A brief history and overview of frequent flier programs
Origins
The first frequent flier program started back in 1979 in my home state of Texas, by Texas International Airlines (which was later acquired by Continental, who eventually merged with United). The program started in the conventional way you probably think about frequent flier programs: you were rewarded frequent flier miles for the exact amount of miles that you flew. Airlines wanted to incentivize fliers to only use their airline and not other competitors (i.e. brand loyalty!) They gave perks that are very similar to today, such as miles that you could redeem for flights, free checked bags, priority boarding, etc.
Even though Texas International Airlines was the first to launch an official frequent flier program, American Airlines was the first major carrier to launch a program in 1981, AAdvantage, which is still active today. With far superior computer technology and global reach compared to Texas International, the AAdvantage program created the foundation of how frequent flier programs look today. Other airlines all across the globe quickly followed suit, including United, which launched a short while later. A major difference between then and now was that a passenger had to be invited to become a member of AAdvantage. This aspect is no longer the case.
As you could imagine, customers were quick to jump on the frequent flier bandwagon, as they were rewarded with “miles” that could be redeemed for free tickets, seat upgrades, and other travel perks. (Why has this proven to be so successful? There’s something in the human psyche that has a drive to reach goals and even tiny achievements. Accumulating and redeeming points for things that complement our daily life, from a free Starbucks latte to a free flight, scratches an itch for us. It’s also become clear that we like rewards not just because of the gifts themselves, but because of who gets to see us receive them, right or wrong.)
Holiday Inn started the first hotel rewards program in 1983. Notably, the rewards could only be utilized for free reward flights, not hotel stays!
The Economics Back Then
Most frequent flier programs, for the latter part of the 20th century, would give miles depending on the distance traveled on each trip. You could then use those miles to redeem for award tickets at a pre-defined rate, utilizing an award chart (i.e. booking a Houston to San Francisco on miles was always 12.5k miles to redeem, no matter the date of travel.)
Contrast this with FlightFund, America West’s mileage program introduced in 1987, which awarded miles based on the price and fare class of a ticket, rather than the number of miles flown. So, gone were the days that you could stumble on a cheap flight that traversed a few thousand miles and earn a boatload of miles. The earning structure was fixed and directly connected to the cash price and fare class of your ticket. FlightFund became extinct after US Airways and America West merged in 2006. The FlightFund strategy, however, did not stay extinct forever, with JetBlue in 2009 and Southwest in 2011, imitating the revenue-based earning structure.
Southwest does not have an award chart, but instead directly connects award pricing to cash prices.
On the redemption side, JetBlue and Southwest also implemented pricing that was directly correlated to the cash price of tickets (instead of utilizing a fixed award chart). A hidden benefit of this: You could redeem your points for any available seat on the airline, since the point requirement was wholly based on the cash price of a ticket, just like when buying airfare. There were no blackout dates or limited award space, like with other programs. The downside: there were no hidden sweet spots. You’ll need more points for more costly tickets.
However, even into the second decade of the 21st century, the three main U.S. carriers (Delta, United and American) were still utilizing mileage-based earning structures (i.e. you earn redeemable miles based on the distance you fly, not the price.) Until 2015. More to come on that in a bit.
I believe no other change to frequent flier programs over the years, even the introduction of revenue-based award charts, has influenced them more than the introduction of airline credit cards that rewarded frequent flier points for daily purchases. The first co-branded credit card, the Continental TravelBank Gold MasterCard by Marine Midland Bank, launched in 1986. Mileage programs as we know them now were completely revolutionized by this one change, which opened the door to the general public to accumulate sizable amounts of miles, whether they were frequent fliers previously or not. It also opened the doors for airlines to make way more money through the selling of their miles to banks than they ever made actually flying!
The Economics Now
In 2014, Delta started a domino effect, introduced a major overhaul of their SkyMiles program that changed how fliers earned miles from a mileage-based scheme to a revenue-based one. Although it caused quite a bit of displeasure from points and miles enthusiasts, honestly, I don’t dislike the revenue-based model in theory.
Delta, like most airlines, has two different types of miles. Those used for elite status qualification (i.e. Medallion Qualifying Miles, MQMs, at Delta or Loyalty Points, LP’s, at American) and redeemable miles (which can be used to redeem award tickets). Although how you earn elite status has changed over the years, what has changed the most is how you can earn redeemable miles. Starting in 2014 for Delta (2015 for United and 2016 for American), you started earning redeemable miles based on the fare you paid instead of the miles you flew.
To clarify, I don’t earn Delta miles. When I fly Delta on a cash ticket, they all go into my Air France/KLM account. Why? The Air France/KLM Flying Blue miles earned for partner flights are based on the distance flown multiplied by a percentage based on your ticket's fare class, not based on the cash price. Also, although the Flying Blue program also has dynamic pricing for all award tickets, they typically have better pricing than Delta SkyMiles for international business-class tickets on its own flights. Let’s check out this example:
Delta Skymiles members earn 5 miles per dollar spent on Delta flights in Main Cabin or above (taxes not included!) So, if we attached our Delta Skymiles number to this flight, we would only earn 420 miles (unless you hold Delta status, which would add a multiplier). However, we would earn 1857 Flying Blue miles for the flight (2,475 miles flown x .75 multiplier for the fare class). *Note: you do NOT earn Delta miles on Basic Economy tickets, but you can earn 20% of the miles flown when you attach your Flying Blue number to the flight!
Of course, this is an extreme example, but it shows why airlines switched to this model. I would pay virtually nothing for a 5+ hour flight, so obviously Delta wants to give me virtually no points. Had I paid $1,200 for my flight, then I’d be earning 6,000 points. However, at this flight cost, I am very likely losing money for the airline, so they don’t want to reward me for that!
Impact of travel credit cards
As I mentioned above, selling miles to banks and other financial partners is where airlines make a majority of their money now. Accrual from non-air sources (activities other than flying) now account for more than half of all miles earned in major programs. A huge portion of airline’s revenue comes from selling large amounts of points to third party banks/credit card issuers that they have long-term contracts (i.e. Chase and United or American Express and Delta.)
Recently, the CEO of Delta, Ed Bastian, made a comment to investors that 1% of the United States GDP is charged to a Delta American Express credit card! A few weeks after those comments, the Bureau of Economic Analysis (BEA) put the nation’s GDP at $26.84 trillion. So you don’t have to do the math: 1% of that is in excess of $268 billion! Now, to clarify, Delta does not make hundreds of billions of dollars off its credit cards; in January, the company reported it received approximately $5.5 billion in 2022 from its AMEX partnership. And an important note: this revenue is WAY more profitable to Delta than revenue from you actually flying.
During the Covid pandemic, all three of the major airlines used their frequent flier programs as collateral for debt. This was the first time in history that U.S. carriers collateralized the future cash flows of their loyalty programs to raise billions in loans. (For example, American raised 10 billion dollars backed by the intellectual property and cash flows associated with AAdvantage.)
The economic reality is: airlines lose money on flying. Airline make money on their frequent flier programs. Their frequent flier programs are valued at higher than the companies themselves!
Want to take a deeper dive into the history (and economics) of how airline frequent flier programs work, specifically the impact of travel credit cards on the industry? Check out this video:
Conclusion
To be honest, that might have been more context than you needed. However, I do think it’s important to at least understand, in broad strokes, how frequent flier programs have morphed over the years. However, it doesn’t change the core of how you can best take advantage of these economics: open up travel credit cards at a sustainable pace for you, meet the minimum spend requirement to earn the bonus, pay off your statement balance in full each month, and don’t spend more than if you were using cash or a debit card. Then, rinse and repeat. The economics work out: airlines will make money from the miles they sold to the bank and the bank will make money from every swipe you make on the card and the millions of your fellow Americans who accrue interest on their cards or pay late fees!
