airfare, while it’s rare for that to be the case nowadays
• Airfare is much higher — back when airlines were publishing $200 roundtrip transcontinental flights, mileage running was easy to justify, but those days are for the most part over
• Airlines aren’t running generous promotions  — I got started mileage running with a promotion that offered 5,000 bonus redeemable and elite qualifying miles per segment… those days are long gone
• Airlines are selling miles cheaply — this is a somewhat new phenomenon, as five years ago airlines weren’t consistently selling miles for less than two cents each, so it’s even tougher to justify the energy it takes to get on a plane for miles nowadays

Don’t get me wrong, if Delta institutes this policy and other carriers don’t match then it may cause people to shift business, but in terms of industry trends I don’t think it will actually change consumer behavior overall. Mileage running as a “sport” hasn’t been lucrative for a while.

Airlines will continue to issue more miles through non-flying means

Frequent flyer programs are massive profit centers for airlines. Not only do they generate loyalty towards an airline, but they are actually in and of themselves profitable. Airlines don’t want to screw that up. What they want to do is “give away” fewer miles for trips people would take anyway.

As it stands, more than half of miles are earned through non-flying means. If the airlines had their choice that number would be 99%, I think. So I don’t think these changes have any implications for those earning miles through credit cards, mileage portals, etc. I only see those getting more rewarding over time, while it gets more and more difficult to earn miles through actually flying.

I don’t think the legacies will shift exclusively towards revenue based award redemptions

When Delta announced a revenue requirement for status, that sucked (for most of us). When Delta announced miles would be earned based on money spent rather than miles flown, that sucked (for most of us). So is the next logical step for the legacies to make mileage redemptions exclusively revenue based?

I don’t think so. I really don’t.

Lets look at the US low cost carriers with revenue based award redemptions, like JetBlue, Southwest, and Virgin America. In each case, the number of points required for an award redemption is based on the revenue cost of a ticket (at least for travel on their own flights). Here’s how much each “point” will get you:

• JetBlue TrueBlue: ~1.5 cents of airfare per point
• Southwest Rapid Rewards points: ~1.4 cents of airfare per point
• Virgin America Elevate points: ~2.2 cents of airfare per point

With Southwest that’s the redemption rate when “Wanna Get Away” fares are available, while with JetBlue and Virgin America you can buy any seat at (roughly) that rate with points.

And at what rate do they issue points for travel?

• JetBlue TrueBlue: 6x points per dollar (if booked on jetblue.com)
• Southwest Rapid Rewards points: 6x points per dollar (on Wanna Get Away fares)
• Virgin America Elevate points: 5x points per dollar

Compare that to Delta which is also offering 5x miles per dollar spent. With the low cost carriers they’re offering you at a minimum 8.4-11% return on your airfare.

Do you think the cost to Delta for a redeemed mile is anywhere close to 1.4-2.2 cents? I’m gonna go with “no way.”

First of all, the legacy carriers are literally issuing billions of miles through their co-branded credit card offerings. I’d be willing to bet the banks are paying less than 1.4 cents per mile. If I were a betting man I’d guess it’s closer to half that (though I have no inside knowledge here). Heck, the cost per mile at which airlines reimburse one another for partner travel is even less than that (for example, if you credit a Delta flight to Alaska).

The legacies have full control over how many award seats they release at the saver award level. What the airlines will continue to do is raise the cost of non-saver redemptions. Those are the award seats that are costing them the most.

Years ago almost all carriers allowed “rule buster” standard awards for the last seat on a flight. Basically you could redeem double miles for the last seat on a plane. Over the years those redemption rates have gone up or been eliminated altogether, and understandably so.

Actually, American is the only legacy carrier offering last seat availability to all members at roughly double the cost of a saver redemption (though in some markets those costs are creeping up). Think of how much how much it’s costing them to offer that last seat for an award. Say two months before departure there’s one business class seat left for sale between Los Angeles and London. You can redeem 100,000 miles for that last seat when someone else would potentially be willing to pay $5,000 for that one-way seat. Now that’s an expensive award offering. So I think we’ll continue to see the cost of non-saver redemptions creep up.

Lastly, even partner award redemptions aren’t that expensive. In December I shared just how little premium cabin award redemptions on partner airlines cost the loyalty programs. When United books a transatlantic business class award seat on a partner airline it’s costing them $300-400, while they’re nowadays charging 70,000 MileagePlus miles for the one-way. That’s a redemption cost of half a cent per mile, which is cheap compared to the redemption costs on any of the low cost carriers. On top of that keep in mind that even that isn’t a “real” cost, since it’s ultimately an accounting exercise. Airlines are booking seats on one another, and at the end of the day there’s mostly equilibrium.

Bottom line

For just about the first time in this millennium airlines are making money by flying planes…who would’ve thought? They want to maximize their profits, and part of that is giving away fewer rewards for tickets people would purchase anyway.

Loyalty programs are healthy businesses in and of themselves, in particular when it comes to partnerships and co-branded offerings. I expect the rates of costly redemptions — like non-saver awards — to continue to go up, as those are the ones actually costing the airlines money.

I also wouldn’t be surprised to see them continue to introduce a “cash & miles offering,” whereby you can redeem 25,000 miles for a ticket, OR something like 15,000 miles plus $100. But I don’t think we’ll see straight, exclusive revenue based redemptions for the legacy carriers anytime soon. Not because I don’t want to see it, but because I don’t think it’s in their best interest.

What do you think? Am I totally off base?