Frequent flyer programs were initially made to give perks to passengers as a reward for sticking with a particular airline.
However, it did not take long for these carriers to realise how seriously passengers valued the points and that they could actually make a profit from this particular exercise.
“About 10 years ago Qantas realised that there was an opportunity for them to commercialise this more widely and it was largely because of how consumers value those points both as a status symbol and as the opportunity to get flights,” said Credit Suisse director of equity research, Paul Butler.
Qantas is considered to be the most popular reward program in Australia, with 12 million members, earning more than 120 billion points last year.
Today, Qantas has partnerships with over 200 firms, which range from major banks, supermarkets and insurance companies.
These partners purchase frequent flyer points from Qantas, which they can use to give to their own customers.
These programs have evolved into a huge producer of cash for the carriers. Qantas’ frequent flyer program pulls in over $400 million a year in profit, which is shockingly, more than it makes flying people overseas.
It is also a very reliable money generator for an industry that is known for its instability in earnings and is highly dependent on oil prices.
Credit Suisse calculates the reward business is worth about $4 billion to Qantas.
Real cash now for future rewards
What is enticing about this business for the carriers is that they get real cash from their partners, but the points are not usually redeemed right away and they actually have control over what they are redeemed for.
“The dominant reason it’s exceptionally good for the airlines’ cash flow is that they’re really getting a revenue stream for a very little cost stream,” explained chief executive of Airline Intelligence and Research, Tony Webber, who previously functioned as the Qantas’ chief economist for almost four years.
Frequent flyer points are a type of currency, with the airline acting basically as an unregulated central bank.
Airlines control the value of the points by ruling how many to issue, how many points are needed to purchase an upgrade or flight and what extra fees or charges the customer must pony up. This gives the airline a massive amount of power to regulate its cash flow.
Technically, the rewards programs “buy” seats and upgrades from the domestic and foreign divisions of the company. But it is the airline that controls how many and which seats are available, which means the marginal costs are reduced.
“Without someone upgrading into business class from economy class that seat will go unsold, so having a passenger sitting in that seat rather than having an empty seat flown doesn’t add that much to the incremental cost to the airline,” stated Webber.
“That additional cost of upgrading the passenger is immaterial to the airline,” he added.
These include taxes and fees that are third party expenses, such as airport charges, but the airline also tacks on a “carrier charge”, which it fixes and “reflects market conditions and varying demand”.
Airlines “really want the points to expire”
Frequent flyer points might be highly coveted, but in the case of both Qantas and Virgin Australia’s programs, they could actually expire.
Webber explained it’s in the interest of the airlines for the points to expire.
“They really want the points to expire, they have a strong incentive to expire the points. As soon as the points expire there is no cost associated to the airlines with these points being earned,” Webber conveyed.
But, the airlines also do not want to do anything that compromises the brand or the charm of the program. Qantas and Velocity could only sell points to banks and retailers if the points are enticing to customers, meaning airlines are unlikely to commit to drastic changes that could devalue the programs in the eyes of users.
“It’s a huge amount of value that investors have a lot of confidence in and, if they were to do something in the short term that increases the earnings on that business by reducing the value of the points for consumers, then it’s going to have a very significant impact on the value that investors believe the program has,” stated Butler.