Frequent flyer miles are worth big money — to the airlines:
The Financial Times pegs the value of Delta’s loyalty program at a whopping $26 billion, American Airlines at $24 billion, and United at $20 billion. All of these valuations are comfortably above the market capitalization of the airlines themselves — Delta is worth $19 billion, American $6 billion, and United $10 billion. In other words, if you take away the loyalty program, Delta’s real-world airline operation — with hundreds of planes, a world-beating maintenance operation, landing rights, brand recognition, and experienced executives — is worth roughly negative $7 billion. But economics of the loyalty program don’t work without a robust airline operation.
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Spending money on a Delta-branded American Express card to earn points feels like getting free money, and redeeming it feels like getting a free flight. Since consumers mentally double count their points, they’re willing to accumulate them, which means banks and other counterparties have found it valuable to offer those points to consumers.
Typically, the airline will sell points to banks, who then offer those points to cardholders in exchange for spending. Once someone has picked out a loyalty program, they’re incentivized to be loyal and rack up points, so the bank knows they’ve acquired a credit card customer for the long haul. Exclusive partnerships between airlines and credit card issuers can be quite lucrative: Delta’s deal for American Express to be the sole issuer of its SkyMiles credit card was worth $3.4 billion in 2018, and the contract has since been extended to 2029. It’s a classic fintech play: provide a novel way to help exchange money now for money later at favorable rates. Since the loyalty rewards business is asset-light, grows fast, and is not as sensitive to economic cycles as the core airline business — United revealed that loyalty revenues dropped just 2% in 2009 — it raises the question: Why not just spin them off? That’s harder than it looks, and it gets to the crux of the airline industry’s problems.
Loyalty programs acquire customers because those customers want to earn and spend points with a particular airline that has flight routes optimized for their needs. That means they’re ultimately dependent on an airline’s route network. For example, if you do a lot of business in Atlanta, Delta’s your go-to airline; if work takes you up and down the West Coast, you’ll probably choose Alaska. When airlines decide which routes to expand and which to cut, they’re not just thinking about ticket prices — they’re also thinking about their loyalty members. Abandoning a major city, or even reducing routes to it, is a good way to permanently lose those lucrative customers.
That problem is especially hard because people like to earn miles on business trips and spend them on vacation. So an airline that cuts a route to the Bahamas or Vail might lose business in New York and Chicago.
The other way of looking at this is that banks/investors have drastically over-paid for their contracts with airlines on issuing frequent flyer miles. Great for the airlines — bad for the investors (which may include some of our retirement funds).
But, but … finance executives are wise & incorruptible! They have to be, because markets are efficient. Just look at the market valuations of Zoom and Tesla if you doubt the smart decisions made by financial executives investing Other People’s Money.
When investors create tens of trillions of dollars, the money has to go somewhere. As all value is created in the act of investing, anywhere is better than nowhere.
Like Vail — Vail is love; Vail is life.
Some government agencies and private companies have tried to confiscate the frequent flyer miles awarded their employees.
I’m surprised the IRS doesn’t classify them as income.