Loyalty in travel is a big deal: the value of miles outstanding on airlines balance sheets sits in the hundreds of billions of dollars. And many of these miles were purchased by banks, who regularly use frequent flier miles as incentives for new users to sign up — and for existing users to spend more on their credit cards.

This has led to an interesting dichotomy. Airlines make a significant chunk of pure-profit revenue from credit cards, and then they hold those outstanding miles on their balance sheets.

While each airline has nuances in how they calculate outstanding frequent flier mile balances, the main thread is that most airlines now consider outstanding miles as liabilities on their balance sheets. This means they are accounting for the cost of customers redeeming those miles as a negative — eventually, that debt will come due as an incremental cost of flying those customers.

Given this shift towards flight mile liability, there is a renewed focus in blending the ways that passengers can redeem miles. As revenue management systems increase in sophistication, airlines can create personalized offers and flash redemptions that incentivize certain passengers to redeem miles for certain routes. There are also other ways to spend those miles, as most airlines also have an online store.

An example of the shift of accounting for airline frequent flyer miles.

The ability to optimize the redemption of frequent flier miles was top-of-mind for the team behind the Loyalty Redemption Optimizer. While the topic of outstanding loyalty points is complicated (read this article for a comprehensive answer to the question of whether not loyalty points are truly liabilities), the reality is that encouraging steady and smart point redemption should be part of any loyalty program’s strategic frame.

The team, Matthew Morgan, Anisuddin Syed and Richard Ratliff, understand the growing importance of evolving the role of loyalty redemption in revenue management. Sabre Insights spoke with Richard Ratliff about the prototype.

What was the thinking behind the Loyalty Redemption Optimizer?

This project was motivated in part by recent changes in revenue accounting practices and how frequent flyer point accruals are treated as liabilities on an airline’s balance sheet.  The outcome of these recent changes is that, if unredeemed frequent flyer points build up, they will show up as increased liabilities on an airline’s balance sheet.  Going forward, it will be more important for airlines to track and manage their outstanding frequent flyer point obligations using either the “carrot” (i.e. customer award redemptions) or the “stick” (i.e. expiration of points).

Our “loyalty redemption optimizer” prototype is designed to help airlines meet their network sales targets for frequent flyer award redemptions while simultaneously minimizing displacement of revenue-paying passengers.  It’s a complicated problem to strike the right balance; it typically pits airline frequent flyer program managers (who want more frequent flyer availability) against airline revenue management analysts (who are instead trying to preserve those same seats for later-booking, high-fare passengers).

What makes this different than other tools currently available?

To the best of our knowledge, there are no existing commercial tools available which simultaneously solve the combined frequent flyer and revenue management availability optimization.  Our decision support tool is focused on setting accurate, annual frequent flyer award redemption sales targets at the network and market-levels and tracking their performance over time.

To make it simpler to deploy and use, we gather historical revenue management system and optimize a 12-month data sample; this avoids the complexity of integrating into existing nightly production systems while still providing high-quality solutions.  As a bonus, it also provides insights into the quality of an airline’s recent revenue management decisions (using the AirVision Revenue Optimizer).

How does loyalty itself play into a comprehensive revenue management strategy?

It’s important because significant revenue can be impacted from making too many (or too few) seats available for frequent flyer redemptions.  Many airlines have implemented simple policies for frequent flyer availability (e.g. making 2-5 seats available on each flight in their network).

A better approach is to estimate the underlying demand for frequent flyer awards (as these demands can vary considerably by market and season) as well as paying passengers; this approach allows us to optimize the availability such that the right number of seats are made available in each market such that the airline can achieve its network sales targets for frequent flyers without undue displacement of paying passengers.

As travel retailing becomes more sophisticated, will we see tools that exist specifically for loyalty or does move towards an all-inclusive solution for revenue management?

At least initially, I foresee them being used as separate tools; that’s because, at most airlines, the loyalty managers are organizationally located in different teams than the revenue management analysts and have different reporting needs.

As such, we geared our prototype user interface towards loyalty managers to support aggregate tracking of loyalty redemption sales progress and making adjustments to dynamic redemption; similarly, we can provide very detailed (flight-service-class level) information and reports for use by airline revenue management analysts.

Check out the Innovation Optimizer concept here.