How Much Airlines Compensate For Award Tickets — Some Insight?

Over four years ago I wrote a post speculating what airlines compensate one another for award tickets. If you’ve ever redeemed an award ticket, especially for travel on a partner airline, I’m guessing you’ve asked yourself just how much the airline with which you’re redeeming miles has to pay the airline on which you’re flying.

Admittedly cash probably isn’t actually changing hands with every transaction, in the sense that there’s some balance — US Airways Dividend Miles members may earn and redeem miles on United, and the opposite is true for United MileagePlus members on US Airways. So my guess is that it gets pretty close to “balancing out” for many carriers when it’s time to pay up.

But that didn’t stop me from speculating how much airlines are compensating one another. My general thought process was that it had to be enough for it to be worthwhile for an airline to release award space, but nowhere near the cost of an actual seat in that cabin. For example, why else (at least until recently) would Cathay Pacific release two of their six first class seats for award redemptions right when the booking window opens? If they’re getting $100 for a seat on a longhaul I imagine they wouldn’t. I think the question gets even more interesting given United’s recent devaluation, whereby they hugely jacked up redemption rates on partner airlines (which suggests they’re disproportionately expensive compared to booking their own flights, where award passengers could theoretically be displacing revenue passengers), so there’s a potentially high opportunity cost there.

At the time I speculated as follows (and yes, this was during the good old days when Aeroplan had an attractive award chart and no fuel surcharges on partner carriers — oh, how times have changed):

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.

So it appears as if I may actually have an interesting data point to share. I was talking to a friend last week that was able to take advantage of the Singapore Airlines premium cabin booking glitch from last July. As some of you may recall, those that booked a route in first class that was later switched to an A380 got booked in Suites Class, which is the first class equivalent on the A380. However, due to the way the rebooking happened, passengers got rebooked in a revenue fare class, since there wasn’t a corresponding award fare class at the time.

What’s interesting in this case is that my friend had his KrisFlyer account number on the reservation for a one-way San Francisco to Singapore flight (via Hong Kong), and KrisFlyer has a revenue calculator in terms of qualifying for PPS Club status. In this case the one-way Suites Class flight posted ~$1,300 in revenue towards PPS Club status. So it could be a coincidence or not actually significant, but that’s exactly in the range of what I predicted redemption costs would be over four years ago.

Admittedly it probably varies by airline and route, though I found it an interesting data point as it’s the first time I’ve seen any concrete number.

What do you guys think? $1,300 for a one-way first class redemption between the US and Asia sound like what you were expecting?

Comments

  1. If they were booked in a revenue fare class, shouldn’t the qualifying revenue show the actual cash fare? Does the computer keep track of different cash fares in the same fare class?

  2. Curious if there was a YQ in there, since UA MP members don’t have to pay but SQ Krisflyer members do (ie does the program have to pay it).

    91K SQ points for that same flight but there’s a few hundred dollars in carrier surcharges.

  3. Since I no longer work for a particular company with access to this info, I will say that, for example LH yields about $300 on an O-bucket ticket one way from JFK to FRA, and about $60 in the X-bucket. I’m recalling this from memory but I believe those are the rough figures from 2 years ago.

  4. @Ex 1A That seems way too low. Think about it: even the marginal incurred costs of carrying that first class passenger have to exceed that (fuel, but then top-shelf champagne, caviar, meals, etc). Why would there be any incentive to release space on a route for $300 in compensation when they are spending $300+ just in marginal costs?

  5. @Ben Hughes: “Why would there be any incentive to release space on a route for $300 in compensation when they are spending $300+ just in marginal costs?”

    Have you noticed that LH releases hardly any first class award seats anymore? And in fact they will soon stop doing so to all but their own elites? Maybe the poor compensation they’re getting is the reason! (Or one of the reasons.)

  6. @ snic — Well that’s also largely a function of the fact that they shrunk their first class cabin in half on all their 747s. Back in the day they’d regularly release half of the cabin to award seats in advance, so I have a hard time imagining they were being paid that little back then.

  7. the YQ should serve as a floor of how much they need to send to each other

    UA now wants 110K mile each way SFO-FRA on LH F

    even assuming *worst* case of 0.5cpm, that’s $550 + $200-300 YQ, so UA should be remitting ~$800 for that ticket ?

    $60 for one-way US-Europe on X ticket would bankrupt airlines – that doesn’t even pay for the fuel

  8. I have access to such data. Ben I can give you some specific stats if you send me an email.

    General Examples: A long haul in LH F (think Germay-Asia/South America) costs UA around $1000, medium haul around $5-600

  9. Yeah it really is that ‘low,’ but keep in mind this is a revenue management calculation and I don’t know how it’s calculated. It might be O&D or it might be the average amount for that segment, regardless of the whole itinerary. I never asked, I just remember seeing that column with $$$ figures.

  10. When I worked for AA, the standard F charge was 250 each way, 150 J and 60 Coach to Europe. But that was until 2003.

    So Ex 1A may be close.

  11. For those questioning the “low” figures, you must recall that this is distressed inventory, a lot of sunk costs and low unit costs for all the little things you believe must be costing the airlines a fortune. You may be willing to pay in cash at these rates but of course you can’t and it’s precisely because of the opaqueness the compensation is closer to marginal cost and not retail price, think Priceline.

    Must not also forget that the airlines are also constantly paying each for codeshares, earning from partners, shared operations, and JVs, in the long run the redemption seats are only a sliver of the bigger operation, although any imbalance hits the bottom line hard!

  12. I’m curious how the service fees work–if UA charges me to cancel a ticket, does some of that cost go to the operating airline? If not, wouldn’t they be annoyed if you cancel only hours before a flight with no one else to take the award seat? But on the other hand, airlines have such varied fee structures I can’t imagine there’s a uniform system.

  13. The realizable value of an empty seat the moment after the door closes on the airplane is zero. The marginal cost incurred by the airline is just the actual cost of servicing a live passenger over leaving the seat empty. That is basically the inflight service since the airline can’t reduce staff since there is always the possibly of a last minute booking.

    Assuming $50-100 for the food and perhaps a bottle of booze that otherwise wouldn’t have been opened except presence of the passenger traveling on the award the result is marginal income net of marginal costs of over $1000/passenger. All of that is profit and goes directly to the bottom line since all other costs are sunk i.e. have to be paid whether the passenger flies or not.

    Check out airlines total profit per flight. Filling a couple of seats that would have flown empty at $1000-1200 a pop can make all the difference. The key is to make sure that only seats that would have flown empty are filled in this manner and are only filled by passengers who otherwise wouldn’t have bought a ticket on your airline.

    The first of these is rather straight forward to handle. The latter is all but impossible for reasons too complex to go into here.

  14. I think Steve and Ex1A are both likely right.

    It is much lower than you expect, and that is because the seats have little value and little marginal cost.

    1)
    2012 int’l load factor for UA for 81%. There are seats going out empty (obviously I can’t separate F/C/Y…), so almost any revenue is going to be value added to the company. (Basic capex decision making, right? Just because the return is below your cost of capital, doesn’t make it bad – it is vs the alternative that matters. If Marginal revenue > marginal cost… and there isn’t a competing offer, you go.)

    2) There are old FT threads that put the marginal fuel cost very low, likely $50 for transatlantic…

    Thus..$60 for Y, and a few hundred for C/F seem perfectly reasonable for covering marginal costs.

    Steve is right on… it is all based on the idea that idea that the revenue is replacing $0, not a customer that would have paid for the seat.

  15. @alan: “…it is all based on the idea that idea that the revenue is replacing $0, not a customer that would have paid for the seat.”

    Exactly. On the surface, then, it’s hard to understand why LH would shut everyone out of FC except for paying customers and their own elites. However, if by doing so they increase the perceived exclusivity and luxury of the product, presumably more people will actually pay for it, and in the end LH will generate more revenue than from selling these seats to their *A partners for award redemptions.

    There may be something to their logic. The alternative for a customer who is willing to pay for LH’s FC is either another airline’s FC or a private plane. By limiting paying FC customers’ contact with the unwashed masses in every way (FC terminal, private cars to the plane, exclusive check in, etc – and now not having to set next to ME!), LH FC becomes more competitive with these other options.

  16. @Lucky I don’t have the same interpretation.

    PPS earning is based on fare. If the ticket does not have a fare attached (as it wouldn’t when rebooked from award) or is too complex for SQ’s computers to break out a fare for each leg, then PPS earning is based on default values given the flight, ticket origin, etc. This will have nothing to do with what FFPs pay each other for the flight because by definition it is a default value for paid fares.

  17. Snic, you hit the nail on the head. They see the free travelers and diluting the experience and I have to say, they’re right.

    My first F long haul was SFO JNB on Pan Am. There was a clear hierarchy in those days. The more you paid the sloppier you dressed (except for europeans who always looked snazzy). So the guys paying wore what they wanted, the businessman who had their companies paying wore sports jackets and the airline employees traveling free wore suits or dresses.

    In other words those traveling for less raised, not lowered the ambiance. Now its the reverse.

    Now don’t get me wrong I’m not saying that those of us on an award ticket are obligated to act some part, but if we did it would register at airline HQ. LH might be a lot more willing to open up last minute F seats if they knew they’d be filled with well dressed folks who looked like the models from the ads the run in Travel and Leisure. That would raise the perceived value of giving these seats away and enhance the ability of the airline to attract those paying retail.

    So maybe that’s the solution. Perhaps some innovative airline like EK will set up a system where we submit our resume are “hired” to play the part of sophisticated traveler. Those with the best “look” get first dibs on free space while those who thing they should be able to travel in shorts, a T shirt and Birkenstocks never see any availability in F at all.

    Give me a system like that and I’ll pull out all my old suits and dress the wife and kids up as well. For a discount ride in a Singapore suite I’m happy to play the part necessary to pull in the customers willing to pay full freight.

  18. How could it be $2000 for Europe Asia r/t when US Airways sells the miles needed for $1850 ? I’m guessing $300 as mentioned is closer.

  19. @ Nick — Well I’m sure airlines don’t make money on all mileage sales. I bet they lose money on a small percentage of redemptions, while the rest of the redemptions balance those out.

  20. @Lucky I don’t see how it’s possible for an airline to ever lost money on mileage sales so long as the seat redeemed would have gone empty anyway. Obviously they are going to have some times that isn’t true but so long as it a very high percentage then filling the seat with an award redemption is extremely profitable.

    Also remember a significant percentage of miles are never redeemed at all. That’s is totally free money.

    Finally remember that miles are sold now but the service is deliver later, often much later. That means the miles are a loan where not only is the interest rate is zero but the airline can unilaterally reduce the amount they have to repay by increasing the miles needed to redeem an award.

    Put these together and you can see how essential these programs have been to carrying the airlines through initially deregulation where had they not existed the legacy carriers would have been extremely exposed to the lower cost upstarts and the downturn, where they could raise financing at no cost by selling miles and then repay that financing with inventory that otherwise had no value.

    The problem as you’ve noted is they have way, way over issued their currency to the point where if holders redeem even a portion of it and even over many years there is no way for that to happen without cutting into inventory that could be sold. That is a real problem since from their inception these programs very existence was based on that not occurring.

    Like a third world nation that can’t repay its debts the airline with either have to inflate their way out of the problem, institute currency controls or default. We are already seeing both the former with devaluation of the award charts and the second with fewer and fewer seats being made available (effectively a currency control…you can’t use your funny money, miles, to buy anything).

    If you’ve watched a nation’s finances implode you know it takes time. This story has only begun to unfold. The only way out I can see is that people sit pat and keep holding their miles and as they die off or give up trying to redeem them money supply comes back into balance with the excess inventory the airlines realistically are likely to sustainably have. Unfortunately the temptation to keep issuing more currency is very high so its possible that will never happen and people will eventually wake up to the fact that the promise of redeeming their miles is a fraud and they’ll stop valuing them.

    If so perhaps in another 20 or 30 years these programs will be gone and only a memory to those of us who enjoyed their benefits.

  21. @Steve If that dynamic is at a critical point you’d expect to see a dangerously high ratio of (number of miles issued) to (redemption cost to fill all seats currently flying empty on airlines with frequent flyer programmes). I.e. I’d be particularly worried is the miles in issue could by all the empty seats going for years to come.

    The real concern for devaluation to me is that seats become more valuable to airlines as they run at higher yields from paying customers. If those seats are worth more $$$ then they’ll need for cost more RDMs.

  22. @Steve If that dynamic is at a critical point you’d expect to see a dangerously high ratio of (number of miles issued) to (redemption cost to fill all seats currently flying empty on airlines with frequent flyer programmes).

    I.e. I’d be particularly worried if the miles in issue could buy all the empty seats going for years to come! I doubt we’re there but I’d be interested in the numbers and especially interested in an historical graph of them. Some chance, but maybe someone has a snap-shot estimate.

    The real concern to me is that seats become more valuable to airlines as they run at higher yields from paying customers. If those seats are worth more $$$ then they’ll need for cost more RDMs.

  23. Given the plethora of cheap J fares we are seeing recently to some perhaps oversupplied markets I am beginning to wonder if using points actually is the best approach. In my particular case, though, the long hauls are usually from SEA to CPT which is not a well supplied route and obtaining even reward seats is difficult and getting much more expensive. 150,000 miles return is almost $4500 at a cost of $.03 per mile at regular rates. Purchased fares are occasionally available at that price point but often are not as flexible in routing/stopovers etc. With EK taking themselves out of the J/F picture with their change in March (and EK Y is never an option) the inventory is slowly sinking.

    It looks like we are seeing the end of the golden age of reward travel.

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