How Do Airlines Make Money off Frequent Flyer Redemptions?

Just how short is the frequent flyer end of the stick?

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From the traveler's perspective, the glory days of frequent flyer programs have passed. While you used to earn miles according to the distance you flew, meaning that you could earn as much as one free roundtrip ticket for every three or four you paid, you now earn only according to what you spend. Award redemption also used to be a lot cheaper: A one-way economy class ticket to Southeast Asia on Delta Air Lines costs 40,000 miles today, but cost 32,500 miles just over a year ago. The list goes on.

As bad as it's gotten for travelers, they often don't consider the other side of the equation—for better or for worse. Here's some of that, including the cost to an airline for a frequent flyer program.

Playing Devil's Advocate

On the surface, it might appear that airlines are getting the short end of the stick when it comes to frequent flyer programs.

Throughout the year, for example, United Airlines offers targeted promotions for certain users to receive tens of thousands of bonus MileagePlus miles when they open a MileagePlus Explorer Visa account and spend a certain amount within the first few months. Let's say, for the sake of example, that the bonus is 70,000 miles for $3,000 spent. Keeping in mind that this card earns 1 mile per dollar spent in general, a customer who took advantage of this promotion would have 73,000 miles to redeem.

If "Saver"-level awards are available, this would be enough for a one-way flight to Japan in business class on United—or any of its partners, including Skytrax five-star airline All Nippon Airways. The cash value of this ticket would be around $4,000, but the customer redeeming points wouldn't haven't directly paid anything to any airline, as the $3,000 spent on the card went for other goods and services.

Of course, most frequent flyers don't earn points this way, but from actually flying. And while this method is much less lucrative today, in the era of revenue-based mileage earning, it still seems to offer the airlines little more than passenger loyalty, which is less of a commodity these days anyway thanks to industry consolidation.

Airlines' Shocking Secret Weapon

Shockingly, the part of the equation where airlines make their money from frequent flyer programs—and they do make a great deal of money from them—has to do with neither flying nor flyer loyalty, but the direct sale of frequent flyer miles, both to travelers and to the private companies that manage and partner with their frequent flyer programs.

For the credit card example above (and credit card partners are one of the main reasons airlines earn so much money from frequent flyer programs), let's assume United charges Chase, who actually issues the miles, 1.4 cents per mile. That would mean United has actually made $1,022 off the customer's bonus, regardless of how the customer redeems it. Or if. 

And that is airlines' secret weapon: Many frequent flyers rarely or never redeem their miles, either because they don't have enough for the award they want, or because they simply horde them. Combine this with the aforementioned customer loyalty and the greater residual earnings from revenue-based mileage accrual, and it might make you even angrier about how much frequent flyer programs screw you.

Weird Ways to Win the Frequent Flyer Game

Of course, just because airlines are winning big at the frequent flyer game doesn't mean that you can't too. TripSavvy published an article earlier this year about using "manufactured spend" to maximize credit card-related earnings, and that's only the beginning of the action you can take—both in terms of earnings and weirdness.

Some travelers, for example, make a point of flying busy routes on busy days, then voluntarily take later flights and include frequent flyer miles as part of their ransom for freeing up a seat. Others, on the other hand, find loopholes in airline policies, such as buying tickets on airline partners of the main program airline, on whose flights the revenue earning mechanism is usually waived.

However you play the frequent flyer game, just remember: You don't have to feel guilty sitting in a "free" seat: The airline makes money off your butt being there—or not. And whatever you do, spend your miles. Unlike cash in a high-interest savings account, frequent flyer balances don't increase in value over time but, thanks to frequent devaluation, decrease. The cost to an airline for a frequent flyer program is almost nothing—it's negative, in fact.