This is a two-part series looking at airline credit cards. Today, we look at how it all works. Then tomorrow, we’ll ponder what happens if it all goes away.
The airlines in the US have developed into a special kind of company… one that consistently loses money on its core business but makes up for it on financial services. This is thanks to the way banking laws work in the US. Cobranded credit cards have been an absolute gold mine for the largest airlines, and as of now, there is no end in sight.
The way it works today is surprisingly not that complicated on the surface. Allow me to post an image that simplifies it for you.
I kid, I kid. But it isn’t actually that complex at a high level. Airlines partner with credit card companies so they can both make money on these cobrand deals. You have Delta and Amex, both United and Southwest with Chase, American recently consolidating its relationship with Citi, Alaska with Bank of America, and JetBlue with Barclays. Those are the biggest ones, at least. But every airline has one. Avelo is with Capital One, Breeze is with Barclays, Allegiant is with Bank of America, and so on. Foreign carriers have them too, though most won’t get as much traction with US-based customers, and regulations at home make them much less lucrative.
The credit card companies charge an annual fee to the cardholder, and of course, there is an extortionary interest rate for those people who don’t pay their balances on-time. Then, the big money is made every time the cardholder uses a card. If you’ve ever accepted a credit card as a business, you’ve probably seen things like “2.9 percent plus $0.30 a transaction.” That’s a pretty typical arrangement. So if you sell something for $100, you’ll only collect $96.80. The rest of that money gets split up in a million ways.
Some of the fees are called merchant service fees and go to the business’s payment processor and gateway. Others — interchange fees — go to the bank of the cardholder. And then there is money that goes to the network. (Think… Visa, Mastercard.)
Sometimes businesses sign up for flat rate pricing, but those are padded to make sure that the card companies do well. Others have variable rates with fees that can fluctuate greatly depending upon the type of card, what information is provided upon purchase, whether the card is present for the transaction or not, etc. Basically, the banks are charging more when they have to pay out more and when they are concerned about fraud. In the end, an airline rewards card will have a higher interchange fee, because the rewards can be costly.
So, where do these interchange fees actually go? They go to the bank that issued the card, but the bank has to make sure it has attractive cobrand partners or people won’t use the cards. Airlines are very attractive, and they have become the most important partners because they can award miles when people spend on the card.
There are requirements around marketing and advertising and all that, but the primary transaction that occurs is that each time someone buys something, that person earns points with the airline that’s named on the card. You spend a buck, you earn a point… or whatever the ratio is at each program. And when you earn those points, the bank actually buys them from the airline using all those hefty interchange fees (and other sources of revenue). Whether it’s a penny a point or something else, this adds up very quickly to big, big money for the airline.
It’s also money that has saved airlines during the lean times. For example, American Express prepurchased $500 million worth of miles from Delta in 2004 to help it avoid bankruptcy… for almost a year before it filed anyway. That’s a pretty nifty little trick.
This is, of course, not just something that airlines can do. There are hotels, Amazon, Home Depot, the Gap, pretty much any place you might shop that has a card available. Heck, even your alma mater probably has a terrible credit card that it hopes you’ll get out of loyalty. And of course, there are cards that aren’t branded that just give you cash back instead of rewards. But nothing matches the size, power, and appeal of the airline cards.
The most important relationship these days is between Delta and American Express. Ever since Costco left Amex, Delta has been by far the largest airline partner for Amex. Without Delta, Amex is in big trouble. And Delta, for its part, netted more than $7 billion 2024 from the deal. It expects that to grow to $10 billion a year. That is a lot of miles.
As Courtney Miller noted in his recent Visual Approach newsletter, that swung Delta from a -2.5 percent operating margin to +10.5 percent. In fact, not a single one of the big airlines would have been profitable in 2024 without that money, though United got closest hitting a mere -1.9 percent operating margin.
While this all sounds great, there are downsides. The fees are higher to support this system, naturally. And this is really an unfair playing field, because the biggest airlines are far more attractive to a credit cardholder. The opportunities are just greater, and that means the little guys get cut off at the knees once again. That hasn’t stopped them from trying, but they are at least somewhat realistic.
On Frontier’s Q4 earnings call, Chief Commercial Officer Bobby Schroeter said this:
Loyalty remains a significant financial opportunity. Today, our co-brand revenue per passenger is under $3, compared to over $30 at legacy and other low-cost carriers. Even capturing a fraction of the legacy and low-cost carrier levels represents a meaningful and achievable growth opportunity over the next few years.
This means that the big airlines have yet one more advantage that keeps them where they are. That I will talk about more tomorrow.
38 comments on “How the Airline Credit Card Financial Model Works (Very Well, Thanks for Asking)”
What’s going to happen when cardholders get upset at the changes to an airline’s mileage program and cancel their cards? Aren’t the airlines worried about dinging their operating margin?
Angry Bob – Hasn’t happened yet, but I’m sure they’ll deal with that if it ever does.
Delta’s consistently been the leader in gutting their frequent flyer program for decades, and yet they have the most valuable of the credit card programs. There’s a reason for that, I think: Delta’s gutting of the frequent flyer program has consistently been to enhance the value of the co-branded cards.
So people in the USA pay an additional 1% or 2% on their supermarket bill (beyond what would allow banks to make a modest profit on credit cards) in order to subsidise airlines with a small bribe to frequent flyers ? This sounds like a cartel… shouldn’t Congress or the Treasury / Commerce Depts be thinking about making this all a little more transparent ? Namely people should get a lower price on their year-round spending instead of subsidising airlines… and airlines overall should set the price of air tickets to be profitable. It seems like a corrupt scheme rigged against ordinary people.
Before anyone thinks these points are free… supermarkets (and every other retail business) will always raise their prices if they have to pay a 3% cut to their bank instead of (e.g.) a 1.5% card processing fee. Supermarket customers don’t see this extra fee because credit card issuers forbid charging an extra fee for credit cards instead of cash
Sorry to contradict you, but the last three restaurants I have visited have differences between using a credit card and cash. Usually 3% to 5% surcharge for cards.
Also, several gas stations in my town are doing the same with a 7 cent to 10 cent markup per gallon using a credit card.
Happen again with my oral surgeon: 5% surcharge is using a credit card. I wrote him a check which he let float for several days by chance.
It’s always been a way to award the rich at the expense of the poor. Company credit cards being able to use the rewards yet the company pays those fees are a good example. The poor can’t afford the annual fee nor spend as much, giving them smaller overall rewards further straining the relationship.
My solution to this is different than yours. I think there should be a published cash discount that basically covers the transaction costs. Poorer people can take advantage of the situation instead of getting hosed.
If a business wants to accept a credit card, it has to sign legal paperwork with their bank / card processor. Buried in the terms is a clause that forbids the retailer (supermarket or otherwise) from having different prices for cash and credit card. It would be extraordinarily difficult to get this clauses rendered null and void… much easier to stop the airline subsidy racket.
Supermarket should look after itself, pay a price to suppliers that allows them to make modest profits… and not be compelled to subsidise other non-supplier profit-seeking companies
Merchants get around this by tacking on a “service fee” for anyone paying by card. Where I live, notices advising customers of this have sprung up at all kinds of businesses.
Went to a barbershop a few months ago & the owner mentioned if you pay by credit card there’s a 3% service fee over the price, so I pay cash instead.
Yep seeing this more and more
And when it’s illegal or against whatever agreements with the credit card companies, there’s no “service fee” but instead a “cash discount”.
AFAIK, the law was changed in the last decade to explicitly allow a percentage based cash discount to be offered at the register.
It used to be it was allowed, but every product had to have a cash and a credit price listed, and that would be unwieldy, so gas stations where the only ones who adopted it in any notable level.
The truth is that the current credit card system benefits that majority of Americans. Some benefit by by having easy access to (admittedly bad) financing to fund their lifestyle, while others enjoy the miles/points/cash they receive. Assuming you are paying the balance in full each month, it is not hard to earn 2% – 4% back in cash on all of your purchases. You also have the other protections and coverage provided by the card.
I am not an airline miles guru, but many do enjoy saving up for a premium seat that they would never purchase directly.
“… pay an additional 1% or 2% on their supermarket bill”
When I buy something at the supermarket the price is the same whether I pay with cash or a credit card. Where are you getting the additional 1% or 2% from?
The supermarket charges everybody the 1-2% upcharge. All the prices are marked up to account for the fees they must pay to the bank. Supermarkets generally have a low overall profit margin, so they won’t give a discount for paying cash.
My best friend works at a local supermarket chain, I’ll mention this to him as we are going to meet at their newest store that opens this weekend.
It’s not like cash doesn’t cost the supermarkets anything. they have to pay people to count and hire armored trucks to haul it away, in addition to theft.
This is true, but cash costs the supermarkets less than the 2-3% that credit card fees cost them.
If you think this administration is going to do anything to benefit the average consumer / increase transparency / decrease bank revenue. . . I have a bridge to sell you.
Boggles the mind that people get so caught up in these point schemes especially when the concept of “miles” has been completely devalued by the airlines. Without a constant award chart, you don’t have any idea what a “mile” is even worth. Back when you knew what 50,000 miles could get you, it was more aspirational and far more worthwhile. Currently if you do anything but use a card with no annual fee with cash back rewards (usually in the 2% or more range), you’re a fool.
Even Homer Simpson gets it:
https://youtu.be/A81DYZh6KaQ?si=Zi_p8vJmx_puP9lJ
Yes Homer, money can be exchanged for goods and services. Including airline tickets!
If you are strategic with your points, you can get a ton of value from it, beyond just 1-2% cash back. I’m going to Maui next week, staying 5 nights at an $800/nt hotel all booked with Marriott points and RT airfare for 2, again, booked with points. I don’t spend nearly enough annually to gain that much in cash back value.
Although it’s not official or published anywhere, the variable pricing usually means that the price in miles corresponds better with the price in dollars, making the value of each mile more consistent (within one program) rather than less.
50,000 miles used to get you an award ticket from ABC to DEF if there was availability. Now it’s more like 50,000 miles gets you a ticket worth approximately $XYZ.
That is how Chase does it. Ultimate Rewards points are tied to the dollar value of the flight.
If you are flexible and strategic with miles, the rate of return is significantly better than cash back. I’m flying business class round trip US->Eur next month for an exchange rate of just over 8 cents per mile. What card is offering 8% back?
Annual fees are wiped out if you hit the spend requirements and actually travel. $95 annual fee but I get a $125 flight credit so the annual fee is wiped up plus $30 profit.
Then add in all the benefits from getting status, priority customer service, no cost flight changes same day, free luggage, buy a cheap seat and select main cabin for free at time of purchase, etc. and it’s way more value than 2-3% cash back.
Same with hotels. IHG card and platinum equates to 13% cash back at IHG properties. $95 annual fee, but one free night certificate a year and where are you staying that’s cheaper than $95 a night?
I’m curious if in Part 2 you can include how Air Canada stacks to the Frontier vs Legacy carrier comparison. Their recent investor day presentation has them switching from betting on density (good article about them by the way) to premium arrangements, with the 787-10 getting 42 business and 27 PE vs the 30/21 on the 787-9. Even the 777 they said “up to 300% more premium seating”.
I suspect they are closer to Frontier then the American legacy in revenue per credit card pax and trying to shift cabin seating to reflect credit card points being used more on travel.
Personally think the companies have diluted their frequent flyers programs and hotel points. When everyone boards in zone 1 and your number 40 for upgrade it’s reached the tipping point for me. Currently a free agent and not being held hostage by frequent flyer programs or hotel points has allowed me to be more flexible (and save money). Cancelling my airlines branded cards too.
Any clear reason the airline cards are so much more popular than all the other card partnerships? Always been curious about the economics (or psychology?) of that.
It’s the fantasy of finally being able to get that dream vacation for free (at least the flight portion). You don’t tend to notice all the costs you pay (annual fee, interest rate, F/X Fees, etc.) in trying to save that currency. And of course the airlines devalue the worth of their miles on an annual basis. I finally saw the light and stopped chasing the miles a couple of years ago. Unless you travel 100+ nights a year, you really can’t gain any status worth having anymore, and availability of travel to those fantasy locations (unless your fantasy involves flying to Cleveland or some place like that) on miles is close to zero. Immediate cost and schedule are now my priorities (and probably should have been from the start).
It’s pretty much a savings account that loses money every year for the average joe while the airlines and banks enjoy the spoils.
I personally don’t care much for the points but as long as these credit cards include the bag fee, I still come ahead after paying the annual fee.
It’s the allure of getting a discount on that exotic trip people often fantasize about taking some day, but reality has a funny way of asserting itself.
Value of status in making air travel more comfortable, cheaper, and more convenient. If I get 5% back at Amazon, cool, I got 5% back. It’s no more special than a sale.
Now, compare to my AA card. Besides the miles (which I redeem for 2-8 cents each by being flexible about when and where to redeem them) the miles give me loyalty points, which helps me maintain Platinum Pro.
Platinum Pro lets me buy the cheapest ticket and select Main Cabin Extra seats for free instead of paying an $80-ish fee per seat. I can check up to 3 bags for free per person. I board very early and never have to worry about lack of overhead bin space. I get priority customer service. I can change flights the day of for free. I get access to nicer lounges on international flights for free, etc. etc.
So, dollar for dollar, its a better value and it includes things you can’t just buy with cash.
Maybe you will discuss this further tomorrow, but it has been alluded too by some of the comments above; I think it’s really an important part of the story that airline miles are funny money and US law is such that airlines are free to debase the value of that funny money at will in the future. This is what makes them particularly attractive to financial companies, because if you are paying a cash rewards instead, you have no control over the value of that award in the future since it typically takes actions by the Fed and Treasury to debase the value of the dollar itself. WIth airline miles you can give out all you want now; and if in the future your liabilities are too big you just arbitrarily debase them with a change to the award chart.
Brett –
What you posted about this Visual Approach Newsletter and all airlines being unprofitable appears to be misleading.
From what I can see in that newsletter they essentially take the reported profit and then just subtract loyalty revenues and then say “this is what their profit would have been without these revenues”. That is not an accurate way to look at this.
These miles purchased by the credit card companies ARE NOT a 100% margin for the airlines. They have actual costs. What about when the miles get redeemed for free tickets, upgrades to First Class/Business Class, Sky Club memberships, checked bags, etc? The miles come with costs. I’m sure these arrangements are very high margin, maybe 50%? But they are not 100%.
The thing to keep in mind is that those costs are basically arbitrarily decided by the airline. It’s a “heads I win/tails you lose” proposition for the customer most of the time unless you’re just really diligent about where you push your miles (this is where CF’s main business comes from I’m guessing-maximizing points redemptions).
Every time say, delta announces a devaluation it’s basically reducing their liability for awards. Oh you want to go to Tokyo in Delta One? Great! That’ll be 640k Skymiles please! And Delta can choose whatever that miles amount is without any legal repercussions.
The only real way to game the system in the USA if you can book partner airlines in cash and get awarded MQDs (or the other carriers’ status) based on a percentage of miles flown (basically getting extra MQDs because of how far you flew). Other carriers you have a better shot if they have award availability (big if).
Zain – That’s not our main business at all. It’s a small part of the business but our main focus is as a travel agency that provides flight monitoring.
I agree 100% with this comment and I am highly confused by people who say flying is not profitable for airlines, only financial services.
The bank is the financial institution, not the airline. They offer the credit cards and buy points from the airline for a given price (unlike the value of the points to the end user, I assume the price the bank pays is pre-negotiated and doesn’t vary except between contracts).
The airline selling points is really selling future travel. Yes, they can play games with the value of the points, but there would be precisely zero value to the points if the airline weren’t an airline. Aren’t the credit card issuing banks really just another sales channel for the airline? They sell a currency (yes, with variable value) that can only be used at one merchant and can only be used to buy flights (and a few peripherals). They are still selling flights, they are just pre-selling them. They make money on the flights, partly by pre-selling them. The games they play with points values make everyone so mad that they miss the point that this is still their core business.
the big airlines have managed to turn the most successful loyalty programs – airline frequent flyer programs – into some of, if not the most successful credit card partnerships.
Those that criticize the US airline industry fail to realize how much they have innovated to not just increase their margins but also win against smaller and lower cost carriers. Foreign carriers simply do not have finance systems that support the credit card interchange fees that US banks get so they will never be able to duplicate what the US carriers have.
and the credit card and frequent flyer partnerships don’t mean anything if there isn’t a strong airline behind them – which includes a robust global network. American’s strategy has been to focus on second tier domestic markets connected to major markets in the US and around the world through its partnership and that model has struggled to deliver profits at AA’s costs far more than DL or UA but AA did manage to land a rich new credit card deal – which is a testament to how much credit card usage there is across America.
United has long touted its global network – until the current mgmt team realized that the value of credit card deals is much more heavily tied to domestic demand – because of the credit card network – than foreign networks. UA is working to build its domestic network precisely because it is missing out on so much “middle of America” demand that drives AA’s passenger and credit card revenue.
Delta has arguably done the best job of using the Amex relationship to grow its network to maximize its presence in major coastal markets which have high credit card spend while giving up nothing in its ability to connect the middle of America to the world.
The chart shows that WN gets a lot more credit card revenue than people realize but is not getting the revenue to offset its high costs. How they restructure their network and partnerships will determine how much more revenue they can get out of their credit card partnership.
and for those that complain about the extra percent or so that is tacked onto prices for the use of credit cards, the ability to use consumer credit is a huge driver of American consumerism – and no one in Washington is willing to undo that because it will have enormous implications for the US economy far beyond airlines.