Financialisation in the airline industry

Deregulation, privatisation, and financialisation are considered essential requirements for economic growth. The airline industry is only one example that highlights the need for caution with each of these policies. 

Ganesh Sitaraman has a new book on the airline industry, where he describes airlines as quasi-banks. This snippet from an article by him on the airline mileage points stood out,

For the airlines, this is a great deal. They incur no costs from points until they are redeemed—or ever, if the points are forgotten. This setup has made loyalty programs highly lucrative. Consumers now charge nearly 1 percent of U.S. GDP to Delta’s American Express credit cards alone. A 2020 analysis by the Financial Times found that Wall Street lenders valued the major airlines’ mileage programs more highly than the airlines themselves. United’s MileagePlus program, for example, was valued at $22 billion, while the company’s market cap at the time was only $10.6 billion.

How do loyalty programs work?

Airlines create points out of nothing and sell them for real money to banks with co-branded credit cards. The banks award points to cardholders for spending, and both the banks and credit-card companies make money off the swipe fees from the use of the card. Cardholders can redeem points for flights, as well as other goods and services sold through the airlines’ proprietary e-commerce portals...

Like the federal reserve, airlines issue currency—points—out of thin air. They also get to decide how much that currency is worth and what it can be spent on. This helps explain why the points system feels so opaque and, often, unfair. Online analysts try to offer estimates of points’ cash value, but airlines can reduce these values after the fact and change how points can be redeemed. Airlines even sell points at above their exchange-rate valuation, meaning that people are paying for something worth less than the money they’re buying it with, in part because it’s so hard to know what the real value is.

What was the context for the emergence of loyalty programs?

In the early years, these programs were simple, like the punch card at a café where your 11th coffee is free. But three big changes transformed them into the systems we know today. First, in 1987, American partnered with Citibank to offer a branded credit card that offered points redeemable for flights on the airline. Second, in the ’90s, the airlines proliferated the number of fare classes, charging differential prices for tickets. With more complicated fare structures came the third change: Virgin America realized that the amount people spend on a flight, based on the fare class, is more important to its bottom line than the number of miles flown. So, in 2007, it introduced a loyalty program rewarding money spent rather than mileage accrued. These three shifts fundamentally transformed the airline industry. They turned frequent-flier systems into the sprawling points systems they are today. And they turned airlines into something more like financial institutions that happen to fly planes on the side.

How does it impact the consumers?

Paying for a flight or a hotel room with points may feel like a free bonus, but because credit-card-swipe fees increase prices across the economy—Visa or Mastercard takes a cut of every sale—redeeming points is more like getting a little kickback. Certainly the system is bad for Americans who don’t have points-earning cards. They pay higher prices on ordinary goods and services but don’t get the points, effectively subsidizing the perks of card users, who tend to be wealthier already.

Sitaraman has this verdict on the deregulation of the airline industry,

The proponents of deregulation made a few big promises. The cost of flying would go down once airlines were free to compete on price. The industry would get less monopolistic as hundreds of new players entered the market, and it would be stable even without the government guaranteeing profitable rates. Small cities wouldn’t lose service. In the deregulators’ minds, airlines were like any other business. If they were allowed to compete freely, the magic of the market would make everything better. Whatever was good for the airlines’ bottom line would be good for consumers.

They were wrong. As I explain in my forthcoming book, most of their predictions didn’t come true, because air travel isn’t a normal business. There are barriers to entry, such as the fixed supply of airport runways and gates. (And, for that matter, mileage programs, designed to keep customers from ditching an established airline for a rival.) There are network effects and economies of scale. There are high capital costs. (Airplanes aren’t cheap.) The idea that anyone could successfully start an airline and outcompete the big incumbents never made much sense.

After a relatively short period of fierce competition, the deregulated era quickly turned to consolidation and cost-cutting, as dozens of airlines either went bankrupt or were acquired. Service keeps getting worse, because the airlines, facing little competition, have nothing to fear from antagonizing passengers with cramped legroom, cancellations, and ever-multiplying fees for baggage and snacks. Worse still, without mandated service, cities and regions across the country have lost commercial air service, with serious consequences for their economies. And when a crisis like 9/11 or the coronavirus pandemic comes along, the airlines—which prefer to direct their profits to stock buybacks rather than rainy-day funds—need massive financial relief from the federal government. Deregulation even failed to deliver the one thing it is sometimes credited with: lowering prices. Airfare did get cheaper in the years after the 1978 deregulation law. But the cost of flying had already been falling before deregulation, and it kept falling after at about the same rate.

He makes the case for greater regulation

Airlines serve a vital public need, just like railroads, the electric grid, and communication networks. They also exist within a system of special privileges from the government. The public has built and paid for a substantial federal infrastructure to coordinate flights safely. Historically, these are all standard reasons to regulate an industry. A modernized set of rules could arrest the trajectory of airlines becoming financialized e-commerce platforms—and maybe even get them to focus on making air travel less miserable.