Do loyalty schemes damage the economy?

18th September, 2010

Dear Economist,

Frequent-flyer programmes are very popular here in Australia, where people often travel long distances for work and can subsequently be rewarded with large perks by selecting their preferred airline ahead of cheaper offers from other carriers – and to the detriment of their employers.

I am sure the airlines must benefit from all of this, but what about the rest of the economy? Are we encouraging an inefficient market by signing up to loyalty programmes?

Oliver Jones, Perth, Western Australia

Dear Oliver,

One justification for frequent flyer programmes is that when an airline has spare seats, it would ideally find some way of filling them. Slashing prices across the board destroys profits; slashing prices selectively, for the spare seats only, may be hard to achieve (although they try); giving the seats away as frequent flyer rewards offers a benefit to the customers without cannibalising too much business.

Yet the effect seems pernicious. Frequent flyer miles typically give employees an incentive to favour particular airlines; the employer pays the price but does not reap the benefits. In other contexts, we’d call this a bribe or a kickback. For frequent flyers, it’s not only legal but a topic fit for discussion in polite society.

Frequent flyer programmes also artfully create what economists call “switching costs”, by offering employees an incentive to stick with an individual airline. This is a serious problem, because if Kickback Airways has bribed its customers to stay loyal, then AirBribe has little incentive to compete on price. AirBribe may even raise prices; and this makes it easy for Kickback Airways, too, to raise prices. Even if you have nothing to do with the whole business, you’ll still pay more for your flight. It makes you wonder how airlines ever contrive to lose money.

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