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ON BOARD WITH RANDY PETERSEN

FREQUENT FLYER PROGRAMS: BRIBERY OR SMART MARKETING?
May 2004
by Randy Petersen

In recent months, a number of industry experts have bemoaned the perceived costs of frequent flyer programs—some going as far as to suggest that in these turbulent times, both consumers and the airlines would be better off without them.

In particular, Stelios HajiIoannou, the founder of easyJet, recently stated, "Low-cost airlines cannot afford to give FFPs—that's why they are low cost. FFPs are a bribery system, and like any such system, you have to persuade people to do things that they would not otherwise have done. Air fares could be reduced by 10 percent or more if FFPs did not exist."

To quote the great late 20th century philosopher, Bart Simpson: "Au contraire, mon frere."

In Stelios' world (and let's make it clear: I do admire his success), price is the only factor in competition. In other worlds, marketing is composed of several competitive factors, price being but one of many.

I disagree with Stelios' assertion that without these programs, airfares would be lowered another 10 percent. The truth is that most major frequent flyer programs are actually profit centers for their sponsors.

For instance, the largest program in the world, American Airlines AAdvantage, sells nearly a billion dollars worth of miles a year to its partners. When United Airlines filed for bankruptcy in 2002, the court papers noted that its frequent flyer program was the only profitable division within the airline.

The success behind these programs is simple: Most airlines only fly at 60-85 percent load factors on average. The real value is in using the unsold seats as leverage for loyalty. Does an empty seat at takeoff cost an airline much money? Depending on the airline, that empty seat may cost an airline from $8-51 (cost of fuel, insurance, any meal cost, divided revenue for redemption, etc.). If the frequent flyer program keeps a member from flying another lower-cost airline, then I would think the benefit is clearly to the airline sponsoring the program.

Another way to look at these programs is that they are simply another form of advertising. If these programs did not exist, then airlines would surely spend that money on more advertising, because the number of ways to attract potential passengers would be limited.

Simply put, the programs work. I don't think Stelios has had enough competition to fully understand the power of these programs. The secret of Stelios' success is that he created new markets without much competition from other low-cost competitors.

But let's move ahead 10 years in Europe and imagine there are now six other easyJets all fighting for similar markets. With more competition, does Stelios continue to see who can really deliver the lowest cost, or does he invent something that can be seen as a discount but doesn't take away his bottom line?

While other airlines may not like it, it's usually because they aren't as clever, and simply complain when they can't compete at the very top of the market. The reality is that these programs can be very, very powerful.

You can contact Randy Petersen at randy@insideflyer.com.