Ever wondered how much airlines compensate each other for award tickets?

What a coincidence, so have I! While I don’t know the answer, I will share my thought process. I’m sure someone that works in the alliances division of an airline somewhere will be laughing their rear off at my analysis, but I’ll provide it nonetheless.

I ask this question in the context of international premium awards. Can the airlines really be making money off of them, especially those airlines with massive mileage arrangements either with a co-branded credit card or a transfer partner (which is basically every airline nowadays)? Take Air Canada’s spun-off Aeroplan, for example. I converted 240,000 American Express Membership Rewards points to Aeroplan miles, which I used to book two crazy first class awards.

While I don’t know how much Membership Rewards compensates Aeroplan for the miles, I’m guessing it’s less than a cent a mile, probably closer to .75 cents per mile, so around $1,800-2,400 for 240,000 miles. For that we got two first class tickets to Europe and Asia on multiple world class airlines in some very comfortable suites. But of course that’s not the typical redemption. The airlines count on passengers using miles at the “standard” level with huge fuel surcharges for their own flights that would go out with empty seats otherwise, or sometimes even see transferred miles expire.

But this does raise the question, just how much are the airlines paying each other when it comes to partner awards? In other words, how much did Aeroplan have to pay United, Swiss, Turkish, and Thai Airways for my first class award ticket? I’m betting it’s way more than the amount Membership Rewards paid Aeroplan for those miles. I think it’s safe to say that the cost has something to do with the complexity of the ticket. In this case I would guess that Aeroplan had to pay somewhere in the ballpark of $2,500-3,000 per ticket. It’s a guess I’m pulling out of thin air, but it seems about right for a first class international award. The amount has to be enough for airlines to be encouraged to release first class award inventory, while not being so much that the airlines can’t afford to pay (minus United, of course). I’m guessing coach awards are substantially cheaper, probably around $400-500 per ticket to Asia.

Long story short, regardless of the angle from which I look at this, airlines must lose money on complex partner first class awards, even if they’re generating revenue from a transfer partner. Of course they’re totally cashing in on basically all other types of awards, which is what makes these programs such cash cows.

Comments

  1. Most airlines value miles at 0.5-0.8 cents per miles, and its the estimated fair value of the liability from an accounting stand point. It’s valued that way because its the cost to the airline on an average spending pattern. You obviously spend your miles mch more wisely than the average frequent flyers, but airlines has to set policy for eveyone.

    Partner awards has to be one of the more costly redemption methods as far as the airline is concerned. However i highly doubt airlines simply pay each other for the awards seats, since they are in an alliance, they probably have some sort trade off program where for example a Thai passenger flying on AC cancels out an AC passenger flying on Thai at some crazy exchange rate. If there’s no “Surplus” or “Deficite” of award redemption between the airlines, it would be as if the passenger awards were taken on their own airlines.

    And when there is a “Surplus” or “Deficite”, I don’t think the airlines simply pay with cash. I was looking through the financial statements of some airlines, and i saw in a disclosure that a majority of the liability of “miles” are not to passengers, but to other airlines. It then gose on to say that airlines buy miles from eachother, many times at the “fair value” and i’d imagine there’re also other situations where airlines give miles to each other to use in a situation like this.

    And when i comes to creditcards, i pretty sure the only party making a loss is the store owners accepting them, and maybe the consummer. I’m fairly sure creditcard companies pay way more than 1cpm for the miles they give out. When you think about it, many credit cards now days give 1 or 2 cents in cash back to customers, and they can charge as high as 6% of the store’s revenue from the creditcard. The bonus miles they gave could easily be repaid by the credit card company charging the airlines less when a customer uses their credit card to buy a ticket from that airline.

    BTW, how did you get so many membership rewards anyways, are you one of those people that buys $500 worth of presidential coins every week just to deposit it back to your local bank? If you are, i don’t blame ya, i would do that too if i lived in the states.

  2. A related question – how much do airlines compensate each other for interline segmentson the same ticket? The non-stop vs connecting fares are usually the same, its often just the taxes that vary. Yet there are costs that each airline incurs in a connecting fare involving multiple carriers, and the interline agreements must be (very complex) arrangements on how to compensate one another.

    AA will sell you an interline ticket BCN-(BA)-LHR-(AA)-JFK. They will also sell you BCN-(BA)-LHR-(AA)-DFW. In both cases, AA has to pay BA some portion of the fare. But, how is BA paid? I can see at least 2 ways (although in reality it must be much more complex):
    1. The same fee for BCN-LHR regardless of destination. This would be based on fare class etc, but would not differ by the eventual destination.
    2. An allocated percentage based on how much of the trip is being provided. (The total fare is allocated to the two segments, and presumably BA gets a lower portion of the DFW passenger’s fare since they only provided 15% of the 4666 miles traveled as opposed to 17% of the 4165 miles. The percentage may not be based on actual distance traveled, but some other similar concept – it could just as easily be percentage of time, for example)

    This gets more complicated with different routings. You could travel BCN-(BA)-LHR-(AA)-BOS-(AA)-JFK for the same base fare, pay the extra taxes, and now each airlines’ allocation of the revenue would presumably change.

    Airlines must calculate the profitability of each segment and must be incentived to take people on the most direct routings, but they don’t seem to incentivize passengers to do so. I am guessing that is because that could cause passengers to take a more direct routing on a competitor, but there must be some break-even point?

    I know I’m asking questions not offering answers, but I would not be surprised if the airlines applied the same interline revenue sharing models to award tickets, maybe just using different cost-per-flight or cost-per-trip multipliers. And, presumably there’s some (complex) bartering going on as they carry one anothers’ passengers.

    You’ve asked a very interesting question, if you learn more would be eager to hear about it.

  3. I’m sure as you said it’s a bit of a loss when somoene redeems for premium cabins on partner airlines. I think most people don’t redeem that way so it more than balances out. My family for example redeems their hard earned miles for coach tickets that they could already buy at a huge discount for cash. They actually use rewards for trips like SAN-OAK in coach! And they think I’m crazy for wanting to use my miles for international tickets in premium cabins. My parents fly all over the world constantly, but they continually jump from airline to airline just to save $20 on a ticket and then my mom complains that she has no status and doesn’t get any free upgrades.

    I think most people are that way, which actually makes the airlines GAIN money on most award redemption. The exception of course being the rare (sometimes forcibly rare ie. starnet blocking) cases where people redeem for premium cabin international tickets.

    I’m sure even United GAINS money overall on mileage plus in general. It’s just that Tilton and friends are so good at squandering the company’s money. Honestly through most of my mileage running the flights have had every single seat filled, service has been cut to almost nil even in first class, and the staff are being laid off left and right and the ones who stay make very little money. WHERE is all that money going? Oh right, $16 million salaries for execs and $86,000 country club memberships, extremely poor fuel hedging, and expensive poorly targeted advertising. Also pissing off customers and front-line employees i’m sure doesn’t help either.

  4. I think one point to be made in United’s defense is that Mileage Plus is the largest FF program in the * Alliance. So they would pay out almost every monthof every year without *net blocking.

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