American Airlines (NASDAQ:AAL) invented the frequent-flyer program concept way back in 1981, doling out "miles" based on the distance customers traveled. These miles could then be redeemed for free award tickets.
However, in the past few years, most airlines -- including industry giants Delta Air Lines (NYSE:DAL) and United Continental (NASDAQ:UAL) -- have moved away from this distance-based system. While they still call their frequent-flyer currencies "miles," Delta and United now award miles based on how much you paid for your ticket, not how far you're traveling.
On Monday, American Airlines confirmed that it will join its rivals by moving to a revenue-based earning system for its AAdvantage loyalty program in August. This marks the end of an era for airline frequent-flyer programs.
Focusing on high-value customers
When American Airlines launched the AAdvantage program 35 years ago, airlines were a lot less sophisticated about revenue management. By contrast, today there is a huge gap between what price-sensitive travelers pay and what business travelers spend for an equivalent trip.
As a result, mileage-based award systems are great for bargain-hunting travelers. Flying is cheaper than ever before -- the average domestic fare has declined more than 20% since early 1995, adjusting for inflation -- and those cheap fares earn just as many miles as they did when fares were higher. This makes these cheap tickets even less profitable for airlines than they otherwise would be.
This is why the move toward revenue-based frequent-flyer programs makes a lot of sense for airlines. Such a system disproportionately rewards the most profitable customers, which is exactly what a loyalty program ought to do.
Delta Air Lines and United Continental moved to revenue-based programs at the beginning of 2015. So far, they seem very happy with that decision. By contrast, American Airlines stuck with its miles-based program last year, as it needed to focus on merger integration work.
If American had seen any benefit (i.e. higher customer loyalty) from standing out, presumably it would have kept its frequent-flyer program intact. Instead, it signaled late last year that it would also move to a revenue-based frequent-flyer program.
Under the new AAdvantage program, which goes into effect on August 1, customers without elite status will receive five miles per dollar spent (not including taxes and government fees). Elite-level customers will get more miles: anywhere from seven miles per dollar to 11 miles per dollar, depending on the elite status tier.
Beginning in 2017, customers will have to spend a minimum amount to qualify for elite status as well: $3,000 per year for the lowest tier and $12,000 for the Executive Platinum tier.
Meanwhile, American Airlines recently tweaked its award levels to better align them with what fliers are getting. Domestic flights under 500 miles are now available for as little as 7,500 miles each way. But some international business class and first class awards are getting a lot more expensive.
While the new AAdvantage program isn't identical to what Delta and United rolled out last year, it's pretty close. The bottom line with all three programs is that customers who spend the most money will receive even more lavish rewards. Meanwhile, occasional fliers will get fewer "miles" -- so few that some travelers may never be able to save up for a free flight.
What it means for travelers and investors
For road warriors who do a lot of travel for business, the new AAdvantage program should be at least as good as the old one. For top-tier elite fliers, the rewards could be even bigger than before.
By contrast, bargain-hunting leisure travelers won't earn nearly as many miles under the new system. For example, a $400 roundtrip ticket from New York to Los Angeles previously would have earned nearly 5,000 miles; under the new system, it would earn fewer than 2,000.
In the long run, these changes are likely to be good for shareholders. Airlines have been doling out a lot of frequent-flyer miles to travelers who are neither loyal nor especially frequent customers. As a result, the airlines have in some cases incurred loyalty program costs disproportional to the benefits they received.
Under a revenue-based frequent-flyer program, that's not a concern. American Airlines' new frequent-flyer program ensures that either revenue will go up or the number of miles handed out for free flights will go down.
Adam Levine-Weinberg owns shares of United Continental Holdings, Inc. and is long January 2017 $40 calls on Delta Air Lines, Inc. and long January 2017 $30 calls on American Airlines Group. The Motley Fool is long January 2017 $35 calls on American Airlines Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.