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History of Loyalty Programs

Pre history

Before there were frequent-flyer programs, there were (remember?) Raleigh cigarette coupons and S&H Green Stamps. The idea was similar: encourage repeat business by rewarding customers for their loyalty. (In case you don’t remember, supermarket customers earned Green Stamps according to the amount of their purchases. The Green Stamps were pasted into books, and the books could be redeemed for various types of merchandise. In other words, the more you purchased, the greater your reward.)

Before such primitive loyalty programs could develop into what we now know as FFPs, two events had to occur:

  • Deregulation (1978) created the marketing environment.

    Pre-deregulation, airline marketing was almost exclusively “strategic”: image advertising with complementary product offerings (Southwest, the “Love” airline, featuring flight attendants in hot pants; sophisticated TWA featuring a piano lounge on the upper deck of their B747s).

  • Computerization created the necessary systems infrastructure.

    FFPs as we know them would be impossible without massive data-storage capabilities to warehouse the customer files, and the sophisticated database software necessary to manage that data.

Absent either of the above, FFPs probably would be unnecessary (assuming a regulated airline industry) or impossible (without the computer-tracking mechanisms which make such large-scale customer tracking possible).

The Beginning

In May 1981, American Airlines (AA) introduced AAdvantage, the first FFP. The goal: Retain AA’s most frequent customers by rewarding them for their loyalty. (It is significant that FFPs were originated by AA, then and still an industry leader in both marketing and computer systems.)

The tactic, specifically, called for tracking members’ flown miles (as a measure of their revenue contribution to the company), and awarding members free tickets & upgrades (the rewards).

A little background…

AA had compiled a database (through its Sabre computer reservations system) of 150,000 of its best customers. These frequent flyers were identified by computer-searching Sabre bookings for recurring phone numbers, which were correlated with the customers’ names. They were the first members of AAdvantage.

To cover the full array of travelers’ needs, AA included Hertz and Hyatt in AAdvantage, offering mileage accumulation and awards on both.

Within days of the introduction of AAdvantage, United (UA) introduced their own program, Mileage Plus. In many respects, Mileage Plus was a mirror image of AAdvantage. The “Plus” referred to the few (but significant) elements in UA’s program which distinguished it from AAdvantage–a 5,000-mile Enrollment Bonus and no mileage expiration.

Later that same year (1981), both Delta and TWA introduced their programs, creating the critical mass necessary to make FFPs a necessary element in any and all airlines’ marketing arsenals. The FFP battle had begun…

Enter the Hotels

In the beginning, hotels were partners in airline programs. As they discovered the power of FFPs, and the costs of participating in the airline-hosted programs, they naturally considered launching their own frequent-stay programs.

Holiday Inn was the first to launch its own program, in January 1983. Marriott followed with its Honored Guest Awards program in November of 1983.

In hindsight, it is obvious that Holiday Inn’s Priority Club program was too generous in its original form. After 75 stays, a member could expect the following:

  • 2 airline tickets to Europe
  • 1 week’s hotel stay in Paris
  • 1 week’s free car rental

So Holiday Inn discontinued the program in February 1986, and relaunched it with less generous award conditions later that same year.

While all of the major hotels today have their own frequent-stay programs, most hotels feel that the greatest marketing benefit derives from their participation in airline FFPs. Conclusion: air transportation is the primary attraction of the programs.

The Converts

Although all major U.S. airlines, and most hotels and rental car companies, eventually joined the FFP parade, many did so reluctantly. Their concern was twofold:

  • They were not convinced the programs were effective marketing tools.
  • They were concerned about the costs of operating such large operations.

The examples of Southwest and Hilton are typical.

Both hesitated to introduce FFPs. They were (a) afraid of the costs, and (b) suspicious that the programs were short-term marketing gimmicks which would disappear in the short term.

Both subsequently realized that they had underestimated the power of FFPs when they suffered significant losses in market share… particularly troublesome losses because the affected segment of the market was the most lucrative: high-frequency high-yield business travelers.

So both entered the FFP game late, and had to work extra hard to make up the competitive disadvantage they had allowed to accrue.

The experience of the hold-outs is well described by Southwest’s Mr. Kelleher.

“We didn’t want an FFP. But it came to my attention that FFPs were siphoning business travel away from us. We did it defensively, and I think if we had not done that we would have been terribly disadvantaged.”

- Herb Kelleher President, Southwest Airlines

Hilton, after losing significant market share to Holiday Inn and Marriott, launched their own program in 1987.

Rental Car Companies

It was not until March 1987 that National Rental Car introduced the first car-rental program, the Emerald Club.

As with the hotels, rental car companies’ first exposure to FFPs was as partners in airline-hosted programs. Specifically, Hertz was the first car rental company to join an airline FFP… they were one of the first partners in AA’s AAdvantage program in 1981.

The Hertz experience is telling. They were a charter member of the first FFP, and subsequently joined several other airline programs. But by 1990, they decided the costs were too high and backed out of all of their FFP relationships. (The costs are considerable: as a group, the rental car companies pay hundreds of millions of dollars per year to participate in FFPs.) They discovered, however, that their market share dropped dramatically without the FFP tie-ins. So today Hertz participates in 20 airline FFPs.

Although a few frequent-renter programs survive, most rental-car companies concentrate their marketing efforts on participation in the airline FFPs.

FFP’S Today

Today, frequent flyer programs (and loyalty programs generally) are everywhere.

There are more than 70 FFPs worldwide.

While the programs were introduced in the U.S., by U.S. airlines, they are now a fact of marketing life globally. Many foreign carriers were reluctant entrants. As was the case with the late-entrant U.S. airlines, foreign carriers initially viewed the growth of FFPs as a marketing fad, and an expensive one at that. Additionally, some carriers felt that FFPs amounted to a kind of rebate or discount, which was inconsistent with their premium-service/premium-price strategy (especially for business and first class). Notwithstanding these qualms, when such FFP-less carriers as South African Airways, Singapore Airlines or Swissair began losing share to their U.S. counterpart carriers, the power of mileage was proved indisputably, measurably, on the bottom line.

In marketing terms, FFP has become part of the “core product” offered by airlines. Mileage is a basic consumer expectation, alongside convenient schedules, competitive pricing, safety and customer service.

The programs boast over 100 million members.

The large U.S. FFPs (American’s AAdvantage, United’s Mileage Plus, Delta’s SkyMiles) have more than 20 million members each. (Many members, of course, are shared. The most frequent flyers tend to be enrolled in 4-6 programs simultaneously. As advocated elsewhere on this site, this is not the best way to maximize the benefits of FFP participation.)

Members receive 10 million awards per year.

What makes loyalty programs attractive (from the consumer standpoint) and effective (from the airline standpoint) is the reward side of the equation. And for most FFP members, the reward is a free ticket. The most popular among members of U.S. FFPs: tickets to Hawaii and London.

As a very general rule, 5% of an airline’s seats are allocated for use by frequent flyer program members using award tickets.

FFP Issues

Mileage Expiration

Mileage expiration has been an on-again/off-again issue since the beginning.

Current situation: Most U.S. programs allow miles to “live” indefinitely, provided a member has some account activity during a 3-year period.

Programs outside the U.S. typically expire miles 3 years after they’re earned.

Taxation

Are FFP awards taxable? As far as a direct tax on the award user, the most recent IRS ruling states (with some equivocation) that free tickets are taxable IF they are earned in the course of business travel AND they are used for leisure travel. This rule has proved too difficult to apply, so enforcement has been practically non-existent. For the future, though, we should never underestimate the government’s appetite for tax revenues.

To wit, the recently enacted 1997 Taxpayer Relief Act attempts to tax FFP transactions covertly. For more information on this continuing saga, please see “The Taxpayer Relief Act — More Grief than Relief?”.

Costs

FFPs work because there is a balancing of consumer and airline interests. From the airline standpoint, the generous awards can be justified because average award costs are closer to the direct costs of carrying a passenger (an extra meal, extra aircraft fuel, etc.) than to the actual cost of purchasing a comparable ticket. That’s because award seats are limited, thereby reducing the likelihood of an award passenger displacing a revenue passenger.

While it can be frustrating trying to get an award ticket on popular routes during peak times, we as consumers must bear in mind that seat limitations are just what make the programs economically viable.

Coupon Brokers

Coupon brokers buy FFP tickets from members, and sell them (at a substantial discount to published fares) to bargain-hunters. All airlines include language in their FFP member materials that states that FFP mileage, coupons and tickets may not be sold, bartered or otherwise transferred for any type of consideration. At one time, this was a $150 million-a-year business. It continues, but on a much smaller scale because the airlines have aggressively pursued and prosecuted the brokers, sellers and buyers. Don’t sell or buy FFP awards. It’s illegal, and the costs of litigation, fines and replacement tickets can be substantial.

FFP Economics

As with any marketing program, FFPs generate both costs and revenues. A summary follows:

Costs
Revenue

OPERATIONS COSTS

FFPs are big operations, employing hundreds of marketing, customer service and technical staff. Other significant costs: facilities, computer hardware and software, phone systems.

COMMUNICATIONS COSTS

Member communications: enrollment materials, program brochures, newsletters, postage, etc.

TRAVEL AWARDS COSTS

Travel award costs depend on whether the member uses a free award ticket on the host airline, or an award on one of the program partners.

1. When a member uses a free ticket on the host airline, the costs include…

(a) Direct costs (extra costs of meals, fuel, etc. required to carry an incremental passenger)

(b) Displacement costs (where a non-paying passenger occupies a seat which would otherwise be occupied by a paying passenger)

(c) Diversion costs (where a customer uses an award instead of buying a ticket)

Whereas (a) will always be a cost, (b) and (c) may or may not apply, depending on how full the flight is, and whether the member would have traveled even if he’d had to pay for the ticket.

2. When a member uses an award on a program partner…

The host pays the partner company, in essence buying the award for the member. Typically the rate would be between 1-2 cents per redeemed mile.

Example: A free trip to London on AAdvantage partner British Airways (available for 50,000 miles) would “cost” AA between $500 and $1000, depending on the per-mile rate negotiated between AA and BA. Assuming the member earned those 50,000 miles flying on AA, and AA earned on average 10 cents per-flown-mile, the award would amount to a 10-20% rebate to the member (simply the member’s revenue contribution to AA, versus the cost to AA of the award ticket purchased from BA).

PARTNER REVENUES

Because FFPs are such effective marketing programs, many companies are willing to pay for the privilege of participating in them as program partners. (Such partnering also benefits the FFP host company, which wants its FFP to boast a wide array of high-quality partners.)

Typically, a partner company pays the host company 1-2 cents per mile earned when a member uses the partner’s product. (These expenses are counted against the advertising or sales promotion budget, and can be significant. A hotel giving 500 FFP miles (@$.01 = $5) for a $100/night room stay suffers a 5% yield dilution, right off the top.)

ADVERTISING SAVINGS

Also counted on the revenue side of the ledger are the savings FFP marketing affords over mass-market advertising.

Because FFPs allow targeted communications with the airlines’ proven customers, it is not necessary to spend as much on expensive (and inefficient) print and broadcast advertising to maintain the interest and loyalty of current customers. The dollars “earned” through these savings run into the millions.

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