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Loyalty trends and best practices

Should You Shift to a Spend-Based Program? Lessons Learned from American Airlines and Others

by Arif Damji
August 05, 2016
Should You Shift to a Spend-Based Program? Lessons Learned from American Airlines and Others

As of August 1st, American Airlines changed the method by which its (roughly) 100 million members earn miles on their airlines. Instead of the number of miles flown, as was the case for the past decades, it has now shifted to a spend-based model that is built on multipliers applied to the base fare purchased. As United and Delta made this move in 2015, we now have over 250 million members in the airline space earning miles based on spend. High spenders have been rewarded and we see a more transactional style of program becoming prevalent. In fact, the real lesson for other programs is not to simulate the same structure, but to understand the motivation and best practices apparent in these changes. Today, we’ll explore why the airlines made these changes, and what it could mean for those who run loyalty programs, are responsible for the P&L associated with their programs, and are concerned about currency liability and investment optimization. These lessons could apply to many brands, across a variety of industries.

 



Last mover of the big 3? Delta and United both transitioned their loyalty programs to become spend-based in 2015.

Why do we think AA made these changes?

There were a number of changes made to the American Airlines program this year, but let’s focus on the two changes that moved the program to more of a spend-based model:

  1. ”Miles Earned” changed to a model determined by base fare  (with a multiplier for tiers) from being based on miles flown (with a multiplier for tier and class of service). This is the move that United and Delta made in 2015 and their respective approaches are similar.

  2. Upgrades have a secondary prioritization based on the total spend of that member in the last 12 months, applied after the initial prioritization based on tier.  For some, this may not seem relevant, but increasing the link between upgrade clearing and higher spend (beyond just tier) is actually a further progression than other airlines have taken towards a spend-based model (United is based on time and class of service).

Before we dig into rationale, let’s clarify that in the travel sector, many loyalty programs are run with their own P&L and ROI expectations. Some in the industry still claim that programs have limited means of being profitable, but in the past we have seen three spin-offs of programs into separate successful companies: Aeroplan, Multiplus, and Smiles.

A company that runs their loyalty program as a business unit has the obligation to make ongoing changes to increase their program’s profitability.  For AAdvantage leadership, it may have been that incentivising miles flown was not enough of a correlator to profitability compared with revenue. A relevant example is where leisure travellers conduct unprofitable mileage runs and earn the same number of miles as last minute business travellers. The shift to a spend-based model helps to keep these business travellers well-compensated, and with limited risk of alienating deal-seeking Leisure Travellers who no longer have viable alternatives across the big 3 US carriers.

In the end, one simple test to understand the profitability implications of a spend-based program is to measure the differential between the high and low spenders (known as the “Member Spend Gradient”).  If American Airlines’s top business spenders are worth 10x+ of low spenders, and they didn’t shift their value proposition and earning strategies, they would risk losing business travellers to competitors in specific markets.  Profitability couldn’t be retained by just acquiring lower spending customers.

So as a senior leader managing a program in another industry, what should you take away from these changes?

The first lesson is not to assume that a transition to spend-based loyalty will be effective for your program in your industry.  Loyalty program design must be tailored to your objectives, customer-base demographics, brand positioning, and industry expectations.  However, there are a few lessons that can be gleaned from this recent shift.  Here are a few starters:

  • Run your loyalty program as if it were a business unit with P&L responsibilities:  One of the most damaging methods of running a program is to treat it as a cost center for your business. Many companies still see loyalty as a part of their business that supports others, but without any clear attribution or expectations on how it should be run profitably.  American Airlines, and many other airlines, treat their program as generators of profits that areexpectedto use a spread on points, negative working capital, and breakage to drive ROI.
  • Ensure that your best members are being retained and understand the “Member Spend Gradient” of your membership:  In many businesses, the difference between top and bottom spenders is 2 or 3x, and sometimes more.  This is especially common in retail and CPG.  Other industries, like B2B and financial services, see the difference at 10-50x. The latter is true for airlines, and was one of the drivers of this decision. If you have a high differential, you need to ensure that the top spenders are proportionally rewarded. Once the other airlines had moved to a spend-based design, American Airlines’s risk of losing frustrated business travellers grew by the day.
  • Be thoughtful in your communication strategy for changes to your program:  One other lesson here is the process by which you announce changes to your loyalty program.  American Airlines’s gave 2 months notice for this change and their prior announcement was 8 months before. Changing some elements of the program at least every year or two is necessary for continuous optimization. Make sure that you give sufficient notice (at least a month) but not too much (over 1 year). You don’t want a repeat of the frustration caused by Delta’s “hidden” devaluation in October 2015.

We know that the lessons here are just a fraction of those available from the last few years of announcements and changes, but we hope it provides some actionable guidance. If you’d like to know more on our thoughts regarding wider announcement strategies, game theory behind timings, or even necessary financial modelling approaches (including how to build “Member Spend Gradient”), please reach out to me at adamji@merkleinc.com.


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