Do airlines make more money out of loyalty schemes than selling seats?

November 17, 2017

 Your loyalty may be worth much more than your ticket or bag fee – it is a more stable source of income and profitable source of income thanks to lower investment and operating costs.

 

The airline industry is well known for its low profit margins and constant financial crises, hence the saying: “the airline industry, in its history, has never made money”. The truth of this statement is to be tested by a product airlines have been able to spin off their core operations: air mile loyalty schemes. For those of you with an airline-branded credit card in your wallets, your daily spending habits play a crucial role in keeping big airlines’ pockets nice and full.

 

Joseph DeNardi, a senior airline analyst with Stifel Financial Corp. in Baltimore believes that airlines can be earning up to 50% of income from selling miles to credit card companies. Banks such as Citi and JPMorgan Chase pre-purchase a bundle of ‘miles’ from airlines and dish them out to customers proportionally to how much spending is done through their credit cards. They pay an estimated 1.5 to 2.5 cents per mile, and make more than enough back through merchant fees and transaction charges for the bank.

 

For carriers such as Delta (on American Express) and American Airlines (Citigroup), these loyalty schemes can be a cash cow in terms of revenue. Comparing profit margins of these with core operations give an easy answer as to why air miles are profitable. Stifel estimates a mile’s sale price can be as high as three times its redemption costs (60% - 70% margin), not including miles that end up being cancelled, expire or otherwise never redeemed. “Fundamentally, airlines are selling miles to credit card companies for much more than they will cost the airline when those miles are redeemed—and they are doing it hundreds of billions of times a year,” Stifel wrote in a February client note.

 

 

On the other hand, take the 2012 financial year for example. US airlines made profits of only $4 per passenger carried – a profit margin of only 1% for that year. Massive expenses include high oil prices, cost of purchasing and hiring jets, landing permits and high salaries for experienced pilots. For instance, a Boeing 737, a relatively small passenger jet, costs around $50 million or more. Larger jets can approach $300 million in price. Pilots represent a major cost: A Captain with 10 years of experience will likely earn upwards of $100,000 in annual salary.

 

Apart from being a highly profitable intangible, air miles also have the benefit of being a stable source of income, immune from the cyclical fluctuations of demand and costs related to flying. The steady income stream acts as a cushion during economic downturns, as in 2009 when Citibank pre-purchase $1bn worth of miles from American Airlines when it was in dire financial straits.

 

Air mile schemes are likely to continue to grow as they greatly benefit banks too. AmEx stated in securities filings that its Delta SkyMiles portfolio accounted for approximately 7% of its business in 2016 and up to 20% of outstanding credit card loans as of December 31st. Although this may be good news for the airline industry, airlines executives must not forget to further improve profits in their core business—namely flying.

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