Frequent Flyer Programs: 5 conditions towards a successful separation

In 2014, Lufthansa announced that the management and governance of the Miles & More frequent flyer program would be outsourced from Deutsche Lufthansa AG to the direct subsidiary Miles & More International GmbH. In doing so, Lufthansa followed a growing number of airlines that moved the FFP into standalone entities, reaping the benefits of separation, including stronger growth and, in some cases, greater visibility of the value creation for shareholders and investors alike.

Perhaps it is too early to call FFP separations a real trend. What is certain however is that airline boardrooms increasingly face themselves with the question:  what is the best way to structure the FFP to realize its full potential?

Here are five conditions that will help assess the potential for a separation initiative:

1. There must be a true view of the FFP’s current performance - Selling miles to partners at high yields can lead airlines to believe that they are running highly profitable programs. Yet at the same time, they don't fully account for the cost of rewards seats. Or, they continue to rely on distressed inventory for rewards ultimately impacting the customer value proposition. On the flip side, marketing departments could consider miles as almost free marketing tools, with limited transfer pricing control in place for awarding miles. Especially smaller and/or younger FFPs may also not yet have reached the boundaries of the traditional in?house mode, giving them a clouded view on the program's performance. 
2. Solution for existing cash flows and outstanding liability - Selling miles to partners generates significant cash flows into the airline. For some airlines, they can become lifelines.  Although moving the FFP into a separate unit must ultimately deliver a stronger and more consistent positive cash flow benefiting the airline, the short-term dynamics have to be managed. Another important issue to consider is the outstanding liability. Programs may have built up significant miles liabilities over time. In order for the separation to be successful, the airline and the FFP must come to an agreement on what to do with the existing liability. There are several solutions that can be applied to handle this issue.
3. There must be (a path to) sufficient third party revenues - An FFP that generates little billings from third parties (outside of the airline) will stand to gain less from a separation. As a rule of thumb, more than 50 percent of the revenues should come from external billings in order for separation to have the greatest impact. One such example is Qantas Frequent Flyer - it reported in 2013 that over 65 percent of its AUD 1.2 billion points sales came from external parties. In Brazil, Multiplus reported that for 2015, over 90 percent of its gross billings came from the Banking, Retail, Industrial and Services categories.
4. Have a supporting management structure – The process of separation can be difficult and complex.  As an illustration of this complexity, when TAM Fidelidade was carved out from TAM in 2009, substantially all of the assets, liabilities, operations and activities of TAM Fidelidade, including 112 contracts with commercial partners, 51 employees and its license to use Siebel Loyalty were transferred by TAM Linhas Aéreas to the new FFP company. The program's management must have a sufficiently long horizon to oversee the completion of the project.
5. Secure support from all stakeholders - It takes the attention and support of all levels in the airline to support the move towards a standalone structure. Starting at the Board: they must gain an understanding of the possibilities and limitations of the current, and future FFP.  Herein lies a challenge - most Boards today have limited exposure to frequent flyer program strategy. It is clear that senior management must be embracing the idea - and moving the FFP into a standalone company is typically not part of the long-term incentive plan of airline CEOs and CFOs. Management in turn must also be able to convince employee groups and councils of the advantages of the new model and address any concerns. Lastly, large shareholders may act as a catalyst, although in many cases the airline's ownership is widely dispersed, making it unlikely for one single shareholder to be big enough to act as a catalyst.

In those discussions, some may raise concerns around the airline's future ability to manage the unit that is separated from the core airline. Today however, there is sufficient proof that airlines are able to separate and manage standalone segments successfully. Examples include ground handling divisions, MRO companies, and catering providers that started inside the airline but were successfully placed outside its core to facilitate growth.  

Airlines also clearly have built up significant experience in partnering with outside service providers as well. And the nature of those partnerships may even touch the core of the high value customer proposition. Cathay Pacific for example, appointed a company called Plaza Premium Group to be the operator of all its lounges at Hong Kong International Airport in 2016. It provides day to day management of its flagship lounges at its home airport.

• The FFP becomes the service provider to the airline, in service of and accountable to its business needs — with the right agreements in place, the airline will enjoy guaranteed performance governed by service level agreements including minimum commitments.
• There will be less internal battle of priorities and interests between the airline  and the FFP management team because of the contract.
• Roles, responsibilities, and most importantly, accountability, are contractually established. The airline can decide what it would like to continue manage, e.g. tier program design and service delivery.
• The airline may even have better control post separation owing to more robust data that allows for better decision-making.

With two of the world's top ten airlines having gone through an FFP separation (IAG and Lufthansa), others must be watching. Separating the program from the airline may not be an easy process - but it's worth considering the option in light of the future possibilities.