Late last week, Atlanta-based Delta Air Lines announced a change to its SkyMiles frequent flyer programme (FFP) in which members will now have to meet minimum revenue requirements in addition to minimum distance requirements in order to reach an individual tier for so-called “elite status” in the SkyMiles programme. These various tiers of elite status offer progressively increasing benefit levels, including such perks as free checked bags, extra earnings of frequent flyer miles, streamlined check-in and security lines, benefits when flying SkyTeam partner airlines, lounge access when flying internationally, and more.
“Starting January 1, 2014, Medallion status will be earned with MQMs or MQSs and a new threshold – Medallion Qualification Dollars (MQDs). MQDs will be paired with our existing MQM/MQS requirements at each tier level and will include base fare and applicable surcharges (excluding taxes and fees) to qualify for each level,” the world’s second-biggest carrier said in a statement.
In order to become a Silver Medallion member, a passenger will have to gain 25,000 MQMs or 30 MQSs and $2,500 MQD; and 50,000 MQMs or 60 MQSs and $5,000 MQDs for a Gold Medallion member, whereas for becoming a Platinum Medallion member, 75,000 MQMs or 100 MQSs and $7,500 MQDs are required while 125,000 MQMs or 140 MQSs and $12,500 MQDs are required for becoming a Diamond Medallion member.
Predictably, the addition of a revenue-based qualification requirement to Delta’s has many in the online frequent flyer community in an uproar, with several of them complaining about the increased difficulty of qualifying for status on Delta Air Lines. It is precisely these types of customers, who qualify for higher tiers through one or more of these “mileage runs” that Delta seeks to stop rewarding, in lieu of rewarding its more profitable customers.
Image Courtesy of Delta Air Lines
“But from revenue perspective we are looking at the evolving SkyMiles to be better loyalty program for its customers and drive the type of customer behaviour that we would like to encourage in the future. So, I think before we didn’t discern between a customer that was a high yielding customer versus a low yielding customer and I think as we continue to evolve those programs, we will be continuing to favor the higher yielding customers over lower yielding customers,” Delta Air Lines chief executive Richard Anderson commented on the carrier’s fourth quarter earnings call.
Yet despite this rather clear description of the goals of the programme, several vocal criticisms of Delta’s decision have surprisingly emerged from the financial press, including an editorial from Fortune magazine.
The most important customers for any full service carrier are high-yield business travellers, flying either on corporate contracts or paying out of pocket for essential travel. These are an airline’s highest yield customers, who have a low degree of price sensitivity and a great degree of customer loyalty in certain cases forced because of corporate contracts, and in most cases their travel spending on Delta flights will already exceed the Medallion Qualification Dollar (MQD) limits for the various levels of elite status; especially because such travellers typically purchase fares in the highest fare bucket for each class of service, which earn much higher MQDs versus discounted tickets.
From Delta’s perspective, such customers are absolutely the most profitable and thus the most deserving in its eyes of qualification for elite status and the benefits while traveling Delta and its SkyTeam partners that stem from such status. Delta has made a conscious decision to shift its business strategy towards its most profitable customers which can be seen not only in its changes to SkyMiles, but also in its other moves, such as product investments in lie-flat business class seats and in airport facilities for key strategic markets such as New York City. There are pros and cons to this strategy, but unlike the Fortune editorial, which claims that, “Delta (DAL) seems to be forgetting exactly what frequent flyer clubs are all about. They aren’t about rewarding people who spend the most money; rather they are about encouraging loyalty.” This is not exactly correct; Delta is seeking to redefine what frequent flyer clubs are about; restructuring their particular clubs so that it rewards the airline’s most profitable customers and engenders product loyalty in these travellers.
The editorial also claims that the change in status qualification will devalue the profits from the frequent flyer programme itself, which through branded partners generates huge amounts of revenues for Delta. But ultimately what drives the value of SkyMiles is the value of those miles themselves; the fact that they can be redeemed for travel on Delta is what ultimately drives their value. Miles earned through ancillary partners for the most part do not go towards elite status anyhow, and with slight tweaks, Delta will be able to maintain the profitability of ancillary miles irrespective of the new revenue requirements.
The one semi-valid critique that the editorial offers is that cheap seats purchased for so-called mileage runs, or in the pursuit of elite status represent excess marginal revenue; i.e. these seats would not have been filled otherwise.
“Many would fly just to rack up miles on the cheap, embarking on flights called ‘mileage runs’. Critics of frequent flyer programmes saw this as ‘gaming’ the system, but they are missing the point. That plane was taking off with or without that ‘lower-yielding’ passenger. Every seat taken up by a person doing a mileage run or by a leisure traveler aspiring to hit that lowest elite tier filled an empty seat yielding zero dollars,” the editorial reads.
It is true that the marginal profitability of such travellers is strong; the additional costs of adding one passenger onto a flight that would have operated regardless are minimal while the revenues are high. However, Delta is considering two important facts. The first is that these customers are primarily attracted by the cheap fares. Recent studies of customer psychology for air travel suggest that their purchasing decisions are primarily driven by price first, especially in the case of the leisure travelers cited in the article. Consider the hypothetical example outlined in the article:
“To make matters more complicated, those amounts are net of fees and taxes, meaning you will have to spend a lot more out of pocket than you think. For example, a 10-day roundtrip economy ticket from New York to London in February bought in advance on Delta.com currently costs US$826, yielding 6,902 MQMs. Today, to achieve Silver status on Delta, one would only need to fly that trip four times in a calendar year to hit the necessary 25,000 MQMs. But under the new system, passengers would also be required to rack up US$2,500 in MQDs to hit Silver.”
What Delta is betting on, in part, with the new strategy is that the customer will still be enticed to fly to London for the entirely reasonable fare of US$826, or fly Delta twice or thrice instead of all four times. The second fact to remember is that the marginal profitability of that fourth trip and of mileage runs in general for Delta is likely highly negative. For a fare of US$826, that customer now gets access to a myriad of benefits on Delta including upgrades, premier access, and extra mileage earning on his or her flying that could very well end up costing Delta much more than US$826. In fact, the profitability of those final “mileage runs” where a customer moves up into a higher elite tier is very poor from Delta’s perspective because of the added cost of one more next-tier elite. Of course, there is a chance that the move will affect Delta’s profitability by causing it to lose these customers entirely. But that is far from a certain outcome. Moreover, it is important to remember that the mass of lower level elite frequent flyers represent a small minority of Delta’s overall passenger base, while the customers who retain their elite status with little to no change represent a larger share of Delta’s profits.
Image Courtesy of Delta Air Lines
None of this is to say that Delta did not make any mistakes with the structuring of the programme. For example, it could have achieved a similar purpose by simply reducing MQM earnings for discount economy and business class fares; it would have achieved the same purpose of increasing the benefit to high revenue customers while making the changes to the programme less complex. Even under the structure of the current programme, Delta frequent flyers will not get any MQD credits for flights on Delta’s SkyTeam partners that were not ticketed through Delta. Since in the case of transatlantic joint venture partners Air France/KLM and Alitalia, Delta shares in the profits on these flights, this is a threat to the current hegemony of the SkyTeam alliance, and it remains to be seen how the upcoming frequent flyer deal with Virgin Atlantic at London Heathrow will fit into the changes to SkyMiles. Delta should also increase the benefits offered to each tier of Elite, such as better mileage earning and redemption rates or opportunities, more fee waivers, and other perks. This would increase the value of Delta’s elite status and replace some of the loss in marginal propensity to fly Delta because of the revenue qualification.
In summary, Delta’s shift to a revenue based qualification for its SkyMiles programme will have an uncertain effect on its profitability moving forward. With a few corrections, it could potentially increase customer loyalty amongst Delta’s profitable high yield passengers while suffering a manageable loss in marginal leisure customers. It could also turn out that the lost revenues outweigh the savings, especially if Delta’s fellow US-based full service carriers refrain from adding revenue requirements to their respective frequent flyer programmes, although several US low-cost carriers (LCCs) already have revenue-based frequent flyer programmes. But hyperbolic statements such as, “such a change could eventually lead to decreased load factors, diminished cash flows and the disintegration of Delta’s SkyMiles frequent flyer programme,” and, “by taking the elite carrot away from the little guys Delta thinks it is rewarding its big spenders, but it only seems to be putting the airline on a path to financial ruin,” are misconstrued. Delta is a well-managed airline, which has reported a non-GAAP (generally acceptable accounting practice) profit of US$1.6 billion in 2012 excluding special charges. It knows exactly how much each elite member costs and it will have set the qualification levels for elite status accordingly to reflect those costs and maximise profitability. The end effect of these changes to SkyMiles remains to be seen. But it most certainly will not be financial ruin.
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