Working in Airline Loyalty, Part 2: Airline Economics

In my previous post about what it’s like to work in Airline Loyalty, I covered off what it’s like to work for an airline, and in particular, WestJet.

Today, I thought I would shed light on some of the knowledge that someone should possess if they want to be successful within a loyalty department. This is of course subjective and solely based on my experience at WestJet, so your mileage may vary depending on your role and the airline you work for.

Because of the somewhat heady nature of these topics, I’ll focus on one subject at a time. Today, we focus on Understanding Airline Economics.

Basic Understanding of Airline Economics

Even though you are seeking a role within the Loyalty department, you would do well to understand how airline economics work, because it directly affects what you can and can’t do.

One of the most important aspects is understanding the idea of “distressed inventory” when it comes to airline seats and the specific role that business travellers play.

Price Elasticity 

To prime you for a better understanding of this, we need to first understand the idea of price elasticity.

Non-essential goods are typically elastic, meaning that as soon as prices go up, demand goes down. Non-essential goods can be described as goods or services that you can live without, such as the latest iPhone or premium credit card on the market.

On the other hand, essential goods such as water are typically inelastic, meaning that no matter the cost, we as consumers tend to be willing to pay that cost.

Price Sensitivity

Your next question may be: “Is travel considered to be elastic or inelastic?” Well, that depends on who you are and what your price sensitivity is.

Think about the price of a Big Mac as an example. At the time of writing, a Big Mac costs $5.59 (CAD) and economists at McDonald’s have carefully examined all the factors that play into the cost of the burger in addition to how much profit each burger should generate and they have weighted that things against demand.

If McDonald’s suddenly changed the price of a Big Mac to $49.99 per burger, many would simply stop purchasing the burger because they are price sensitive, meaning that the price of the item largely determines if you are willing to purchase it.

Now, even at $49.99 per burger, there are some people that are so in love with the world-famous sandwich that they are willing to pay the exorbitant pricing that McDonald’s economists have conjured up. Those people are considered price insensitive.

Price insensitive customers are driven by factors other than price. In this example, perhaps it’s a way to connect with an NCAA National Football Championship Team and show them that you’re the “cool” president and that you “get them”.  

Leisure vs. Business Travellers

In a very broad-brush classification, we could say that leisure travellers (i.e., those travelling for fun) are price sensitive. If the cost of a flight to New York is too high, they will either wait until prices are more attractive or simply not fly.

Business travellers, however, are largely price insensitive. If there is an important contract to sign in New York and the only time that works to consummate this arrangement is tomorrow, the business traveller will look for any flight that will get her to New York in time, regardless of the cost. 

Why Does This Matter?

I’m sure you have gone into your local grocery store and seen a sticker for a dollar off a 4L of milk. That’s because if the store doesn’t sell it before it expires, it’s a sunk cost, so it behooves the grocery store to liquidate its inventory.

However, airlines don’t work in the same way. The value of unsold airline tickets also goes to zero as soon as the plane takes off, but they aren’t priced the same way as other time-sensitive commodities like milk.

As you get closer to the date of departure, airline tickets go up in price rather than down, which may be counterintuitive at first – but it makes sense if you think about the business traveller. If an airline reduced costs as it got closer to the day of travel, it would not be able to capitalize on the price insensitivity of business travellers. 

Essentially, airlines are gambling that the high price that a business traveller will pay on a close-in flight will generate more revenue than if they reduced the price and a few leisure travellers booked the seat last-minute. 

Also, remember that leisure travellers tend not to be all that flexible. So even if an airline reduced prices for last-minute tickets, how many seats would they sell to leisure travellers? Probably not that many.

Distressed Inventory

The seats that are left unsold 1–2 weeks out are considered “distressed inventory”, meaning that they are unlikely to sell. Still, as discussed above, airlines are not willing to discount these distressed inventory seats because there is the potential that a business traveller may pay a premium for those seats.

So, what do you do with these distressed inventory seats?

Airline Loyalty Programs to the Rescue

If an airline cannot discount its distressed inventory seats but they want to get some value from these seats, what options do they have? Well, the answer is to release these seats for points redemptions. 

If you’ve been in the game a while, you’ll know that there are some airlines that are better at this than others. Lufthansa, Cathay Pacific, and Emirates come to mind as airlines that release plenty of close-in availability for points redemptions.

This form of active inventory management allows the airline to unload distressed inventory seats at a steep discount, but without actually making the discount transparent.

As these seats are available for points redemptions, most of the public (except you fine readers) don’t understand that the points redeemed are a mere fraction of what a cash ticket would cost.

In this fashion, an airline loyalty program allows airlines to unload seats without letting the public know that the seats are deeply discounted.

Loyalty vs. Revenue Management

When you work for an airline loyalty program, your primary business partner is Revenue Management, also known as “RevMan”. 

RevMan’s primary objective is to increase revenues for the airline by whatever means at its disposal, but because many airlines are driven by quarterly results, short term results are the name of the game.

That’s in direct conflict with the goals of the Loyalty department. Our goal is to also increase the revenues of the airline, but our outlook is much longer-term.

If you think about how much time the average loyalty program member requires to earn enough points or miles to redeem for a flight to Europe, you’ll understand that the work of the Loyalty team must reflect a great deal of patience, as it can sometimes take years to build that loyalty.

My Experience Working with Revenue Management

Much of the success of any airline’s loyalty program is determined by how well they can work in tandem with Revenue Management, even though the two departments often have competing agendas between short-term and long-term goals.

Indeed, my day-to-day work in the Loyalty department often required thinking about how we could achieve both the short-term and long-term goals of the airline with RevMan. But to be honest, it was always difficult to pull the attention of the Revenue Management department away from the quarterly results. 

As a result, many of the initiatives that I wanted to implement to improve the WestJet Rewards loyalty program often failed to materialize.

As an example, I had built a redemption chart that would allow for the combination of partner flights (Delta, Air France/KLM, Qantas) with WestJet flights, but Revenue Management was unwilling to agree to a set price for the WestJet portion of the redemption because there was no certainty as to where the flight would originate from.

RevMan continued to push for a dynamic award chart to recuperate costs, while I was pushing for a fixed redemption chart to provide value to WestJet customers. Unfortunately, a compromise could not be worked out.

If your Revenue Management partners cannot understand the value of unloading seats that will simply fly empty without loyalty redemptions, it’s going to be very challenging to get much done. 

Conclusion

I’ve only scratched the surface of airline economics, but I’ve tried to give you at least a working knowledge of what drives some of the decisions made by an airline loyalty department and the complicated interplay between two competing goals: short-term and long-term revenue generation.

Next up, we’ll talk about credit card acquisition channels and the ways we try to affect behaviours.