How the pandemic exposed the truth about airline profits and why loyalty schemes are worth more than the airlines themselves.

At the height of the COVID-19 outbreak, with people being told to stay at home, airlines were losing incredible amounts of money.

With 95% of flights grounded worldwide, it’s estimated that airlines lost on average $230m, each day.

To help fill an ever-growing black hole in their finances, airlines turned to banks for loans. However, the pandemic caused airlines to plummet in value, so to secure the loans they would need to offer a huge percentage of their company as collateral.

United Airlines, one of the biggest carriers in North American, were looking to borrow $5 billion to stay afloat. Although, instead of offering planes as security, they offered one of their subsidiaries – their loyalty program.

As a publicly traded company, United need to file documents whenever a major business event takes place, say for example taking out a multi-billion-dollar loan. One line in all those documents stood out most. “Multiplying MPH 2019 EBITDA by a factor of 12 equated to a MilagePlus valuation of approximately $21.9 billion.”

Compared to United’s market cap of $10 billion at the time, which indicates what Wall Street considers the company is worth, this meant that the airline’s loyalty program was worth more than the airline itself.

In short, this meant that United Airlines was worthless. In fact, they were more than worthless, they’re loss leaders.

Other US carriers like Delta and American Airlines also used the same tactic to secure loans, both of which exposed the same startling truth.

Before the historic downturn in air travel, in 2018, American Airlines earnings report disclosed that they earned about $14.42 in passenger revenue per mile flown.

The same report also reported that it cost them $14.85 per seat per mile flown. Meaning that American lost 43c per seat, per mile. However, the company earned $1.9 billion in pre-tax profits thanks exclusively to their $4.2 billion dollars in frequent flyer program revenue.

American Airlines, in 1981, were the first major airline in the US to introduce a reward scheme.

They quickly realised that American Advantage Members were more likely to fly with American, even if it meant paying slightly more, so they could accumulate enough miles to earn a free flight.

Overall, this did come at a cost for the airline, but they quickly understood that the additional revenue through increased passenger numbers far surpassed any expenditure.

Soon after, in 1982, American partnered with Hertz to allow its members to earn points when renting cars. While a partnership like this wasn’t ground-breaking, how it worked was.

American put a real value on its imaginary points, meaning that Hertz paid American for each point they gave to incentivise customers to rent with them.

While the amount paid per point is a closely guarded secret, if Hertz paid American 1c per point, and roughly 25,000 points earned you a free domestic flight at the time, it meant that American would have earned $250.

Considering that the typical variable cost of a seat on a domestic flight was about $15, American quickly saw how profitable this type of partnership could be.

Fast-forward to 1987 and American teamed up with Citibank to offer a co-branded credit card, earning one point for each dollar spent, encouraging many other airlines to quickly follow suit.

Rather than a simple reward scheme to incentivise more spending on travel, these loyalty programs became their own profit-making enterprises. But the way in which these frequent flyer programs were first set up wasn’t perfect.

The traditional one-mile, one-point system meant cheaper, non-direct flights could earn you more points than the total cost of your journey.

This was bad for airlines as it encouraged people to take longer, multi-stop journeys which cost the airlines more to operate and more in redemptions. To solve this, almost every major airline has now pivoted to rewarding points based on the amount of money spent.

Airlines then also began restructuring how people could redeem points too.

By adding dynamic redemption, on high-demand dates and routes, airlines began tracking the number of points needed to redeem a free flight with the retail cost.

These frequent flyer programs have made airlines incredibly powerful. Not only are they able to set the price and supply of their currency (points) and the availability of goods to spend it on (flights), but they’re also the only entity that can convert it to cash, making it almost impossible for airlines to lose.