Revenue-based programs don’t pass the Covid test

17 November 2020

Although only a minority (23%) of Frequent Flyer Programs has opted for a revenue-based model on the accrual side so far, many of them are about to discover the inconveniences of such a system – or even the hidden danger.

In harsh times like the current ones, you typically see a sharp drop of prices to lure the few remaining customers. Loyalty programs are to work against that tendency by offering a decision element beyond price.

So far for the simplified theory.

While some Frequent Flyer Programs, notably in the low cost space, started on a revenue-basis straight away, others have moved from a distance basis to a revenue basis over the last few years, creating something what many called, maybe in a premature manner, a trend. As a matter of fact, only 23% of programs work today on a full or at least a hybrid revenue basis on the accrual side and that movement has pretty much stalled. Many of these programs having moved to a revenue basis have probably never fully understood what they were doing – just following that presumed « trend » – and they are now waking up to reality in not such a pleasant manner.

There is no doubt that a revenue basis is appropriate for certain airlines, but the currency is at least as rigid as anything that was around before. So, if prices drop, customers earn less points. And long-haul customers (higher margins) tend to be better off with a revenue-based model than short-haul customers.

There is a logic to that approach in normal market conditions, but if overall fare levels drop across the board as there is tremendous overcapacity and long-haul travel is quasi non-existent, you’d better not reduce the loyalty benefits, which are still comparably cheap to airlines. The logic to punish a customer looking for a bargain doesn’t work anymore if airlines have to create such overall market conditions from their side in a battle for survival, which you can only win together with your customers.

Of course, you can still work with promotions, but to make them meaningful, you often need to go to extremes such as Lufthansa offering up to quintuple miles in its Miles & More program – raising though some doubts among customers how valuable the core proposition really is.

The limits of a revenue-based model on the accrual side become hence clearly visible. It is a model – for some – for sunny days, but probably not for anybody during Covid storms.

The situation might be even worse for programs having moved to a revenue-basis on the redemption side as well, whereby each loyalty points has a clearly defined redemption value. While dynamic award pricing pursues the same objective, it remains nevertheless more opaque for customers – and does not automatically include 1-point redemptions.

Again, that seems to be the perfect model in good times as it convinces by its sheer logic. On the balance sheet, it has the same impact whether a customer pays 1 USD in cash or whether liabilities are reduced by 1 USD.

But what is happening now? As soon as some news emerges questioning the future of an airline – see Virgin Australia or Thai Airways – a run on the bank starts since customers want, obviously, to redeem their hard-earned points before it is too late. With a traditional redemption approach, you can contain such behaviour to certain degree through controlling the inventory offered for redemption.

But a true revenue-based redemption, as practised by Norwegian, lets you use each point at a predetermined cash value – and like cash, i.e. without any capacity control. So, what would you do if, in front of the current news about the state of Norwegian, you had still some Norwegian points left and, moreover, the program didn’t offer any alternative redemptions? You’d try to burn them on a Norwegian trip as quickly and as long as you still can, meaning you’d deprive Norwegian of the so much needed cash. In tough times, cash remains though king as you don’t pay your staff and suppliers out of reduced financial liabilities. Making a simplified calculation that 50% of Norwegian customers are loyalty members (and all earn at the lowest 2% level) and excluding any points accrued with partners, Norwegian sits on liabilities of almost 50 million USD from the year 2019 alone. It becomes the perfect vicious circle.

As we start to see the light at the end of the tunnel, it obviously doesn’t make any sense now to touch on the currency chosen for your program. But there might be some interesting lessons to be learnt here for anybody in the industry since the one thing that we should all be aware of is that there will be a next storm in the industry. Until then, you should work on making your loyalty program the most flexible tool possible for all thinkable and unthinkable scenarios – whereby the choice of the currency you base it upon is a decision with a major impact.