Frequent flier programs were intended to create brand loyalty, particularly among business travelers, thereby creating a margin for competition other than price. Over the years, airlines have debased frequent flier miles as a currency by “printing money” — creating vastly more miles than they intend to allow customers to redeem. Airlines sop up these excess miles by unilaterally raising the “price” of frequent flier tickets, directly (by increasing the number of miles required to redeem) or indirectly (such as by restricting the number of seats eligible for awards). They have to be careful, though, because this undermines efforts to encourage brand loyalty.
The most recent restrictive practice in frequent flier programs is to award miles based not on mileage flown but on dollars spent. That has predictable effects on the market, and as a recent article shows, it exacerbates a longstanding conflict of interest between business travelers and the companies that pay them to travel.
Wall Street Journal columnist Scott McCartney reports (subscription; free access for 7 days):
Tension is growing between employers looking to rein in spending and business travelers who treasure their hard-earned frequent-flier miles.
Under new airline policies that reward travelers based on fares, not distance, fliers have incentive to book expensive tickets close to the departure date rather than plan ahead with cheaper advance-purchase itineraries. The Business Travel Coalition, a lobbying group of travel managers and travel agencies, polled 66 industry executives this week and found 84% believe the new way of calculating frequent-flier rewards will lead to higher travel prices.
Business travel has always displayed what economists call principle-agent problems. Decisions are made by agents (business travelers) on behalf of principals (entities paying for business travel). Principals want travel costs minimized; agents want travel to be comfortable and indirectly rewarding if possible.
This principal-agent problem is interesting because third parties are involved (the airlines), which have incentives to ensure that the problem never goes away. Rather, the airlines’ goal is to seek the optimum level of discord between principals and agents. Too little conflict between them means lower profits, but too much conflict threatens to destroy frequent flier programs as a source of revenue and brand loyalty.
Fare-based awards give agents an incentive to book travel late, when only expensive fares are available. McCartney gives two examples:
Southwest Airlines, which switched to fare-based rewards in 2011, offers 1,847 Rapid Rewards points on its $353 “Wanna Get Away” discounted fare, and 11,654 points on its $1,066 “Business Select” fare. Pay three times the fare and collect six times the points.
Starting next year, Delta Air Lines will pay four times as many SkyMiles on a $1,600 ticket as on a $400 ticket.
It appears that airlines are not ready to admit that their purpose is to encourage agents to purchase high-priced tickets. McCartney quotes a Delta spokesman:
“The 2015 SkyMiles program isn’t intended to change the behavior of a corporate or business traveler or to direct them to more expensive fares,” he said. “It will benefit the traveler who often is unable to book lower fares that require an advance purchase or who must book flights that have only higher classes of service available.”
The second sentence is an unremarkable truism that does not address the predictable behavioral effects of the new policy. Delta describes this change as “part of our ongoing efforts to improve your travel experience,” but that implies no frequent flier will be made worse off, which in Delta’s case is transparently untrue. To its preexisting mileage and flight segment requirements needed to earn elite status, for 2015 Delta will add spending requirements. All other factors held constant, Delta frequent fliers will have to spend more money (not fly more miles) to retain their elite status designations. This change unambiguously makes most Delta frequent fliers worse off, and it just as unambiguously reinforces the incentive provided by fare-based awards for agents to purchase more expensive tickets.
We can predict that corporate travel policies will now change to make it harder for travelers (i.e., agents) to steer airline ticket purchases in ways that jointly benefit themselves and the airlines at the expense of their employers. It will be challenging to devise strategies that effectively neutralize what the airlines are doing, but it is not impossible, and airlines have given travel managers good reason to try. The good news for them is that economic analysis is a two-way street: sauce for the principals also can be sauce for the agents.