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American Airlines Quietly Rolled Out the Industry's First Frequent-flier
 Program 25 Years Ago; Today, Loyalty Programs Face Significant
 Challenges as Travel Business Transforms
By Trebor Banstetter, Fort Worth Star-Telegram, Texas, Fort Worth Star-Telegram, Texas
Knight Ridder/Tribune Business News

Dec. 26, 2005 - In the late 1970s, Rolfe Shellenberger and a few other marketing executives at American Airlines were kicking around ideas for a way to persuade business travelers to fly the carrier more often.

The project was code-named Loyalty Fare, and they initially planned to offer a 25 percent discount on airfares to frequent fliers.

"After a while, it seemed to me that wasn't going to work," said Shellenberger, now 76.

For most business travelers, he said, companies paid for the airline ticket, so a cheap fare wasn't much of an incentive. "So we thought, let's figure out a way to give them a free ticket to Hawaii if they fly regularly with American."

With that idea, the airline industry's first frequent-flier program was born. Dubbed the AAdvantage Travel Awards Program, it was quietly rolled out in early 1981, with 283,000 members who began accumulating miles they could exchange for free tickets.

Today, approaching its 25th anniversary, the frequent-flier program is widely considered one of the travel industry's most successful promotional plans. Soon after American's launch, every major airline adopted a similar plan, and today 75 million people worldwide are estimated to belong to at least one frequent-flier program.

But airline loyalty programs are also facing some significant challenges as the travel business transforms.

The low-fare revolution spurred by discount carriers such as Southwest Airlines and JetBlue Airways has diminished the value of a free ticket to many consumers.

And companies are more frequently directing employees to book the cheapest possible fare when traveling, regardless of the airline or its loyalty program.

Meanwhile, cutbacks by most major carriers in domestic capacity have resulted in airplanes that are packed with passengers, leaving fewer available seats to give away to frequent fliers. And available seats are shrinking even as credit-card partnerships and other programs make it easier for consumers to rack up miles.

Some fliers also worry about the status of their miles as airlines file for bankruptcy and the industry consolidates.

"I would argue that it's gotten to the point where we're on the verge of these programs becoming less important," said Tim Winship, a longtime travel executive who publishes Frequentflier.com, an Internet site that monitors airline loyalty programs. "If things keep going further in this direction, you're going to find a lot of consumers that say, 'Oh, so what?'"

Still, it's hard to discount the sheer numbers of travelers who participate, and the revenues the plans generate for the struggling airline industry.

American's plan, the world's largest, has more than 50 million members as well as partnerships with more than 1,500 companies. On any given flight, according to some estimates, as many as 10 percent of the passengers could be flying on frequent-flier awards.

Analysts say American's program may be worth $2.6 billion, and other experts say it brings in as much as $1 billion annually in revenue by selling miles to partners such as credit-card companies and hotel chains.

"This is the world's most significant loyalty program," said Dan Garton, American's executive vice president of marketing. "It's an incredibly important asset to us."

Starting small

Ross Lunan was an engineer who regularly traveled between Montreal and San Francisco in 1981 when he signed up with American's fledgling program.

It almost immediately changed the way he booked airline travel, he said. The free tickets meant he could take his wife along on business trips occasionally.

"I started primarily booking on American," said Lunan, 60, who has earned more than 2 million miles since then and still travels regularly for Harris Corp. "It really did influence my choice of carrier. It still does."

That was the original goal of Shellenberger and others who developed the program: persuade travelers to fly American all the time, even if fares were higher than competitors', to earn those free tickets and upgrades to first class.

And the way the program was designed, it cost the airline very little. American reserved only a few seats on each flight for frequent-flier awards, seats that almost certainly would have gone unsold anyway.

"That was the key" in convincing then-Chief Executive Bob Crandall to sign onto the plan, Shellenberger said. "There was no negative impact on revenue."

But although it began as a fairly small program aimed at a top segment of business travelers, it quickly exploded with popularity. "It caught on like wildfire," he said.

Soon American, as well as rival airlines with their own plans, implemented "tiers" of travelers who earned perks and benefits for accumulating a certain number of miles annually.

The top tiers became an elite club for the best customers, with access to luxurious airport clubs, free upgrades to first class and special treatment from airline employees.

But the program's real financial engine was kick-started when airlines worked with other companies to offer miles for buying goods and services unrelated to travel. For American, the largest partner is Citibank, which offers the AAdvantage credit card that awards miles for spending money.

But customers can rack up miles doing just about anything. Points are awarded for buying Sealy mattresses or Hewlett-Packard computers or eating Kellogg's cereal.

Those partners buy miles from the airlines. For American, third-party mile sales bring in an estimated $1 billion a year, Winship said.

"With all that's going on in the industry right now, that revenue source is critical," he said.

One analyst recently said American's frequent-flier program is a "hidden asset" that could be tapped if necessary to pay down debt or fend off a possible bankruptcy filing.

In a report, David Strine of Bear, Stearns said the AAdvantage program is worth between $2 billion and $2.6 billion, and could be partially or completely sold off if necessary.

Air Canada made such a move this year when it spun off 13 percent of its Aeroplan loyalty program for $250 million. The plan is considered the airline's most profitable segment.

Garton of American said the airline has examined what the plan would fetch in a sale, although he stressed that executives have "not looked at it aggressively."

"There definitely is value there; you could generate some cash by using it as an investment vehicle," he said. "It's certainly doable."

Under pressure

Although they're as popular as ever, some analysts say that airline loyalty plans are becoming less attractive to travelers, and that could be bad news for airlines that increasingly rely on that revenue.

At American, the cash-in cost of a free ticket hasn't changed in more than 15 years: 25,000 miles buys one round-trip economy-class seat. But over the past five years, the price of airfares overall has dropped substantially because of heavy competition from discounters like Southwest.

That means a free seat is worth less to buyers. According to analyst Winship, the value of one mile has dropped in half, from about 2 cents five years ago to about 1 cent today.

"That's a pretty precipitous decrease," he said.

The broad availability of low airfares has also spurred many companies to direct employees to book the cheapest tickets available regardless of the airline, often using online travel sites such as Orbitz. That undercuts the traditional practice of business travelers sticking to one carrier to accumulate miles.

At the same time, the program's greatest success -- the lucrative partnerships with credit-card issuers, automakers and other companies -- has also resulted in frustration for some travelers.

The miles-for-mattresses deal and other incentives allow consumers to collect miles at a rapid pace without ever stepping on an airline.

"You've got a lot of people out there with a lot of miles, and they want to travel for free," Winship said. But at the same time, he said, heavy demand this year has packed airplanes, meaning fewer seats are available for frequent-flier awards, particularly to popular destinations such as Hawaii, Florida and London.

"You have this escalating disconnect between the demand for awards seats and fewer seats available when people want to redeem all of those extra miles they're earning," he said. "It puts the airlines in a tricky situation."

One obvious solution would be to increase the number of miles needed for a free ticket or upgrade. Or airlines could overhaul the system to reward passengers for the dollars they spend on fares rather than miles flown.

But tampering with the basic formula carries great risks. If an airline angers its frequent fliers with draconian restrictions, it could find its best customers flocking to competitors.

"You have to be very careful about changes," said American's Garton.

American, for example, has considered awarding customers extra miles when they buy the most expensive tickets, while reducing the number of miles given for cheap, advance-purchase fares.

When he outlined the proposed changes to focus groups, Garton said, "everybody loved the idea of the extra miles but absolutely hated the idea of getting less on the [cheaper] fares." Even customers who would generally benefit from the change didn't like it, he said, and the idea was scrapped.

In 2003, Delta Air Lines implemented a similar change to its SkyMiles plan, cutting in half the number of miles awarded on the most deeply discounted fares, while doubling awards to the highest-paying passengers.

But an outcry from customers and an exodus of frequent fliers to competitors caused Delta to eventually roll back the changes when it restructured in 2004.

"Nobody else matched what Delta did, so they were out there all by themselves with their pants down," Winship said.

Garton agreed. "The customers screamed bloody murder," he said. "Everyone paid attention to that."

Strengths remain

Although acknowledging many of the challenges, American's Garton said that airlines can continue to wring substantial benefits from their loyalty programs if they play to their strengths.

At American, that's primarily the airline's global network and availability of flights. Unlike discount carriers, American can reward frequent fliers with trips to such cities as Paris, Tokyo and São Paulo, Brazil.

And upgrading to the airline's first-class service remains a popular option for many frequent fliers, an alternative that some competitors, such as Southwest and JetBlue, lack.

"More and more today I find myself using miles to upgrade to first class," Lunan said. "It's really a great benefit and clearly a good tool for the airline."

And as some companies have cut back on travel or ordered employees to choose different airlines, carriers have allowed customers to buy some of the benefits, such as elite status, that had previously been earned solely by flying.

That's created another source of revenue for the airline, Garton said.

Customers themselves are also finding new value in the plans as many begin to branch out from traditional destinations such as Hawaii. With awards seats to Honolulu in high demand, more and more fliers are choosing beach destinations in Mexico and the Caribbean, where seats are easier to obtain.

The benefits of the program also extend beyond revenue and customer loyalty. Garton said it gives American executives a valuable tool for identifying and communicating with their best customers.

"We are in close contact with them" using e-mail and other means, and regularly solicit their input through surveys and interviews, he said.

Former marketing executive Shellenberger thinks that the program he helped create will still be around in another 25 years.

"I think there will always be a place for it," he said. "And it's the kind of thing you can't really get out of even if you wanted to."

IN THE KNOW

What they're worth

5,000 miles provides a one-way upgrade to the next class of service in the U.S. and Canada.

25,000 miles wins one round-trip domestic coach ticket where seats are available

50,000 miles provides an "anytime" award -- a guaranteed round-trip domestic coach ticket on any flight

60,000 miles buys a peak-season coach fare to Paris

125,000 miles provides a premium-class seat to Brazil

360,000 miles buys an "anytime" premium-class fare to India

SOURCE: American Airlines

IN THE KNOW

Miles mania

American Airlines' frequent-flier plan is the oldest and largest airline loyalty promotion.

The plan began in 1981 with 283,000 members.

Today it has more than 50 million members worldwide.

More than 1,500 companies offer miles for products ranging from hotel rooms to mattresses to credit cards.

About half of all miles are earned from products and services other than flying.

In 2004, members redeemed 129 billion miles. That's 701 round trips to the sun.

SOURCE: American Airlines

Trebor Banstetter, (817) 390-7064 tbanstetter@star-telegram.com

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Copyright (c) 2005, Fort Worth Star-Telegram, Texas

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