Why Delta Air Lines Is Changing Its Mileage Rewards Formula Now

Delta is confident enough in its operations to gamble on a new formula for rewarding frequent flyers. Why is it making this change now, and will the action prove to be profitable or a mistake?

Feb 27, 2014 at 5:03PM

Yesterday, Delta Air Lines (NYSE:DAL) announced that it will change its mileage rewards structure from one based on total miles flown to one based on ticket price. Racking up miles on long cross-country and international flights solely on distance will soon be a quaint memory for Delta's loyalty program (SkyMiles) participants. Effective Jan. 1, 2015, the company will dole out miles tied to dollar purchases: the more you spend, the more you'll be rewarded.

A change that's been in the works for some time
Delta actually laid the groundwork for this action in January of last year, when it announced that beginning in 2014, SkyMiles members would have to meet certain dollar purchase thresholds in addition to miles flown to enter its coveted "Medallion" classes. For example, a flier must now must travel at least 25,000 miles and reach a $2,500 spend annually to become a "Silver" Medallion level customer, the entry Medallion class. To reach the highest Medallion status, "Diamond," a traveler will now have to travel at least 125,000 miles, as well as spend at least $12,500. 

This sets up a system in which the highest level medallion customers will be rewarded handsomely for buying business and first-class tickets. The following table provided by Delta demonstrates how the new, price-based rewards work:

SkyMiles Program Status

Miles per Dollar

Miles Earned When Purchased With Delta Credit Card

Total Miles per Dollar

General member

5

+2

7

Silver Medallion

7

+2

9

Gold Medallion

8

+2

10

Platinum Medallion

9

+2

11

Diamond Medallion

11

+2

13

 

Source: Delta Air Lines 2/26/2014 press release

As you can see, an infrequent traveler who doesn't qualify for Medallion status will receive five miles per dollar spent with Delta. A Diamond Medallion traveler who pays for his or her ticket with a Delta-branded credit card will receive thirteen miles per dollar -- more than two-and-a-half times the "general" member's reward.

Now consider that the infrequent flyer is likely scanning for the lowest price ticket available. In fact, take a scenario in which an infrequent, economy flyer and a business flyer with Diamond Medallion status both purchase a round-trip Delta ticket from New York to Tokyo, for travel this summer between June 12 and June 19.

As of publication time, the prices found on Delta's reservation flight system came to $1,905 for an economy ticket with class "X" and "T" segments, and $6,051 for a business ticket with class "Z" segments. 

Under the new system, the infrequent flyer, likely paying without a Delta-branded credit card, will receive a total of 9,525 rewards miles, which is considerably less than the previous system, in which nearly 16,000 miles would have been awarded based on distance.

In contrast, the Diamond Medallion frequent business flyer, if paying with a Delta-branded credit card, would chalk up 78,663 miles -- the price of his or her ticket ($6,051) times the eligible 13 miles per dollar. That's enough to garner another round-trip flight to Tokyo for free, if the traveler's future dates are flexible. Listen closely: That sound you hear is the roar of the disgruntled masses being drowned out by the creaking of embossed leather wallets opening at businesses around the world.

Why Delta is introducing the new structure now
Delta is choosing to tweak its mileage rewards model now because with recently increased profits and cash flow, the company can take increased risk to maintain its revenue and earnings growth. The airline possesses the financial wherewithal to take risks that it couldn't just four years ago, when it merged Northwest into its operations. Delta generated $3.4 billion of operating profit and $4.5 billion of operating cash flow last year from revenues of $37.8 billion. While the company has a bit of wind at its back in the form of lower fuel costs, it's asserted control over its destiny in the last few years. Take the example of yearly interest expense, which peaked at $1.3 billion in 2009, the year after Delta merged with Northwest Airlines. This total has been cut nearly in half, to $698 million last year, as Delta has judiciously paid down long-term debt. Cleaning up the balance sheet and striving for higher profit margins and return on invested capital (a stated management focus), gives management the confidence to make wholesale changes to its loyalty program.

It's possible that the new paradigm will create higher total rewards that Delta has to honor at a future date, as premium customers take advantage of the attractive incentives to continue to buy the best seats on the planes. The transportation portion of this liability is booked to Delta's "air traffic liability" account. Management will be prepared for an acceptable increase in this account in the coming years. This is because as rewards flights are taken and Delta reduces its liability, the profit associated with the then recognized earnings will likely be higher than it is under the current frequent flyer structure.

While Delta's sea change may alienate some long-standing members of its loyalty program, this action answers a philosophical question: just who should the airline reward for its loyalty? In this case, the company is making an economic decision. Customers with the resources to buy steadily throughout the year, at a higher average ticket price, are the type of long-term purchasers the company is seeking to bind to its revenue stream. There's an enormous disparity in the value of a traveler who buys five to 10 business-class tickets in a year, and the value of an economy traveler who flies perhaps one to three times annually, once you multiply the differential over the lifetime of each customer. 

The potential boost to profit from incentivizing premium fliers is enough in the long run to justify any short-term turbulence on Delta's income statement. Unless this foray is a total disaster, with either a backlash from the economy passengers who fill the bulk of the plane, or a miscalculation on profitability on Delta's part, look for this program to stay, and potentially influence the direction of other international carriers' loyalty programs.

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