Co-Opetition - Adam M. Brandenburger [67]
At least that was the game until May 1 of that year, when American Airlines unveiled its AAdvantage frequent-flyer program.25 The program allowed passengers to build up credits for each mile flown and then redeem these credits for free flights to Hawaii and elsewhere. The more miles traveled, the better the reward. Each flight on American created a greater incentive to stick with American for the next one. American’s customers thus became loyal.
With the help of plastic membership cards, a computer program to track miles, and some empty seats, American had created loyalty out of thin air. Even better, AAdvantage was most valuable to American’s most profitable customers—frequent business travelers.
AAdvantage created loyalty by rewarding it—a fine idea, as long as it’s not too costly. The frequent-flyer program was very cost-effective. What was the cost to American of providing the free-flight award? Some peanuts and a little fuel—about $20. Just as TWA’s Comfort Class took out empty seats to give passengers more legroom, American used otherwise empty seats to give loyal customers free travel.
Of course, there was some cannibalization. Some of the people who got free trips to Hawaii would have paid to go there anyway. In these cases, the cost to American was more like $1,000 than $20. The traveler saved $1,000 he would have paid, and American lost $1,000 it would have collected. Even here, AAdvantage bought loyalty—in fact, $1,000 of loyalty—but the cost was a dollar per dollar of loyalty-created.
But most of the time there wasn’t cannibalization. Awards went to people who were very happy to fly to Hawaii for free but wouldn’t have gone if they’d had to pay $1,000. For argument’s sake, let’s say the person valued the trip at $500. Then American bought $500 of loyalty at a cost of $20. Half as much loyalty at one-fiftieth the cost—much more cost-effective.
There were two caveats, however. First, American had to ensure that free travelers didn’t displace other, fare-paying passengers. If the free trip bumped a fare-paying passenger because the plane was full, then the cost to American was again $1,000. So American restricted the free travel by limiting the number of seats on each plane available to award holders and imposing blackout dates. Second, American had to prevent resale of the awards. Otherwise, they would have likely ended up in the hands of people who would have paid full fare. And once again, the cost to American would have been $1,000.
Of course, customers would have found the frequent-flyer program more desirable without these restrictions. So why didn’t American listen to the customer? Because then the cost would have been closer to $1,000 than $20, and the program might not have been worth doing. The restrictions weren’t there to annoy people; they were essential to make the program fly.
Some economists have asserted that a frequent-flyer program doesn’t add value. In an op-ed piece in the Los Angeles Times, Oxford University professor Paul Klemperer and UCLA professor Ivan Png argued: “The customer loyalty built by frequent-flyer programs is … not based on enhanced satisfaction of consumer wants, unlike the development of a milder soap or a more fuel-efficient sports car.”26
We disagree. American spotted some underutilized resources—empty seats—and put them to good use. People got to take vacations in Hawaii that they otherwise wouldn’t have. In this way, American made the pie bigger and raised its added value.
AAdvantage American. But there was nothing in the program that other airlines couldn’t copy.
Divided Loyalty Only two weeks after American introduced AAdvantage, United Airlines launched its own Mileage Plus frequent-flyer program. Within three months, all the major U.S. carriers had frequent-flyer programs of their own. Even so, AAdvantage continued to lead the way with more than 1 million members enrolled by