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Sizing Up the Largest Frequent Flyer Programs

As a consumer, frequent flyer programs are exciting, engaging, and rewarding to participate in. Frequent flyers not only receive discounted airlines tickets, they can redeem their points for everything from overnight hotel stays to car rentals, magazines, and more, thanks to a significant amount of program partners.

 

As a program manager, providing such benefits engages customers and builds brands loyalty. Of course, in an ideal world, the revenue generated from these loyalty programs would exceed their costs.

 

Yet, while loyalty programs have been a staple of the airline industry since 1981, benchmarking data is limited.

 

Last month, we launched a series on loyalty program benchmarks to uncover valuable insights for our readers. The goal: to establish key benchmarks across industries that utilize loyalty programs as essential revenue generation strategies.

 

Our benchmarking series carefully examines the publicly available financial information regarding each of the following program attributes:

 

Loyalty program revenue

  • Revenue from sale of points
  • Loyalty program usage & membership

 

Loyalty program costs

  • Loyalty program liability
  • Loyalty program breakage
  • Current vs non-current liability
  • Program liability sensitivity
  • Loyalty program point expiration
  • Implementation of ASC 606 & IFRS 15

 

The first piece in our series gave readers an inside look into the hospitality industry. Now, we turn our attention to the airline industry.

 

For this installment, we examined a large subset of US and international companies, including:

 

US Airline Companies

  • American Airlines
  • Delta Airlines
  • United Airlines
  • Southwest Airlines
  • Alaska Airlines
  • JetBlue
  • Hawaiian Airlines

 

International Airline Companies

  • Air France - KLM
  • Lufthansa
  • Avios (British Airways)
  • Emirates
  • Air China
  • Qantas Airways
  • LATAM Airlines
  • SAS
  • Avianca
  • Virgin Australia
  • Air New Zealand
  • Copa Airlines
  • El Al Israel Airline

 

In examining the results of this study, we hope you take away valuable insights for your loyalty program.

 

Loyalty program revenue

loyalty program revenue

 

Revenue from sale of points

Frequent flyer programs add significant value to the airlines that employ them. Although companies are not required to disclose the revenue generated by their loyalty programs, we can get a sense of the magnitude of this value by examining the revenue recorded for the sale of miles to co-branded credit card or other partners.

 

There are generally two revenue elements associated with the sale of miles to partners: the transportation component (the fair value of the miles to the end consumer) and the marketing component (the value to the partner of the airline brand and other advertising). Several US companies report the marketing component of the revenue associated with the sale of miles.

 

Company
Revenue associated with sales of miles (marketing component)
American Airlines
~$2,200 million
United Airlines
$1,183 million
Alaska Airlines
$396 million

 

Revenue associated with the transportation component of the sale of miles (above and beyond the cost of fulfilling the redemptions)The marketing component of the sale of miles to partners is a material source of revenue - capable of reaching billions of dollars annually - yet it reflects only a fraction of a loyalty program’s value. Other components include:

  • Revenue associated with ticket sales to loyalty program members (net of the cost of good solds and redemption costs)

 

International companies tend not to share the revenue related to the sale of miles. However, Air China does publish member contribution information.

 

Company
Loyalty program member contribution
Air China
43.7% of total revenue

 

The percent of total revenue attributable to frequent flyer members for Air China falls within the range of the loyalty program contribution we observed in the hospitality industry. Loyalty program members generate a large portion of these companies’ revenues.

 

However, we still don’t have the full picture of the value of these loyalty programs. Instead of looking at these historical revenue numbers, a more complete picture would require an understanding of the expected future revenue from members, net of expected future cost, and how the loyalty program has increased this expectation over time. This metric is called customer future value (CFV), and the sum of CFV across all members is known as member equity. Unfortunately, this is not something that is often calculated, but can be extremely valuable to managing and optimizing the frequent flyer program.

 

Loyalty program usage & membership

Numbers on airline loyalty program membership is scarce, and current data for US companies is not readily available. However, several international airlines share member count, which is roughly correlated with company revenue.

 

Company
Members
Total 2017 Revenue
Emirates
20 million
$25,139 million
Air China
51 million
$19,044 million
Qantas Airways
12 million
$12,632 million
LATAM
30 million
$9,614 million
SAS
5 million+
$5,118 million
Avianca
8 million
$4,442 million
Virgin Australia
9 million
$4,155 million
El Al
2 million
$2,097 million

 

On the other hand, most US airlines do share information on award redemptions. These redemptions include flight awards, hotels, and other perks. The table below shows that the quantity of award redemptions appears to align with company revenue levels, and that, with the exception of Southwest Airlines, award travel generally makes up between 5% to 8% of total passenger revenue miles.

 

Company
Award Redemptions
Award Travel as % of Total Passenger Miles
Total 2017 Revenue
American Airlines
11 million
6.1%
$42,207 million
Delta Airlines
14.9 million
7.9%
$41.244 million
United Airlines
7.7 million
7.5%
$37,736 million
Southwest Airlines
9.6 million
13.8%
$21,171 million
JetBlue
2 million+
5%
$7,015 million
Hawaiian Airlines
612,000
5% (of passengers)
$2,695 million

 

Conclusion

Selling miles can be a great revenue generator for airlines, with revenues reaching several billion dollars for the largest carriers. But the value of a loyalty program doesn’t stop there. Frequent flyer programs present a mechanism to influence millions of customers and, consequently, millions, or even billions, of dollars in future purchases. Companies that don’t harness this mechanism to maximize those future purchases using predictive metrics like customer future value and customer potential value are missing out on an enormous opportunity.

 

 

Loyalty program costs

loyalty program costs

 

Liability

Driving customer engagement through loyalty programs leads to a backlog of redeemable miles, points, and rewards. These redeemable rewards can drive significant growth in both revenue and brand loyalty.

 

When looking at financial statements, this backlog of redeemable points is represented as deferred revenue, or loyalty program liability. The account value represents potential performance obligations in exchange for future customer point redemption.

 

Company
Total Revenue
Loyalty Program Liability (Deferred Revenue)*
American Airlines
$42,207 million
$8,822 million
Delta Airlines
$41,244 million
$6,321 million
United Airlines
$37,736 million
$4,783 million
Southwest Airlines
$21,171 million
$2,667 million
Alaska Airlines
$7,933 million
$1,725 million
JetBlue
$7,015 million
$502 million
Hawaiian Airlines
$2,695 million
$322 million

*Restated to reflect ASC 606/IFRS 15 where necessary


In general, loyalty program liability increases along with total company revenue. The table above shows that the US airlines appear to follow this pattern.

 

Company
Total Revenue
Loyalty Program Liability (Deferred Revenue)*
Air France - KLM
$30,941 million
$983 million
Lufthansa
$27,931 million
$2,608 million
Avios
$27,517 million
$1,406 million
Emirates1
$25,139 million
$611 million
Air China
$19,044 million
$530 million
Qantas Airways2
$12,632 million
$1,709 million
LATAM Airlines
$9,614 million
$1,218 million
SAS3
$5,118 million
$213 million
Avianca
$4,442 million
$384 million
Virgin Australia2
$4,155 million
$344 million
Air New Zealand
$3,711 million
$232 million
Copa Airlines
$2,528 million
$50 million
El Al
$2,097 million
$104 million

*Restated to reflect ASC 606/IFRS 15 where necessary
1 Year-ending 31 March 2018
2 Year-ending 30 June 2018
3 Year-ending 31 October 2017

 

For airlines headquartered outside the US, the correlation between loyalty program liability and total revenue doesn’t appear to be quite as strong.

 

This could be driven by the lower maturity of international frequent flyer programs. While the first US loyalty program was established in 1981, European airlines didn’t introduce loyalty programs until 1991.

 

Breakage

A key metric for any loyalty program is breakage. Accurately forecasting your breakage rate is essential to maintain financial statement credibility, and avoid material impacts to net income.

 

While there is no reporting requirement for breakage rates, two US airlines of significantly varying revenues reported an average rate of 17 – 18%.  

 

Company
Total Revenue
Breakage
United Airlines
$ 37,736 million
18%
Alaska Airlines
$ 7,933 million
17.4%

 

This suggests that nearly 1 in 5 airline loyalty points will not be redeemed. However, given the small sample size, it’s unclear if this is representative of the entire industry.

 

Program liability sensitivity

Breakage rates are an essential component to calculating program liabilities carried on financial statements. If estimated breakage rates are too high, liability is underestimated. If estimated rates are too low, liability is overestimated.

 

In both cases, errors in breakage estimation can result in revised financial statements and material impacts to earnings. Understandably so, companies report their sensitivities.  

 

Company
Sensitivity
Total Loyalty Program Liability
American Airlines
1% change in breakage changes liability by $38 million
$8,822 million
Delta Airlines
1% change in breakage changes liability by $34 million
$6,6321 million
United Airlines
1% change in breakage changes liability by $53 million
$4,783 million
Southwest Airlines
1% change in breakage changes liability by $48 million
$2,667 million
Alaska Airlines
1% change in breakage changes liability by $10 million
$1,725 million

 

While US airlines range in their liability sensitivity, on average, a 1% change in breakage estimates will result in a 1% change in liability.

 

Company
Sensitivity
Total Loyalty Program Liability
Avios
1% change in breakage changes liability by $10 million
$1,460 million
LATAM Airlines
1% change in breakage changes liability by $33 million
$1,218 million

 

Only a few international airlines report sensitivities. Among those that do, a 1% change in breakage estimate will result in a 1% to 3% change in liability.

 

Current vs Non-Current Liability

Loyalty program liability can be split into current and non-current time periods.

 

Company
Current liability
Non-current liability
American Airlines
35%
65%
Delta Airlines
44%
56%
United Airlines
46%
54%
Southwest Airlines
60%
40%
Alaska Airlines
37%
63%
JetBlue
23%
77%
Hawaiian Airlines
-
-
Average
41%
59%

 

US airlines show an inclination towards more redemptions occurring outside a 12-month window. On average, 59% of their program liability is non-current.

 

Company
Current liability Non-current liability
Air France - KLM 100% -
Lufthansa 100% -
Avios - -
Emirates 53% 47%
Air China 20% 80%
Qantas Airways 39% 61%
LATAM Airlines - -
SAS - 100%
Avianca1 45% 55%
Virgin Australia 100% -
Air New Zealand 48% 52%
Copa Airlines 34% 66%
El Al 67% 33%
Average2 44% 56%

Period ending 3/31/2018
2 Excluding companies that place their total liability into one bucket

 

The picture isn’t quite as clear with international airlines. Several airlines group their entire liability into one bucket. On average, the split between current and non-current liability among the remaining airlines is about 44%/56%.

 

Loyalty program point expiration

Expiration rules introduce a clearly defined end to points accumulation and program participation, should consumers fail to log any earning activity.

 

Expiration rule strategies vary by company, but generally they incentivize participation and point usage. Data analytics can help study and assess the optimal expiration period.

 

Company
Required activity period
American Airlines
18 months
Delta Airlines
None
United Airlines
18 months
Southwest Airlines
24 months
Alaska Airlines
24 months
JetBlue
None
Hawaiian Airlines
18 months

 

Most US airlines require activity within an 18 to 24-month period; otherwise points expire. Two exceptions are Delta and JetBlue.

 

United Airlines customers redeem the majority of points within 4 years, with most points used within the first year, and 18% of points ultimately expire. Among JetBlue customers, most points are redeemed within 3 years.

 

Company
Required activity period
Air France - KLM
24 months
Lufthansa
Expire in 36 months
Avios
36 months
Emirates
Expire in 36 months
Air China
Expire in 36 months
Qantas Airways
18 months
LATAM Airlines
Expire in 36 months
SAS
Expire in 5 years
Avianca
12 months
Virgin Australia
24 months
Air New Zealand
Expire in 48 months
Copa Airlines
24 months
El Al
Expire in 36 months

 

International airlines expiration policies are diverse. Most commonly, points expire after 18 to 36 months of inactivity. Several airlines have a strict expiration timeline where points will simply expire as early as 36 months, or as late as 60 months from earning date.

 

Expiration policies among international airlines may be converging closer to the standards of US airlines, however. In recent years, Avianca and Virgin Australia have reduced their expiration period from 24-months and 36-months of inactivity to 12-months and 24-months, respectively.

 

Implementing ASC 606 & IFRS 15

The ASC 606 / IFRS 15 implementation drove several key changes:

  • Removed inconsistencies from reporting
  • Improved the revenue recognition framework
  • Improved the comparability of revenue recognition practices across entities
  • Provided more useful financial statement information
  • Simplified financial statement preparation

 

Net liabilities increase with ASC 606

Effective as of December 2017, ASC 606 drove major revenue recognition changes for US airlines. Many airlines that were following an incremental cost model had to reassess their program liabilities with the deferred revenue model.

 

Company
Model Pre-ASC 606
Post-ASC 606 Result
American Airlines
Incremental Cost
Program Liabilities +216%
Delta Airlines
Deferred Revenue
Program Liabilities +53%
United Airlines
Deferred Revenue
Program Liabilities flat
Southwest Airlines
Incremental Cost
-
Alaska Airlines
Incremental Cost
Program Liabilities +39%
JetBlue
Incremental Cost
Program Liabilities +67%
Hawaiian Airlines
Incremental Cost
-

 

As a result, program liabilities increased across most airlines – primarily due to changing valuation models. Both United and Delta Airlines already followed a deferred revenue model. While United had very little change in liability numbers, Delta Airlines revalued and reallocated revenue categories to be consistent with the new standard.  

 

Slight increase in deferred revenue with IFRS 15

While many US companies experienced substantial liability increases as a result of ASC 606, international airlines didn’t see quite as significant a change under IFRS 15. Most experienced merely a reclassification of revenue, and many had no substantial change in reporting at all.

 

Company
IFRS 15 Changes
Air France - KLM
-
Lufthansa
Higher deferred revenue, reclassification
Avios
Higher deferred revenue; negative earnings impact
Emirates
-
Air China
-
Qantas Airways*
Revenue recognized earlier
LATAM Airlines
-
SAS
-
Avianca
Higher deferred revenue
Virgin Australia
Model change
Air New Zealand
Revenue reclassification
Copa Airlines
+9% liability
El Al
-

*In response to AASB 15 - Australia’s IFRS 15 equivalent

 

Copa and Virgin Australia both utilized a residual value model and shifted to valuing performance obligations at the relative stand-alone selling price. As a result, Copa realized a 9% increase in liabilities.

 

Similarly for Avios, the impact of assessing the stand-alone selling prices of the individual performance obligations has resulted in a greater portion of revenue being deferred on issuance, because the stand-alone selling price of the points was higher than the fair value applied under IFRIC 13. As a result of deferring more revenue, Avios experienced a material impact of 399 million EUR to retained earnings.  

 

Air New Zealand will present NZ IFRS 15’s impact on its financial statements for year ending 30 June 2019. Net impact is not expected to be material, but revenue will be reclassified from “other revenue” to “passenger revenue.”

 

Avianca experienced a net increase to deferred revenues. Its loyalty program recognizes only one performance obligation, fulfilled upon redemption of customer miles. Previously, Avianca recognized multiple performance obligations for marketing, branding, and mileage redemption.  

 

Lufthansa’s deferred revenues will increase, with retained earnings being hit negatively by several hundred million euros. In response to IFRS 15, all of Lufthansa’s liabilities were reclassified as current: 1,237 million EUR was reclassified from non-current to current, while 532 million EUR was reclassified from deferred income to contract liabilities.

 

Finally, Qantas Airways will change revenue recognition timing, as well as temporary earnings reductions. For Qantas, AASB 15 (Australia’s equivalent to IFRS 15) provides new guidance for points that are expected to expire unredeemed, which results in revenue being recognized earlier than under current accounting standards.

 

Conclusion

Frequent flyer programs have a material financial footprint on the balance sheet, with the largest programs tying up several billion dollars in deferred revenue. But these liability amounts are based on estimates, and small estimation errors can drive income impacts of tens of millions of dollars.

 

Furthermore, for the average airline, over 40% of these liabilities will be recognized within the next twelve months. This can create a potential cash flow challenge if many of the redemptions are for partner rewards. On the other hand, over 50% of these liabilities won’t be recognized for twelve months. Financially savvy frequent flyer programs can use the free cash flow created by this delayed fulfillment to invest in the program or other assets to generate additional value.

 

Finally, while these liabilities are substantial, it is important to place them in the appropriate context. Focusing on the costs in isolation is suboptimal and will result in suboptimal business decisions. It is critical to remember that the value generated by rewarding customer loyalty can be massive and will almost always outweigh the cost.

 

The best metric to truly assess a loyalty program is customer future value, which considers both the cost and the benefit of giving rewards. Unfortunately, this metric is not often calculated, and it's certainly not disclosed in financial statements.

 

 

Applying these insights to your program

 

In our second piece examining loyalty program benchmarks, we examined 20 top airline companies.

 

A clear takeaway from this look at publicly available financial statements is that the cost of these loyalty programs is substantial, with liabilities capable of reaching billions of dollars. Even a small change in breakage estimates can drive an income impact of tens of millions of dollars. Given the financial materiality, it is essential that stakeholders have confidence in the deferred revenue balances on the books.

 

Perhaps the most important takeaway, though, is that loyalty programs generate a tremendous amount of value. For many companies, the marketing revenue accrued from selling points can be considerable, upwards of several billion dollars. In addition, significant revenue is generated through the sale of flight tickets to members – for Air China nearly half of its revenue came from program members.

 

What this means is that a loyalty program represents a massive lever to drive financial value, influencing millions or even billions of dollars in future purchases. Unfortunately, effectively using the program to drive this value can be difficult without the proper analytics. For most companies, the program liability is a very visible metric, but the marginal revenue received for holding this liability is less tangible. This can often lead to a focus on cost minimization rather than value maximization.

 

A full picture of the value of your loyalty program includes projections of future revenues net of future costs, also known as customer future value. KYROS Insights builds tools to make it easy to quantify customer future value, allowing you to properly assess cost-benefit trade-offs and ultimately make decisions to unlock the untapped financial value in your loyalty program.

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Len Llaguno
By Len Llaguno
Founder and managing partner of KYROS Insights. I'm an analytics nerd and recovering actuary. I use machine learning to help loyalty programs predict member behavior so they can identify their future best customers, and recognize and reward them today.

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