Josherich's Blog

Points, profits, and packed planes, with Gary Leff

to offer free Wi-Fi is going to be able to market that as a huge differentiator. So, you know, it’s funny to think about how quick the perception of value can change.

The function of loyalty programs intersects with a lot of broader trends in consumer behavior, especially the increasing expectation of personalized service and value. As you pointed out, the emotional attachment many people have to travel means that they often don’t see just the dollar value in what they are receiving. They see experiences, and that has powerful implications for how businesses structure their rewards.

Furthermore, many companies have started to think about customer loyalty in broader terms. It’s not only about the discounts and points earned but also about the experience of being part of a community. For airlines, this sense of belonging can make all the difference as they compete for travelers’ attention and preference.

It’s also interesting to note how the accumulation of points or miles is often framed as a game. Consumers are encouraged to think of their travels not necessarily as expenses but as opportunities to collect rewards. This gamification of loyalty programs adds a layer of excitement and engagement, making customers more likely to choose one airline over another, not just for the practical reasons but for the sense of achievement they get from earning rewards.

As these programs continue to evolve, there’s a constant balancing act between offering real value to consumers and managing costs effectively for the airlines and hotels. In today’s market, where consumers have countless options at their fingertips, loyalty programs will need to adapt and innovate continually. Otherwise, they could risk becoming just another average feature that fails to stand out.

Ultimately, whether it’s through enhanced technology, creative marketing strategies, or aligning emotional connections with financial incentives, the future of loyalty programs will be fascinating to watch as the industry works to retain and attract customers in an increasingly competitive landscape. in the U.S. to do that, the first carrier at all would do that, was JSX out of Dallas. But Hawaiian now has that and Qatar has that. And United’s installing it in its aircraft and it’s faster than anything else in the sky. You have the low-Earth orbit satellites. And so there’s just less latency in the communication.

But Delta said, okay, look, we’re going to use this to drive sign-up in our loyalty program. The reason they want this, of course, is because then they can market their credit card. It’s like what makes them profitable. And just about anybody that actually flies Delta regularly who is not new to it has already been marketed that enough times that almost everybody who’s going to get it has gotten it.

And so one of the great values in anything that drives new sign-ups, they may have a lower propensity to ultimately convert. But it’s a new pool to fish in, a new ocean to fish in. Similarly, they benefit from, say, their Starbucks partnership in that way as well. They get more people into the program they can market to because they want to earn Delta miles for reloading a Starbucks card in addition to their Starbucks transaction points. And because then they can market those conversions.

Yeah, the attributability of this is pretty major. Travel is one of the largest spenders on advertising. But as you mentioned, you pay Madison Avenue to produce a wonderfully lit shot in Hawaii, and who knows how many seats the merchant that drives, whereas there is presumably some business analyst deep in the bowels of Delta who can show you a Tableau dashboard with exactly how many dollars were spent on the Starbucks co-branding opportunity and then trace that to an actual revenue number.

Aspirationally, the interesting thing is they have all of this data. They’re not always great in practice about deploying it, answering questions, and testing their marketing in a way that informs future decision-making in a real way, but certainly better than they were. I mean, you mentioned the confluence of technology developing along with the advent of frequent flyer programs. Some of the early programs actually were managing individual accounts on paper.

This is hard to imagine that, you know, 45 years ago, your frequent flyer account was like this paper ledger. I mean, that had changed pretty quickly, but the technology that was in place in the early days leads to some interesting things today with regard to the nomenclature. If you’re a frequent flyer of United Airlines, you’ve got status with United Mileage Plus. I was like, okay, I’m a premier 1K, right?

1K. So the legacy was, it was the 100,000 mile flyer called a 1K. That’s weird. 1K is 1,000, right? Well, the database back at the time is the advent of the program. They had these status levels allowed for two characters, right? So you had premieres and premier executives, and they had the two-character indicators. This was never even meant to be a customer-facing name.

It was just in their computer system, the two characters then to get the status, and customers began to see it and talk about it that way. It was ultimately folded into the branding, but it’s purely an artifact of the database limitations from the 1980s that influence how we call the status level today. Yeah, we see similar economies and status in a variety of places.

These are things that happen organically versus a company understanding that anytime we create a new schema, anytime we create a new namespace, we’re creating value in the world. Maybe we should think about how we distribute that. Low-length Twitter names and Twitter names that are particularly sought after. There’s an entire shadow economy in that.

For geeks of a certain generation, there was a website Slashdot, which had auto-incrementing user IDs, meaning they were assigned one, two, three, four, five, instead of being assigned random social security numbers over a specified number of digits. The people that had low user IDs were the OGs of the forum. After a while, people were like, oh, having a five-digit user ID is like a mark of status in both this forum community but also the broader geeky community around Slashdot.

So there would be people selling five-figure, five-digit user IDs to other people for them to use for their own purposes.

Yeah. I mean, years ago, maybe this was, you know, 15 years ago, in Dubai, a license plate sold for 14.2 million dollars. Right. Oh, the city of Chicago also has a number of license plates reserved for the mayor, the cardinal of the archdiocese, etc. They are very serious about that reserved list. Humans are weird, but scoping back from the great nature of humans to attach value to any namespace that we can create, oh, anthropology is such a fun field.

Credit card reward programs are an enormous business. I have my own point of view on these because I think they are probably the largest single contracts written in capitalism. Why is that? Why are these such a great business to be in? Right. So, I mean, first in terms of the scope. Delta talks about their co-brand deal with American Express representing, they rent; there’s a lot of rounding up involved in this, but they talk about it as representing something on the order of 1% of GDP just on their particular co-brand credit card.

I think it’s closer to, you know, two-thirds of a percent, but that’s still an incredible amount that going back, say seven years, you would have seen each of the three largest airlines in the U.S. with a hundred billion dollar plus charges across their specific co-brand products. Those have only grown since then. For the benefit of people who don’t understand how credit cards make money, I will link to an essay titled something like “How Credit Cards Make Money.”

Presumably, Delta’s using no non-public information. Presumably, Delta has struck an agreement with American Express in this exact example to do a revenue share. American Express makes money on their credit cards in a variety of fashions, charging people interest but also charging businesses what is called in the industry interchange, which is a fee for credit card acceptance.

American Express’s interchange rate is relatively high in the industry. The transaction that they encourage businesses with is to say, just like airlines, you like having attributable marketing dollars, you also like having attributable marketing dollars. We will bring you the best, most well-heeled customers into your business, and they will be spending American Express money.

To accept the American Express money, which your well-heeled, very desirable customers very much want you to take in return for goods and services, you will need to pay us a percentage. That percentage might be, for example, 4.5% or whatever. Get a quote from a webpage, not from me. So when someone spends, indicatively, 4.5% in interchange on a $1,000 transaction, that’s $45 revenue.

Delta and American Express have pre-committed that if you bring us $45 of revenue via one of your desirable customers, having signed up for an American Express account because a Delta flight attendant pitched them on the desirability of doing that, we will pay you some portion of that $45. We will pay you some portion of their interest charges, and we might even pay you some portion of their annual fee.

Right. So a lot of these deals have gotten incredibly complicated as they’ve grown with a lot of different elements to them. But roughly speaking, if you go back in time to when the modern frequent flyer program was born in 1981, it didn’t take very long before the airlines realized that people absolutely love these points. At the beginning, they were an experiment, right?

So a promotion, the original American Advantage program in 1981 was conceived of as a two-year promotion. It wasn’t even a permanent feature of American Airlines, but they were selling points to travel partners because people wanted to accumulate the points, and those travel partners could reward their points to encourage your business. The very first airline co-brand was the Continental Travel Bank MasterCard from Marine Midland Bank, which is effectively through acquisitions and whatnot, HSBC today.

That was just five years in. Very quickly thereafter, we saw co-brand cards with United Mileage Plus, which was with First USA at the time, and with American Advantage the next year with Citibank. The banks realized that they could get this well-heeled business, high spending business, by taking a portion of the money they were making and rebating it to the customer.

They have a huge marketing expense to attract customers because these customers are very valuable. If we gave them some of that money, effectively as a rebate in the form of miles that customers really value, you value at a higher level than they’re even costing us back then. We are going to get an outsized return on bringing in those customers. We may make less than every individual transaction if we’re spending more than we’re spending now in marketing, but we’re getting more transactions through our network.

A lot of the value comes from scale and transactions at a lower marginal cost anyway, so it’s profitable. What we’re really buying in many cases, especially as the value of the rewards goes up, is Revolve, right? Some portion of the customers. We’re not just rebating the transaction and making a smaller spread. We are going to make money by acquiring a lending business.

People don’t always pay off their credit card in full every month, and the demographics on this vary by card. Some of the cards that rebate, and especially a large portion of the interchange, even all of it, turn out not to get very much Revolve at all, and so the banks bend wrong and they wind up losing money.

We’ve seen Chase with their Sapphire Reserve product. It was a huge hit. They introduced it nine years ago, in October of 2016. They were spending a huge amount of money on the customer, and customers loved that. They filed a series of 8Ks about how much more expensive it was than they were expecting. Ultimately, they’ve lost cumulatively like a couple of billion dollars based on publicly available information on the product in part, because they’re not getting the criteria for the customer that they’re looking for in this product.

I have a somewhat minority point of view with respect to how good of an idea the Chase Sapphire product was, but complicated; I have to talk around some things here. So one, just like there is cross-subsidization within a particular product in that you could rebate more interchange but hope to make it up on the revolving business attached to a credit card. Certain banks have the panoply of financial services to sell to someone.

They might make the decision that there are certain customer cohorts where some products for the bank are sold at very thin or even slightly negative margins to a large number of customers. The classic checking account is very thin or negative margins to probably 80% of Americans. You hope to get the entire banking relationship and then make your money in other places such as in mortgage origination and similar. Credit cards were historically not one of the “loss leaders,” but some banks have some products which might or might not have been intended as loss leaders at various points.

Yeah. So, I mean, that’s certainly the justification that Chase provided after the fact with regard to Sapphire Reserve when some of the numbers started to come out. I’m not entirely sure how well that’s actually worked out for them in terms of generating, say, mortgage business. Judging from the outside, they had early on some promotions where they tried to stimulate Sapphire Reserve cardholders earning the ultimate reward points attached to that card for other sorts of transactions.

We haven’t seen them go back down that well quite as often, and my sense is that they didn’t quite work as well as they’d hoped. But at the same time, if you’re a bank the size of JPMorgan Chase, $2 billion sounds like a lot of money, but when you’re talking over a course of a decade, it’s not super material and it is a prestige product.

It’s reasonable to make all sorts of bets. Like, you know, when Citibank took the Costco card away from American Express a decade ago, this actually was one of the impetuses for the cost of some of these deals for the airlines beginning to really skyrocket, setting a new bar for the price that banks were willing to pay for co-brand deals. There was a bet Citi was making. They were clearly overpaying just on the basis of the transaction volume they were getting.

There was a bet on Revolve. There was a bet that they wanted to acquire these customers. I’m not sure that the execution’s been as great as hoped in that particular product, like just the frictions involved. But for quite a long time, the problem to get a Costco credit card, you’ve got to be a member of Costco. At the beginning of this deal, if this is the multi-billion dollar a year deal, you would have to, if you didn’t, if you wanted a Costco credit card but weren’t already a Costco member, they would tell you, oh, we can’t give it to you.

Go over to Costco and sign up and then come back to us. They couldn’t even get the technology going, right, to do it all in one transaction. There are problems attached to it, but yeah, I mean, there are bets and not every bet works out as well as you hope either. But you can make a reasonable argument that, you know, ex ante, there’s positive expected value to be created.

It is even a multi-party bet too because one of the public factors involved in the decision to take a swing at Amex for customers that are on the upper end of the American socioeconomic spectrum. Amex does business substantially worldwide, but they were most interested with respect to U.S. customers and this one. So Amex competes with Chase as an issuer of cards, but Amex competes with Visa as a card scheme.

Visa would like there to be more Visa cards in the upper echelons of American society than currently prevail. Chase said to Visa reportedly, we can do that, but we can’t do that under the current constraints of Visa’s rules and price tiers. Every credit card is assigned on the back end. If you are extremely adept at reading disclosures, you can probably reason out which one it is, but it’s assigned a tier by the credit card brands, and the tier determines the interchange rates that get applied to merchants under the hood.

There are price schedules. You can find the price schedules on the internet. Chase told Visa, the top line in this price schedule just does not have enough interchange in it for us to make this worthwhile to our best customers. American Express charges much more than your top most exclusive cards do. We want a new top line, make an entirely new category, and there will be one entrance in it. When you start out, it will be ours and we will go head to head with Amex for this.

Visa did that, and then some jostling has happened. I have limited ability to comment on the jostling. The Chase Sapphire Reserve literally caused a change in how Visa’s cards are priced worldwide. And, of course, Chase can do that too because they are predominantly a Visa issuer. They have a deal referred to as leasing Visa’s network, which allows them to drive much higher levels of spend without much higher levels of cost.

They are collecting more of the interchange themselves and funding some of the efforts they’re undertaking. So lots of different things in the deals make this all work. Chase is also one of the largest credit card processors in the world. A mistake that people sometimes make outside of the industry is to view a credit card issuing program only within the four walls of the issuance itself.

There might hypothetically be a team at Chase involved in issuance and another team involved in credit card acceptance. You can hypothetically link the complex multi-year, multi-billion dollar commercial discussion about credit card issuance with a particular large consumer of credit card services with the multi-year, multi-billion dollar discussion about who do you use to process your credit cards and then play games around where the margin is made.

That is the thing that might or might not happen in the world with regards to some issuers. Well, you know, when you look at some of the deals, say with the airlines, it’s not just around the credit card spend. Delta, there’s a lot of ways in which American Express and Delta go back and forth and embed themselves into each other’s ecosystems. Delta has an American Express card that they use for the purchase of jet fuel as part of their deal with American Express so that American Express can earn interchange on the purchase of fuel, a good portion of which gets rebated back to Delta in the deal.

Delta had disclosed the credit line on this credit card for jet fuel at 1.1 billion dollars. When Delta is the most generous with overbooking compensation, if you go back nine years, airlines for the most part had more involuntary denied boardings than they do today. There was a famous incident in nine years ago with David Dow on a United Express flight where United needed to take him off because they wanted to put employees on the flight to operate another flight back.

They said, look, we don’t have enough seats, and we’re going to ask you to get off. He refuses. Chicago aviation police come on. This was a very, very unpleasant situation. The man was taken off bloodied, and there was a worldwide outcry overbooking. Airlines just say, look, they might take volunteers to try to limit this, but they wouldn’t give you very much compensation because the most they ever had to do was what the DOT said they would give you in cash. If it was involuntary, they want it to be voluntary. They want to pay you less than they had to pay you in cash.

At the time, I want to say it was $1,350. Shortly after that, it became very, very bad for airlines to have involuntary denied boardings. They would go to extreme lengths, paying out in a couple of edge cases close to $10,000 to be voluntary, not involuntary. Now that began as a cost center to be clamped down on by airlines like American and United just before the pandemic.

The pandemic really tightened things, except for Delta, where they really do still make efforts to almost never have an involuntary denied boarding. The other thing is that airlines usually give out travel credits, not cash. Delta gives out—can you guess what they give out? Is it gift cards with an issuer attached to them? It might be. Can you guess what issuer is attached to them?

I think it might be— not that I’ve ever received this in the recent past—I think it might be American Express. Yes. Right. So this is how they get up to some of the really big numbers. The credit card issuing company is paying for checked bag fees for card members. That’s part of why people get the card and put it in their wallet.

This is part of the acquisition cost. They’re paying for lounge access in the case of some of the premium cards with the airline. They’re paying; there may be dollars attached to the earlier boarding. The accounting on this gets really interesting because if I just buy an airline ticket and I earn miles for that ticket, the airline is the party to both of those transactions directly with me.

The accounting rules under what’s called ASC 606 say that they have to make a provisioning for the value of the travel that’s going to be provided. They recognize most of the revenue upfront for the ticket, but they provision, and the big airlines are roughly the same on this. They’re provisioning about a penny a piece in value per mile for future travel that they provide.

The accounting is entirely different when they sell a mile to a third party. It’s not splitting the transaction with themselves anymore. The rules are much, much looser. When they sell the mile to a bank, they say, okay, we’re going to split this out between how much money are we getting for renting access to our database to market the card? How much are we getting for use of our brand? How much are we getting for bag fees? We’re kind of deciding ourselves.

We have to have a plausible model that passes muster with our auditors that we hire, so there are kind of industry standard ways of doing it. By the time you split across all that revenue, the amount that actually gets booked as a liability for future travel is on the order of an eighth of a cent. The exact amount is a little different by airline, but roughly speaking, there’s this eightfold difference in the value of the same mile on the books of the airline.

The airlines really, really like the sold miles. In fact, the head of the Avianca Life Miles program, once said that they describe the miles that you earn from flying as bad miles, and the miles that you earn from selling to partners like credit cards or that you buy directly from them, those are good miles.

Yeah, and that’s just in the year of issuance. After the miles are in the bank, theoretically speaking, they are a liability rather than an asset. However, there are some ways to do accounting gamesmanship. Accounting gamesmanship can be useful if you’re having, for example, a soft quarter or a soft year. You might push a little more on various people to get more revenue recognized this year so that you can make your numbers, get your bonus, etc.

In a future year, when you owe customers literally billions of dollars of this deferred service provision, you can do things to cause that cost to go lower and then recognize the difference between the current valuation of that and your new restated valuation as a revenue opportunity for this year. Can you describe that process?

Right. So there’s a couple of pieces to this and a couple of ways that they do this. For one thing, fewer airlines expire miles in the U.S. now than used to, but changing expiration policies was one way of moving the liability off the books. You have these miles on your books as a liability, and you have an assumption about how those miles are going to be used in the future.

Small changes in how often they’re used or how many miles go unused have huge impacts on revenue given the scale. They can change their assumptions about future use or how many are going to go unused. They can expire miles, literally moving miles off the books into revenue that had previously been assumed would be redeemed. You can also change the price of redemptions.

During the Great Recession, airlines, one of the ways that they generated liquidity was they were structured as loans, but they were pre-selling miles to their co-brand credit card partners for large amounts of money. You would pre-sell 500 million or a billion dollars’ worth of miles at a discount to your credit card bank partner, and that raised a lot of money. But nothing compared to what they did during the pandemic.

As part of the first CARES Act, American Airlines accessed federally subsidized loans backed by their frequent flyer programs to the order of about $5 billion. Eventually, they paid those back and borrowed more by going into private debt markets. Delta and United went to private debt markets. Those three airlines each raised between $6.5 billion and $10 billion against the future revenue streams of their frequent flyer programs, which largely involve selling miles to their banking partners.

One of the ways that they marketed this to the debt investors is explicitly to say, look, one of the reasons you can be sure of getting your money back—now you’re at the front of the line, frankly, even ahead of our customers—because we control the currency, we control how it’s earned, we control how it’s redeemed, and we control the pricing.

We can adjust those levers to manage our expenses to ensure that you’re prioritizing getting your money back. Adjusting the prices is another thing. Now, there’s always the risk that you harm your future revenue if you alienate your customers. Historically, some airlines have alienated customers more than others even when taking similar steps.

For the most part, Delta had not suffered from the same reduction in spend volume that followed devaluations at United and American. Partially because of a stronger brand and stronger operational reliability, partially because of the role that Delta plays in some of its hub cities. If you’re in Atlanta, you’re probably flying Delta, and you associate that with a credit card you need to have. Most consumers aren’t thinking through the challenge of “if I actually get a membership rewards-earning card that transfers to Delta, I can even earn more Delta miles than if I had a Delta card.”

I have other options as well. Delta hadn’t suffered in the same way until, interestingly, perhaps a year and a half ago. Delta announced major changes to their elite status program and their lounge access for their credit card customers. Perhaps because it was centered on their most fervent, most loyal customers, the backlash was tremendous. They very quickly backtracked on those changes—not entirely all the way back although they also added some sweeteners about a month later.

I expected that they would make a little bit more of a change after a year and they didn’t. By all outward indications, it seemed clear that they got scared because of things they were seeing in their relationship with American Express. People were certainly saying, “look, I’m canceling my American Express card,” or “I’m sock-drawing the card; I’m not using it anymore.” There was a huge outcry and a bigger risk perhaps than the benefit, which was much of the changes were meant to drive spend on that American Express card.

Changes to how you were earning elite status, you were going to increasingly earn it through things other than flying. The simplest one was by spending on the co-brand American Express card. You were going to retain the amount of access to their lounges that you already had by hitting spend thresholds with their premium American Express card. The stick was you were going to get less, but it was to such a degree that they may have pushed customers a little bit too far.

There are revenue, there are also other revenue recognition games on the flip side. When you have extra seats that are going unsold, there is a built-in reason why you want to make those available for points redemption. You want to encourage that redemption because when the points are redeemed, you recognize that liability off the balance sheet as revenue. Instead of getting nothing for those flights, you are actually recognizing revenue at the point of redemption.

During the financial crisis, getting award seats was like the easiest thing. I helped someone one time. They said to me, “I need to get my family of nine from Mexico City to Frankfurt, and I have some points.” I said, “Well, how would you like the Lufthansa nonstop flight?” I asked, “How would you like all nine passengers to go not in business class, but first class?” Because that’s available on your preferred day to travel.

This is now not so easy and much more expensive. This also functions as a bit of an economic shock absorber for the airlines. Since airlines are exposed to a relatively small section of industries for a large portion of their travel business, we need tech and finance in the United States—tech, finance, consulting; those are three very large travel spenders.

During the financial crisis, go figure, a lot of the finance and consulting firms stopped spending so much money on business travel. The airlines are able to say, we still prefer to earn revenue for flying airplanes this month. One way we can do that is by going to our book of customers and saying, “Alright, if you’re paying us in our own currency, we’re going to be extremely solicitous of taking that business right now,” or “would we be less solicitous if McKinsey et al. were spending as much money as they did a quarter prior?”

Yeah, airlines have gotten a lot better now at filling planes than they used to be. Certainly at the beginning of the program. Whereas you might have had 60 to 65% load factors, 40 to 45 years ago, you often have 85 and 90% now.

That’s overall, which means there are some routes that they’re selling out virtually every plane, every day, every seat. So there’s almost never the case that there’s that extra seat that costs them almost nothing to provide. There are a few routes where there are lots of extra seats.

Oh yeah, I have a hilarious anecdote about what causes at least one route in the world where things are routinely under-provisioned. A large automobile manufacturer in central Japan considers it to be very positive for its interests for there to be a certain number of flights between central Japan and also Tokyo.

Central Japan is their number one concern here to Detroit specifically. Japanese leisure travelers don’t open up their Atlas to the world and say, “You know where I really want to go on vacation this year? Detroit.” That’s a plane that would not have a huge amount of utilization normally, but this automobile manufacturer doesn’t want to, on any given Tuesday, need to charter private jets.

On any Tuesday, there must be a certain number of committed flights for that reason. Also, because the same flight that is flying a very small number of brains between factories of this automobile manufacturer and their American counterparts, and also their American factories, are there are some relatively low-rate, relatively high-dollar value cargo things that are flying on the plane routinely.

That particular flight is economical with five people on it. I have occasionally been on that flight because Detroit is very close to Chicago. It’s like, wow, this is really nice to be able to spread out. Can I expect this flight to still… Does the airline exist next year? And the airline was like, “Oh yeah, this one will be around for a while.”

Yeah. There used to be a United Airlines flight from San Francisco to Nagoya for a very similar reason. And it was always precisely the case that if you could find award seats in business class on no other flight, you could always get it on the United San Francisco Nagoya flight.

On the other hand though, some corporate deals for travel are so big for people. Before the pandemic, there was some information that was unfortunately from United’s perspective released by some of their salespeople that they were selling 50 business class seats a day between San Francisco and Shanghai for a company that is often referred to as the Cupertino fruit company, also known as Apple. Yep. And so, Apple was extremely displeased about that information leakage.

But loudly. They absolutely were. But the story of how airlines have gotten better at filling seats over the years, meaning that there are fewer available seats that are virtually costless to offer, has tremendous implications for the pricing of frequent flyer miles awards. Some of this has to do with having fewer airlines, some of it has to do with better technology and marketing, and some of it has to do with just who runs the airlines and sort of how they’re run.

Given that they’re filling planes, I wrote something 22 years ago, which basically said, “Here’s why you can expect the cost of frequent flyer mile awards to go up.” Think of miles as a currency and just understand nothing more than the simple formulation of MV equals PQ. You have the amount of money, or in this case miles, in the economy and the speed at which they’re redeemed on one side, and you have a quantity of available saver award seats on the other and its price.

You’re printing more and more miles and having the quantity of available seats to offer is not going up. In some cases, it’s even going down. So that alone is going to suggest, the imbalance either means you have a shortage. And in fact, there was that style back 20 years to David Spade doing commercials for Capital One. They built up their own branded miles program that weren’t frequent flyer miles, but a currency to spend on travel. His idea was that nothing is available, right? You call up wanting the award and say, “Not available.”

So customers were frustrated even then, but you either had the shortage idea or price to go up in order to ration the available seats. Airlines have said, “Look, we know we have to deliver to our customers. We can’t just tell them nothing is available or they’re going to stop accruing the points.” They don’t want that to happen because this is really richly valuable to them.

Right. You need to protect the perceived value of the currency. But airlines have mostly done with their own flights. There are still sometimes outsized value, less so with Delta. What they do is they say, “Okay, we’re not just making these seats that are going unsold available. We’re making more seats available back at some level, almost every seat at some price.” The frequent flyer program is going to buy those seats at some internal price.

When displacing paying passengers, the value per mile, that perceived difference shrinks. The value per mile shrinks, and you’re pretty much just spending miles as a currency to buy the thing you want from the airline at a lower value, which is why you often get the best value using miles from one program for seats with its partners. Usually, that is still only dealing with the seats that are liquidating excess inventory.

It’s also the case in the US context that, with foreign partner airlines, there’s often a lot of excess inventory. I used to live in DC. I lived there for 18 years, and this was a great market for it because at Washington Dulles airport, you have flights on Qatar Airways, Saudia, Emirates, and Etihad. They’re all flying pretty near each other.

The economics of the market doesn’t necessarily support that, but they all had this idea that they need to fly to the capital of the United States. For a while, ANA had their flight to Washington Dulles. It was ANA flight one for a reason representing the relationship between Japan and the United States. As a result, all of this excess capacity meant a lot of unsold seats. It was a great place for me to fly using miles.

One of the best places to fly right now, internationally, you can want business class seats to Asia. Asia flights have gotten really hard with miles. Part of that is because of the US relationship with China, and there are just a lot fewer flights between the US and China than there were before the pandemic. There was this land rush of Chinese airlines trying to get into the United States.

China had a rule that Chinese-based airlines could not compete with each other on the same route. Only one airline was allowed to fly a given route. They all wanted to be first to absolutely stupid routes that they might eventually want to fly later. Cities that most people in the US have never heard of, but that meant empty planes that they were flying every day in some cases, with the hope of eventually needing it, so that nobody else could have it.

You could buy tickets on these flights and connect elsewhere in Asia. I mean, China Eastern via Shanghai, you could often buy for $400 round trip in coach. But with all this excess capacity in Asia, it meant it was drawing passengers away from other flights too. There’s pricing pressure and you could get award seats.

Well, without the return of these flights, which by the way, US airlines have lobbied against allowing, right? China originally cracked down on them during the pandemic, but US airlines didn’t want it because they don’t want the overcapacity. It hasn’t been as easy. You get plenty of award seats in business class flying between Seattle and Taipei because you have three different Taiwanese airlines and Delta flying the route between Seattle and Taipei, which is sort of crazy.

It’s the one route that you can sometimes get good business class award values with SkyMiles because they don’t want to give up the route. I don’t even know that that one is necessarily crazy on the fundamentals given fruit companies and other people who might want to take advantage of exactly that route. But there are four airlines doing it, and not all of them have the relevant corporate deals.

Okay. And what that does is it depresses, right? I mean, everybody says, “Okay, if I’ve got the chip business and I can make the economics of my flight work,” but they don’t all have it.

Makes sense. Oh, wow. I feel like we could go for a million miles on other places for customers to benefit from quirky dislocations in the global economy or nation-state level politics with airlines doing politics with each other, which is also a thing.

I think one of the reasons that partner miles maintain their value in a way that first-party miles sometimes don’t is it’s no longer an airline negotiating with the customers as a class. You’re negotiating with another very sophisticated partner that might have you locked into a multi-year contract.

There are expectations of continuity in airline programs, but those expectations are typically not contractualized vis-à-vis an individual user. Does that match your expectations? In fact, sometimes those expectations are contractualized between the airlines, right?

In terms of their multi-year deals, what they charge to a consumer may be in the deal. These are multi-year deals. When American Airlines changed the award chart for its own flights a couple of years ago, I asked, “What are we going to see changes to award truck for your partner flights?”

And I got told, “Oh, that’s hard,” right? Because all of the chart reflected pricing that covered all of their partners, but each one of the partners was negotiated bilaterally. It is such a long process that it’s not like on the immediate horizon. Right.

It’s not merely just negotiated bilaterally, but they’re on different start, stop dates, different cadences, and so on. Multilateral coordination of organizations is hard. The alliances are difficult to aircraft carriers to turn, etc. There will likely still be some alpha to be had by savvy customers looking for partner flights.

At the same time, these are negotiated differently depending on different alliances as well. Which airline is making the change matters too. Interestingly for earning status with an airline within OneWorld, there used to be a rule that said, not only did you have to meet the flying criteria of your airline for their status, but you also had to have a minimum number of segments on that airline.

You couldn’t just earn British Airways status only flying American Airlines. That was a OneWorld rule. American decided they didn’t want to do that anymore, so they just stopped. The rule went away, right?

Because in fact, OneWorld headquarters moved from New York to Dallas to American Airlines headquarters. The influence in the alliance was such that the rule mattered and constrained all of the parties except for American Airlines. Subsequently, Alaska Airlines, which is also a member of OneWorld, has gotten rid of that rule for their own program, but it’s no longer an alliance rule.

Some of them still have the rule for historical legacy reasons, but there are rules, and they apply differently to different players. I’m curious, what was American Airlines’ reason for wanting to go away from a flight-based qualification?

Was that to sell more credit cards or just because the contours of their business are a bit different than some others? During the pandemic, they made a big change to how status was earned. They no longer said you had to fly a certain number of miles and have them spent on tickets. They said, “Look, you’re going to earn what they call loyalty points.”

Loyalty points are earned from most activity in the program because, ultimately, selling miles to partners has a lot higher margin than earning miles from flying. In fact, even selling a ticket is the lowest margin activity that the airline itself has. It interacts with a passenger; selling a seat is higher margin, selling an upgrade, selling bags, any upsell is going to be higher margin.

The thing that they were rewarding frequent business in was their lowest margin activity. They want to use this powerful part of their program to incentivize growing the high-margin parts of their business. They said, “Look, in the past, you maybe spend on airline tickets and fly a certain amount to earn your status. A very valuable customer is somebody that doesn’t fly much at all but puts a couple hundred thousand dollars of spend each year on our Citibank credit card, which is our biggest customer.”

They want them to be an even bigger customer, and encourage you to do that. So they reconceptualized that and restructured their status program. Increasingly, all of the US airlines have had a growing role for their co-brand credit card and sometimes some other activities, but none had gone quite as far as American.

American wasn’t the first, to be sure. Frontier Airlines before the pandemic said $1 of spend on our credit card is a status mile in our program. They just didn’t have quite as much to offer as American. It didn’t take off in the same way. They said, “Look, we want to have full rewards for this and not have a minimum number of flights. If you want to earn your status through us.”

By the way, it doesn’t even cost us very much to deliver status benefits if you’re never flying us, like go for it. I have to make an aside about large credit card transactions. Obviously, you can get to $400,000 a year in spend on a co-branded card in a variety of fashions. One is to just put all the businesses expenses from office paper, etc. on that.

There are other and faster ways. Once upon a time at a credit card processor, there was a young engineer facing many design decisions when coding up a computer program, which is what is the largest number we would accept as input here? I won’t say what the largest number was, but this was an engineer who didn’t have a huge amount of experience.

He was asked to decide what’s the largest amount you could do in a single credit card transaction. They picked some number X, and not the next day, not the day after, but pretty soon people started complaining to the credit card processor, “Hey, your maximum charge is X. What’s up with that? We want to do transactions that are much larger than X.”

The follow-up questions were, “Why? You understand we charge you a percentage times the dollar value. That makes a lot of sense when the typical charge is $40 or $80, but at X, you’re paying an awful lot per transaction.” Customers would say, “We’ve got reasons. It’s not your job to second guess us here, like bump up the limit.”

The limit has gotten bumped a number of times in response to that. There are various transactions in the world that you would never expect to make, but like the example of the American Express fleet card. “Okay, I’ve got a 747 in Paris, fill her up.” That’s a bit of money.

Without using anyone’s private information, the captains of ships, including super tankers, have substantial necessity to be able to transact anywhere in the world they find themselves in. As you know, many credit card brands have statements like, “Visa, it’s anywhere you want to be.” In lieu of having a safe full of gold bars or hard currency, although they also have those wildly, they will often have a fleet card that has, “Okay, how much oil does it take to get a super tanker from one part of an ocean to a different part of the ocean?”

The card must be able to pay at least that much while that it works. A couple of quick stories. Ten years ago, there was a lot of news worldwide around a wealthy Chinese man who won teacups at auction in Hong Kong and earned 2 billion membership rewards points.

Now isn’t quite as much money as it sounds because the Hong Kong membership rewards program is sort of an inflated number, divide by eight, basically. You get an equivalent, but the story was about how he paid with an American Express card and earned his points.

You think, “Wait a minute, an auction outside of the Chinese mainland taking place by credit card?” You immediately know where this is going. What is the incentive there? It wasn’t the points. This is evading capital controls, which is a business that many credit card issuers would not officially like to be in, but you’re not required to understand the entirety of your user’s economic life.

Plausible reasons existed for the transaction and frankly with the auction itself. I’ve gotten merchants their accounts shut down because of the size of transactions I’ve put through them. In 2009, US Airways ran a holiday shopping promotion where they were offering a 250% bonus in the miles that you earn, provided that you made between 6 and 10 different transactions during a particular period and no more than one qualifying transaction per merchant.

They had one partner, a company called Track It Back that would sell you stickers. The idea was like you put these stickers on your stuff and they would help you find the thing if you lost it. You put a sticker on your laptop. There’s a number to call. They’re going to provide a reward and take care of shipping if you lose your laptop and somebody calls in.

Now it turns out what the reward was when the person called was very low cost to them. It was stickers. Normally, they would give out 20 miles per dollar. It was this great way to get US Airways miles. Concomitant with this holiday shopping promotion, they decided to offer double the miles or 40 miles per dollar.

This is a big marketing push for the holidays, and people are just going to buy 40 miles per dollar. They didn’t really do the math or understand the implications of this promotion. A 250% bonus on 40 miles per dollar equals 140 miles per dollar, buying miles at about seven-tenths of a cent apiece.

If you’re really ingenious and decide to donate the product that you receive to a qualifying charity for the tax write-off, maybe you reduce your cost basis to that half a cent. Buying, you know, business class round trip tickets to Hong Kong for $450 is like a pretty good deal.

For myself and others, I worked out that we wanted a lot of miles. Christmas morning, 2009, I’m sitting in a hotel room with a stack of Amex black cards and just one after another, buying stickers from Track It Back. They were used to doing $40 transactions, $100 transactions, but I’m aiming for earning 16 million miles.

We’re doing $100,000 transactions that get denied. I’m on the phone with the president of Track It Back on Christmas morning. He’s trying to get his Amex merchant account reopened. Offhandedly, he says, “We’re out of product, but don’t worry. We’ll have some shortly after the New Year.”

I said, “Okay, stop. Here’s the thing you have to understand.” He still didn’t quite get it. Nobody actually cares about your stickers. Traditionally, merchants are going to post the transaction with the miles when they ship the product. If you do that after the first when the promotion expires, you are getting everything returned.

You do not want that. Post the miles now and fulfill your end of the deal later. Everyone’s going to be good with that. Trust me. He never got his Amex merchant account back. They just couldn’t overcome it. We were using visas.

In one day, one promotion, we generated 16 million miles across the different accounts. This is bringing to mind one thing that I just have to mention here, which is occasionally both the financial industry and the airlines have been surprised by the degree of adverse selection that has happened with respect to promotions.

In one case, the United States government was surprised by this. The mint had a wonderful idea. They had new commemorative coins. US currency is worth what US currency is worth. They like to protect the perceived value of currencies that generate senior revenue on.

They would sell you $1 of commemorative coins for $1 with no additional fees and no credit card charges. The thing that folks like yourself discovered very quickly was that you could buy any number of dollars from the mint. It’s not like they’re going to run out and receive the dollars in the mail, walk the dollars over to your friendly local federally chartered bank, which will credit you with $1 in your account for every dollar of US currency you bring them, earn the points, and then round trip this as many times as possible based on shipping speed and similar.

People were racking up, I think there were reports of deep into six-figure spends on commemorative coins. Seven-figure. I’ll tell you a bit of the rest of the story. There was a frequent flyer trip I used to help with called a Megadu, where a bunch of frequent flyers would literally charter a plane from an airline and do tours of stuff with airlines and hotels and kind of behind-the-scenes sorts of things.

On the Star Alliance Megadu trip, we’d get some media to come along too. Scott McCartney, who I know really well, came on the trip. He was the airline reporter for the Wall Street Journal. He gets to talking to a guy on the trip who is public about his stuff, but I won’t name him in this conversation.

He gets talking to a guy who did $2 million worth of coins, and this is interesting become a Wall Street Journal story on these dollar coins. Once it was a Wall Street Journal story, we talked early on about how when there’s too much attention on something, it becomes very awkward for a lot of people, and they have to pay attention and begin to clamp down.

That’s a lot of what triggered some of the climbing down. But another piece of it lived on in the broader culture. This Wall Street Journal story apparently inspired the idea of the trillion-dollar platinum coin being deposited at the Federal Reserve as a solution to the debt ceiling.

It has all sorts of implications, but it was this frequent flyer charter trip 15 years ago that triggered a lot of the attention to that particular opportunity. Sometimes, by the way, the deals come more directly at the expense. You think this works out well for a lot of the players.

The government wanted these in circulation. It wasn’t actually getting them in circulation, but their metric was how many are they shipping out? They were happy with that. We were able to report great growth in these dollar coins. The credit card company is getting their piece on the transaction, and the customer is getting their miles, and the airline is getting paid for the miles.

Everyone’s pretty happy until there’s too much attention. Sometimes it actually does cost one of the parties involved. Also, in December 2021, American Airlines has a venture with MasterCard called Simply Miles, which is card-linked transaction offers. You sign up, you opt into offers from a merchant, and when you transact with that merchant with a MasterCard, the transaction detail flows through, triggers this offer, and you get rewarded with miles.

MasterCard was funding an offer with a charity they were supporting called Conservation International with 40 miles per dollar. They were also funding this bonus effectively. They were buying miles, and American was a joint venture.

American was offering them at a lower price on the miles for this. But at 40 miles per dollar and sextuple miles, all of a sudden you’re buying miles for about 45 basis points, 43 basis points. This sounds pretty good.

It was supposed to be available only while a certain supply of miles lasted until they hit a cap because MasterCard had a budget for this. Well, it exploded on a few places, including my blog over a weekend. It wasn’t maybe monitored as closely over the weekend, and they immediately hit that cap, but they didn’t remove the offer until Monday.

By my estimate, it cost them several tens of millions of dollars more than they had planned. There was this period of limbo where nobody would confirm that they were actually honoring the deal. I had said, “Look, they’re going to honor it. Worst case, they’re going to do some refunds, but there’s no way MasterCard isn’t going to stand behind an offer to reward donations to their sponsored charity at Christmas.”

There’s just no world this isn’t working out. So take the operational loss, move on. We’ve learned our lesson, but somebody had to go to their boss or go to their boss’s boss and say, “You know, we have an oops,” and recognize this and the thing.

So it took a few days to work through that. I did 7 million American Advantage miles on that. I had a reader that I think did 50, but there were lots of people who did quite a lot. American had just started to reward transactions other than flying with status. A bunch of us became concierge key members at American Airlines.

They’re the super top secret unpublished level that George Clooney was in the movie Up in the Air. Because all of a sudden, American was recognizing probably $70,000 of revenue just from MasterCard alone on me.

It was like pretty good. I looked like a valuable customer. A bunch of eyebrows were raised when everyone saw that I had become a concierge key from this thing. I didn’t get renewed, and I knew that I never would be, but it had lots of benefits to it, but it did come out of at least one pocket there.

I think the most classic example of an airline, I think it was also American, getting heavily adversely selected with regards to a promotion was way back in the day. They decided to do I don’t know if it was an attempt to raise capital or whether it was a marketing stunt that went horrifically right, but they sold lifetime tickets for, if I recall, about $250,000 after having mathed out what the expected usage over a lifetime for airline services was.

There were people in various roles, such as finance or traveling consultants or similar, who were very good at doing that math and had more knowledge of their current intentions or planned course of their life than American Airlines did and leapt at the chance.

They’ve continued to honor their obligations under those lifetime passes. While it’s been reported every few years in the media that they’re really not revoking those contracts because contracts are contracts, but they’ve attempted to tighten some of the edge cases there.

Well, the edge cases, you know, people who bought there were different versions of these passes. Some people bought for themselves and a companion, so whoever was going to fly with them. There were people who would sell the companion travel or accompany the companion wherever the person needed to go and make money by flying. This was against the rules, and there were people who had their passes canceled.

In terms of how much some people did with this, the most frequent flyer of United Airlines is a man named Tom Stuker, who has flown over 24 million miles with United and has two planes named after him.

The incremental flights don’t cost him anything. He earns the miles, which he turns into gift cards, or he literally makes money flying. It didn’t quite work the way that was. I thought you were going to say the probably most famous mileage transaction was the pudding cups and Dave Phillips, who earned over a million American miles.

Not only American miles, but it was memorialized in the P.T. Anderson and Adam Sandler film, Punch Drunk Love. They actually did other things. It worked on other promotions as part of the filming and scripting of this that didn’t make it to the final cut. There was a program called Latin Pass that was awarding a million miles that included you had to fly on all the different partners to earn those miles.

Some of this was flying on planes to earn the miles. The plot was that in order to keep up a long-distance relationship, Adam Sandler figured out ways to cover the tickets. He discovered in the aisle of a supermarket that he can earn these miles from the pudding cups, but the miles were per scan transaction.

Individual pudding cups were coming with their own barcode. It was those individual pudding cups, and then he figured out he could donate the pudding cups to a food bank and get the volunteers there to peel off the barcodes. You had to send them in because back then this was all by mail.

Then there was this hope that something between the kind that you send them and they reach there with no real tracking that it all works out, but it did. There have been all kinds of things like that. Amy cheese was another one over the years.

I had years ago when I had a lot more hair than I do today, Bosley hair restoration was offering 20,000 Delta miles for a hair loss consultation. I went in for one, my wife went in for one. She has very nice long hair. You just go in and do these things because British Airways miles, you earn enough British Airways miles by test driving Jaguars because they have family accounts.

You get four people’s accounts linked together, and you have the salesperson sign four forms. You tell them, “Don’t worry. I’m not going to waste your time actually making you do the test drive because I’m not buying. Just sign my forms.”

It was going to a Jaguar dealership, flying to Europe. A lot of these were great arbitrage opportunities. Well, I’m sure we could continue talking on this for hours, but do have to end it somewhere, and this is as natural a point as anywhere.

Where can people find you on the internet? On social channels, I’m at Gary Leff, and you’ll find me on my site viewfromthewing.com. Leff is spelled L-E-F-F for people who don’t have it in front of them.

Well, thanks very much, everyone. We’ll see you on Complex Systems next week. Thank you very much. Pleasure and an honor.

Thanks for tuning into this week’s episode of Complex Systems. If you have comments, drop me an email or hit me up at patty11 on Twitter. Ratings and reviews are the lifeblood of new podcasts for SEO reasons and also because they let me know what you like.

Complex Systems is produced by Turpentine, the podcast network behind Econ 102, Riff with Berne Hobart, Turpentine BC, and more shows for experts by experts in tech.