How Loyalty Programs Make Money, Courtesy of United

Frequent Flier Programs, United

We’ve long known that airlines make big money from their loyalty programs, but the exact structure has been shrouded in secrecy. That is now changing as airlines look to leverage these money-makers as collateral for financing. United has just unlocked more than $5 billion by putting up its MileagePlus loyalty program, but to do that, it had to give a lot more public information about the nuts and bolts of how it all works. Lucky us.

The 47-page MileagePlus document has a lot of charts and dizzying details, but underneath, there is a very clear understanding of just how these programs make their money — as expected, it’s by selling miles to third parties. In 2019 alone, MileagePlus pulled in $5.3 billion in total revenue and $1.8 billion in profit (EBITDA), but those numbers need to be broken down.

Loyalty programs have to be more independent for them to be usable for collateral, so United has taken a page out of Norwegian’s book and created one of the most complex structures around. I mean, just look at this ridiculousness:

Ok, now stop looking at it, because it doesn’t really matter. What does matter is that with this independence, United has to record money moving around within United Airlines, Inc. For the most part, this isn’t new money for the company. The one exception is when someone buys miles from the airline instead of earning by flying, but let’s pretend that doesn’t exist and be even more conservative. Of the $5.3 billion in cash that came into MileagePlus, 29 percent came from United itself, so we will conservatively assume that’s not net new cash at all.

Confused? I can’t say I blame you. So, let’s use a real-life example.

Cranky Flies to Newark

Back in January, before the world ended, I flew United from LAX to Newark. I bought my ticket for a mere $133.30. In the old system, I would have earned 2,454 miles for the flight, but now that United awards miles based on the money spent instead of the miles flown, I earned a lot less. Since I’m not an elite member, I get 5 times the BASE fare, not the total amount paid. The base fare before taxes and fees was $110.70. Since United so kindly rounded up, I received a whopping 555 miles.

When I earned those miles, United “paid” MileagePlus Holdings (MPH) at least a penny per mile. The formula — as United so eloquently puts it — is:

The price at which United buys miles from MPH is subject to adjustment such that MPH’s United related EBITDA margin (defined as the quotient of (i) United related revenue, minus MPH operating expenses excluding depreciation and amortization, minus estimated future redemption cost of miles sold, divided by (ii) United related revenue) is at least 20%

Technically this means that United paid MPH at least $5.55 so it could award me my miles, but it could have paid more if required to get MPH up to that 20 percent margin. Just keep in mind that this is funny money. This is just United moving money from its left pocket to its right pocket.

Where the Big Money Comes From

The real money here — the remaining 71 percent — comes from selling miles to third parties. Do you have a United credit card issued by Chase? For every mile you earn, Chase pays United. In fact, if you have any Ultimate Rewards-earning Chase credit card, every time you transfer points to United, Chase pays United for the privilege. (Technically it settles up quarterly, but you get the idea.) If you buy flowers from Telefora or earn miles by shopping or dining, those vendors all pay United every time a mile gets awarded to someone who bought through them.

This is real money that comes from outside companies. How much? Well, United gives an example of a partner buying 15,000 miles from United at 2 cents each. I would assume that’s probably an average. A massive buyer like Chase probably gets a better per-mile deal than a small player. But if United is pulling in 2 cents a mile overall, then that’s a nice chunk of change.

Giving That Money Back

MPH is sitting here collecting all this money, but it doesn’t just get to keep it. Of course, when a MileagePlus member goes to redeem those miles, then MPH has to pay money out to the vendor. Here’s how those redemptions break down:

More than 77 percent of redemptions are for travel on United so that is money moving from the right pocket back to the left. United values redeemed miles at a penny per mile, so for miles that were originally sold to third-parties for two cents, MPH is making half as pure profit. For miles sold internally, it’s making a paper profit of 20 percent. These are pretty hefty margins. Now let’s do some more math.

The Power of the Program

United generated $3.7 billion in revenue from selling miles to third parties last year. If we assume that those were at 2 cents each, then United issued 185 billion miles from those transactions. Add in the ones issued to people flying United — and assume those were at the minimum cost of a penny per mile — then you have another 154 billion miles for a total of 339 billion miles issued.

Let’s make the silly assumption that all of these miles get redeemed. Since 77.6 percent are on United flights, there is again no money changing hands. Sure, there are some costs involved for carrying that passenger and potentially bumping a paying traveler, but we can’t accurately evaluate what that is. Let’s just assume that United’s valuation of one cent per mile redeemed is right. That means this costs $2.6 billion. I tend to think that’s overstating things, but again, we’ll go conservative.

That leaves us with 76 billion miles that will be redeemed with partners. Now on this point, we don’t know how much that costs, but let’s just say that it’s at 1.5 cents per miles redeemed which equals just over $1.1 billion. That means combined, United would be paying out about $3.7 billion ($2.6 billion of which just goes back into United’s pocket). This equals the amount it generates in pure revenue from third parties.

Now remember, I’ve made a lot of stupidly conservative assumptions here assuming people will redeem all their miles and that United derives no revenue from the miles it awards internally, among others. In essence what this suggests is that if United saw zero internal value to the program, which we know isn’t remotely true, it would still break even just from third-party sales.

This is all wrong, of course. There is enormous value in the program for United, but the selling of miles to third parties means everything else that generates value is done with no real cost to the airline. Since we can’t get more clarity without more details, this can at least point us in the right direction regarding the value of the program.

Of course, if United goes out of business, then there’s a problem. But the chance of that happening is so slim that it’s hardly worth considering. Sure, bankruptcy is possible, but the program is so beneficial to the airline that there is no chance the miles and related value would be wiped out. This is an important piece of the airline, and so nobody should be surprised to see banks being willing to lend big money with that as collateral.

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27 comments on “How Loyalty Programs Make Money, Courtesy of United

  1. United’s need to use Mileage Plus as collateral provided the world with better insight into the workings of legacy carrier loyalty programs as never before. Absolutely fascinating.

    And, yes, loyalty programs are the crown jewels and the heart and soul of an airline.

    United is pledging Mileage Plus as collateral for a private loan and will get $5 billion for it gives UAL an enormously long rope on which to swing. United will use its remaining assets as collateral for a Treasury loan, if it is approved while American is pledging AAdvantage as collateral for a Treasury loan (so we might not see the details behind it) while using its remaining collateral (slots, gates, routes) for private sector financing.

    Delta says it still has $5 billion plus in unencumbered assets and is not talking about pledging Skymiles as collateral for any loan; it is likely it is more valuable than either AAL or UAL’s because of the higher value of the Amex relationship. Southwest has plenty of collateral remaining as well; it would be interesting to see how much their program is worth but we probably won’t know that about Delta or Southwest.

    It is also worth noting that, even though the American and United loyalty programs are worth more than the loans, it is doubtful that they can keep borrowing against them from multiple lenders.

    It should be more than a little scary that American and United are pledging their last assets for their survival; there is no margin for error in turning their companies around.

  2. Fascinating, indeed, Mr. Dunn. After reading United’s convoluted accounting practices and bottom-line free profit, can we suggest that the Big 4 are all de-facto subsidiaries of their credit card partners, when it comes to profit? No wonder Southwest wanted Hawaii so badly: think how many Californians signed up for the SWA Rapid Rewards Card when they announced Hawaii so far in advance of commencing service or even having FAA approval for service. LUV is probably making more profit off Albertsons and ARCO than they are from flying people to Hawaii. And I bet Delta generates far more credit card profit than Southwest does. Perhaps we can figuratively say that Delta is a credit card company that just happens to fly airplanes??? (No slight intended.)

    1. There is no doubt that airlines have created enormous profit centers in their loyalty programs.
      If we use the ratios that UAL provided in terms of the amount of cash they get from their primary credit card partners, Delta and Southwest did operate their airline operations at a profit while American used AAdvantage to subsidize its airline operations and United was about breakeven.

      1. Why would we use United ratios when Delta told us their new credit card partnership Is worth $7B/year at a run rate?
        Perhaps delta was running a profitable operation pre-coronavirus. We don’t know how much immediate added benefit came from the $7B/year number projected by 2023. But the reality is that delta is a credit card subsidiary just like everyone else now.

        https://news.delta.com/american-express-and-delta-renew-industry-leading-partnership-lay-foundation-continue-innovating

        1. Delta was not getting $7 billion/year from Amex in 2019. That is where they expect to be several years down the road – and all of that pre-virus

          But the Delta-Amex relationship is worth far more than what American or United have come up with which makes Skymiles worth more.

          Even if you want to argue that Delta is no different than everyone else in making money from their credit card operation, they clearly make more money from their credit card operation than American or United or anyone else because Delta’s profitability was much higher.

          let’s check back after a year or so – but the chances are very high that Delta and Southwest’s loyalty programs will be distinctly and solidly theirs while American and United will have to work hard to regain the right to call their loyalty programs theirs.

          1. You’re making assumptions. Like we all do, but the rest of us admit our assumptions.
            You don’t know the value of AAdvantage, the program of the world’s largest airline.
            You also don’t know what Incremental value Amex provided Delta’s pre tax In 2019 due to a deal announced in April, 2019. It would hardly be a surprise to anyone if the deal provided signing sweeteners or immediate benefit to delta’s income

      2. And perhaps Delta would’ve made $7B/year by 2023. We won’t ever know now but it seems just as likely that in a non-covid world, Delta was planning on a world where Their credit card agreement led the way on a loss-leading operation (I.e. making less than $7B/year pre tax)

        1. you are making the same assumptions that you say I should not.

          The bottom line is that American and United have pledged their loyalty programs as collateral.

          Delta and Southwest have not.

          Delta and Southwest were much more profitable and less in-debt airlines before the virus crisis and will be in the future – and they will not have to provide any details about their loyalty programs as long as they are not used for collateral.

  3. Well, here are some actual numbers to play with, courtesy of UAL’s 10-K:

    In 2019, approximately 6.1 million MileagePlus flight awards were used on United and United Express. These awards represented
    7.2% of United’s total revenue passenger miles. Total miles redeemed for flights on United and United Express, including class-of-service upgrades, represented approximately 87% of the total miles redeemed. In addition, excluding miles redeemed for flights
    on United and United Express, MileagePlus members redeemed miles for approximately 2.2 million other awards. These awards
    include United Club memberships, car and hotel awards, merchandise and flights on other air carriers.

    Percentage of miles earned not expected to be redeemed (estimated based on management assumption) – 14% . If you apply this value across the board, this means that this is pure profit for those sold miles, and you don’t have to account for them as deferred revenue.

  4. Thanks, interesting.

    As I read through this, I come away with a couple of observations as where I the airline consumer, the United customer, the United traveler stand with regard to UA..

    1. United can sell miles I paid for as part of my ticket. OK, but I am forbidden from selling a ticket I paid for with my money. How is it fair for UA to sell miles, but I can never sell my ticket?

    2. Customers who buy tickets using this or than card, are ranked higher on the loyalty scale that those who don’t pay with the card. If I spend $133 for a ticket, not with a particular card, and someone else spends the same amount, using a card, why reward the latter more than the former? We didn’t have this issue when points were based on miles.

    3. UA, as others, is regulated by DOT because it is an airline and so, responsibility was placed with DOT, not FTC. Frequent flier programs do not involve running an aircraft from point A to Point B. Maybe airlines should be fully regulated by FTC, and DOT gotten out of the regulatory business.

    1. They are also regulated by the SEC which is far more relevant and applicable in comparison to other companies; We got this document precisely because UAL had to disclose how it makes money via a program that is a significant source of revenue for the company and will be pledged as collateral for UAL’s loans.

      MPH IS a subsidiary of an airline.

    2. 1. United chooses the terms including no resale simply because they are United’s miles to do with as they please. If you don’t like it, you don’t need to use them (and you don’t need to fly United).
      2. It gives you an incentive to get the card. Again, it’s simply United and the credit card company choosing the terms because it’s their airline and credit card.

  5. Really interesting post, Cranky. How do things settle if someone earns miles on a partner or they redeem with a partner? Is there actually a cash transaction behind the scenes?

    1. Chicago Chris – As far as I know yes. If there is a redemption on a partner, then the partner has to be compensated by United for that seat.

  6. The last time I flew AA (couple years back) it seemed like half the flight time was a pitch for the AA credit card. Flight attendants mentioned it at least twice of each segment I flew (4 total). It was clear to me then that the AA advantage program was more profitable than the meager $250 that I paid for the flight.

    I do question if “award trips” will be the same draw for consumers post-Covid as they were before. If people truly are afraid to pack into a plane that isn’t socially distanced will they swap airline credit cards for cash back or some other perk? What good are miles for that trip to Orlando if you decide to road trip instead? Personally, I’ve shifted most of my spending to a cash back card as I’ll see that benefit likely sooner than I can book an award ticket to a destination that isn’t under some sort of Covid lockdown.

    1. My impression is that the flight attendants themselves get a decent commission for each credit card signup they get. So it’s in their own personal interest to push the card.

      1. Flight attendants are very well compensated for completed credit card applications. At a rate of at least 25 times more than Reservations agents for transferring a call for a phone application. Some FA’s enjoy participating and/or rely on it as part of their income. Some of them are as turned off by the required announcements as most customers.

    2. Some people will be more afraid to get on an airplane now, but many of those wouldn’t be frequent flyers anyway and wouldn’t have the credit card.

      Others will be switching to a cash back card, but all that means is that United and Chase will need to offer a better card, whether through more miles earned, other perks, or lower fees (probably not).

      1. Count me among those who have completely switched to cash-back cards for now.

        But to your point about the stay-at-homes not being frequent flyers, I think back to post 9/11. I flew two TATL roundtrips on AA in the next six months. On all four legs, the business and first-class cabins were completely full, and the back of the plane nearly empty. The premium cabin passengers outnumbered the economy passengers.

        My guess is we’ll see the same when international travel becomes possible again.

        And today’s business class seats come pretty close to social distancing.

        1. Take a look at the BA 787-10 seating chart – almost 50% of the seats are premium seats (includes premium economy).

  7. @JayB

    I agree with your thoughts to a degree. It doesn’t seem fair. The thing to remember is that United has the right to set the rules for their own company. They prioritize customers that use their credit cards over a non United partner credit card or debit card because they believe the customer may choose United over another airline because of this.
    Even away from the airline industry most companies will have offers that provide perks to certain groups over others because of their perceived value. In my business I will offer deals to someone that I perceive as more valuable to future business than someone I feel will not care to bring future business. I may be wrong at times but it is often the best use of marketing funds to get the best return.

  8. Really interesting post, thanks cranky!

    Do the documents reveal if elite benefits are charged/recharged to the program too ? Such as lounge fees on intl. itineraries? would be interesting if it reveal more about those.

  9. While my mind is still spinning from the example, your explanation is very good. Anytime there is “funny money” floating around financial analysts and auditors (internal and external) will earn their keep just keeping everything straight. All of the funny money transactions except for the first external revenue in and expense out fall out of corporate earnings since they are internal transactions. (The subsidiary who receives the revenue gets the “internal” credit, and the one that spends the money gets the expense.)

    I have been involved in 3 bankruptcy proceedings representing the funding team. There is nothing simple or fair in a bankruptcy proceeding as the judge is the judge and executioner. The “spoils” go to the group that makes the best pitch to the Judge, who then invariably will issue a statement saying, “he did the best he could for both the bondholders and the stockholders.”

  10. What is really interesting is that United can sell a mile for 2 cents that it values at 1 cent. Consumers can use a Citibank 2% back credit card so why would they use a credit card that gives miles, usually at 1 cent per dollar spent? I answer as follows:

    1) I use Chase Ink in my business and for most purchases it is only 1 mile per dollar spent. But, it would be a nuisance to change my card with various vendors so I stick with it long after it has paid its bonus.

    2) My wife and I typically only redeem airline miles for a value of 1 cent. BUT hope springs eternal that if we are flexible we will occasionally snag a great deal on premium trans ocean seats where the miles are worth several cents a mile. This has become increasingly harder to do, but there are still opportunities, particularly for last minute travel. In a sense we may overvalue miles the way folks overvalue lottery tickets.

    3) With Chase’s premium travel card it is hard to calculate what you get for the fee. On the one hand, 3 points, transferrable into 3 mile on many airline program, per dollar spent on travel or restaurants and admittance to non-airline airport lounges and you pay a fee, and how many folks really do the math at the end of the year to see if the premium card was worth the annual fee???

  11. If ones miles are valued at 0.01 and you can get 0.15 to 0.2 in cash, what is the rationale for miles over money. Cash has the advantage of having value at all venues, not just for a seat on a plane if you can get one. Oh and as side cash does not expire.

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