Australian airline loyalty programs - reaching new heights
Australian airline loyalty programs have experienced strong growth over the last decade.
However, as the saturation point approaches, with increasing competition, the appearance of technological disruptors and a shifting credit card partnership landscape, where should existing players focus to reach the next phase of growth?
The Australian airline loyalty program market is fast approaching its saturation point, with an average of one Australian frequent flyer membership for each Australian over the age of 15.
Competition in the Australian airline loyalty program market is intensifying with Qantas Frequent Flyer experiencing decelerating growth since Affinity Equity Partners purchased a minority stake in Virgin Velocity in October 2014.
Technological disruptors such as blockchain and the increasing sophistication of big data analytics present both opportunities and threats – it is crucial for existing players to understand how these disruptors may impact their business model.
There is opportunity for existing players to focus on increasing member engagement and improving their program’s value proposition to grow average revenue per member, and harness the opportunities created by the latest technological disruptions to stay ahead of the competition.
Existing players may also want to revisit whether it makes sense to spin off part of its program to free up some cash for other parts of its business while at the same time bringing in expertise to help its loyalty program reach the next phase of growth.
While the two main Australian airline loyalty programs, Qantas Frequent Flyer (QFF) and Virgin Velocity (Velocity) have experienced strong growth in recent years, market and technological trends mean there is potential to explore new ways to maintain growth and stay ahead of the competition.
Overview and Australian market context
Brief history of frequent flyer programs
Airline loyalty programs have a long history. Flying was not always something that the general population could afford – it was once considered a luxury reserved for the wealthy. Gradually, through the 1980s and 1990s as the price of flying decreased, more of the general population started to make use of this mode of transport. Eventually, the prestige of flying began to wear off and flying became an everyday occurrence. As shown in Figure 1, the number of passengers carried by air transport in Australia has more than quadrupled over the last 30 years (15.5m in 1986 to 72.6m in 2016).
Figure 1. Passengers carried by air transport (Australia) vs. average cost of air fare (US)
SOURCE: VENTURE INSIGHTS Analysis, World Bank, Airlines for America
As flying became more commoditised and as incumbents started to face new competition, there was a need for airlines to keep customers from switching to other airlines. This led to the genesis of the first frequent flyer program in the world – American Airlines’ AAdvantage program which was launched in 1981. The success of this program led others around the world to follow suit – with Qantas launching its iconic QFF program in 1987, and Ansett Australia launching its program in 1991. QFF dominated the Australian frequent flyer landscape (particularly after the collapse of Ansett in 2001) until the launch of Virgin’s Velocity program in 2005 which sparked renewed competition within the market. This report will focus on the Australian airline loyalty program landscape, and its largest incumbents QFF and Velocity.
How do frequent flyer programs work?
There are two main components to an airline loyalty program – earning, and spending of points. Airlines also have program partners who can improve the proposition on both the earn and spend side of the equation. Airline loyalty programs need a good balance in the value propositions of both the earning and spending components to be attractive to members.
Figure 2. Earning and spending points
SOURCE: VENTURE INSIGHTS
There are three common point-earning models used by airline loyalty programs – distance-based, value-based, or a hybrid of both.
Distance-based programs reward members with reward points predominantly based on distance travelled – e.g. Velocity points are earned based on fare class and number of miles flown for Virgin Australia international flights.
Value-based programs reward members with points predominantly based on how much they spend with the airline – e.g. Velocity points are earned at a rate of 5 points per $1 spent for Virgin Australia domestic flights.
Hybrid programs use a combination of distance-based and value-based metrics to calculate how many reward points members can earn.
The other side to the value proposition equation is the ability to spend points that have been earned. There are three main ways members of frequent flyer programs can spend their points – flight redemptions, flight upgrades, and spending on non-flight rewards.
Flight redemptions generally fall under two categories – A) redemption of entire flights (e.g. Qantas Classic Rewards) where airlines usually have a set amount of reward seats that must be pre-booked, sometimes well in advance, and B) using points as a substitute for cash (e.g. Qantas Any Seat) where members can pay for part of a flight with points (and the other part with cash). Generally, the former will provide better dollar per point conversion than the latter while the latter provides more flexibility.
Flight upgrades involve upgrade of flights that have been purchased by the member (e.g. from Economy to Premium Economy or Business, or Business to First). Different airlines have different rules regarding what fare types can be upgraded. Generally, only non-discounted airfares can be upgraded in this way. Flight upgrades generally provide the best dollar per point conversion compared to flight redemptions and non-flight rewards.
Non-flight rewards (e.g. Qantas Store) allows redemption of points for a large range of non-flight rewards, including goods such as appliances, clothing, gift cards, etc as well as services such as hotel accommodation. This form of redemption usually provides the least favourable dollar per point conversion but provides access to a large range of different types of rewards.
Importance of program partners
Outside of direct earn and spend through the airline, airlines also have numerous important relationships with program partners. The airline loyalty program in a sense becomes the ‘anchor program’ while the program partners form part of the anchor program’s distribution network. The airlines and program partners participate in a symbiotic relationship which benefits both parties – on the one hand it allows airlines to extend its distribution network, improve the value proposition of its program and also earn additional revenue from wholesale of points, on the other hand it allows program partners to improve the value proposition to their own shoppers by providing access to an attractive frequent flyer program.
Partners can be earning partners and/or spending partners. The biggest non-airline partners include supermarkets and financial institutions (credit card providers). There are also airline partners (e.g. Qantas’s partnership with Emirates) which allow members of one frequent flyer program to book flights with a partner airline.
Earning partners allow members to earn frequent flyer points when they purchase items at the program partner. For example, Qantas has a partnership with Woolworths Everyday Rewards which allow members to earn Qantas points for purchases at Woolworths supermarkets. This partnership started in 2008, but was terminated by Woolworths in 2015 before being reinstated again 3 months later – this shows the importance and value placed on partnerships with frequent flyer programs. The benefit of such partnerships to the program partner is that it provides additional incentive for customers to shop with them – the proposition is stronger the more prevalent the frequent flyer program is. To receive this benefit, the program partner purchases frequent flyer points from the airline at a wholesale rate. It is then able to distribute these points to its shoppers.
Spending partners allow frequent flyer members to spend their points to purchase goods or services from partners.
Airline partners allow members from one frequent flyer program to use their points to purchase flights on other airlines – usually for routes overseas that the anchor program may not service. For example, Qantas has a partnership with Emirates, where members from either loyalty program can use points from either frequent flyer program to book flights on both airlines.
Trends impacting airline loyalty programs
While both QFF and Velocity have experienced strong membership and revenue growth over the last decade, various market and technological trends will have an impact on how the airline loyalty program market evolves going forward. These trends include deceleration of membership growth as frequent flyer program penetration reaches saturation point; intensifying competition within the industry meaning airlines will have to fight harder to keep members from switching; the appearance of technological disruptors such as blockchain and the increasing sophistication of big data analytics which presents both opportunities and threats to existing players; and the impact of an evolving credit card partnership landscape with changes to interchange fee regulations taking effect in July.
Reaching saturation point
Historically, both QFF and Velocity have experienced strong growth. From 2008 to 2017, QFF grew strongly at 10% p.a. from 5.0m to 11.8m members, while Velocity grew at 20% p.a. from 1.5m to 8.0m members over the same period. This has been driven by aggressive marketing campaigns by both programs, and the onboarding of major program partners, in particular QFF’s partnership with Woolworths which started in 2008, and Velocity’s partnership with BP which started in 2015.
Figure 3. Qantas Frequent Flyer and Virgin Velocity membership base (millions, FY)
SOURCE: VENTURE INSIGHTS Analysis, Company Websites
However, over the last 3 years, while both programs are still growing (5% p.a. for QFF and 22% p.a. for Velocity), the rate of growth for QFF has decelerated relative to its growth over the longer term. On the one hand, QFF’s relatively slower growth indicates the penetration of QFF may be reaching ‘saturation point’ where it becomes progressively harder to gain new members because such a large proportion of the population are already members, on the other hand the fact that QFF is still growing even though it already reaches 3 in 5 Australian adults shows its continued strength.
In the most recent year, ~60% of the Australian adult population were QFF members, and ~40% were Velocity members. Taken in aggregate, there is on average one frequent flyer membership per adult in Australia. It is not hard to see that saturation point may be approaching.
Increasing competition within the industry
Since Velocity launched in 2005, QFF has faced increasing competition. This competition has further intensified since Affinity Equity Partners, a regional private equity firm, took a 35% stake in Velocity in 2014. The ramping up of competition from Velocity since Affinity’s minority acquisition has included investment in promotions, new program partners (e.g. BP in 2015) and a revamped brand and marketing strategy.
This intensification of competition can be seen in Figure 4, which shows that on a number of members basis, Velocity has grown from being 44% of QFF in 2014 to 68% in 2017 – a rate of growth that surpasses historical levels before Affinity’s purchase.
Figure 4. Virgin Velocity member base as a percentage of Qantas Frequent Flyer member base (FY)
SOURCE: VENTURE INSIGHTS Analysis, Company Websites
During the same period, as shown in Figure 5, Roy Morgan Research indicates the number of members who reported to be part of both the QFF and Velocity programs increased from 27% in 2014 to 34% in 2017. Venture Insights analysis shows this data implies approximately 70% of Velocity’s membership gain from 2014 to 2017 was due to QFF members signing up for Velocity as a second membership, while the other 30% was from members who were not a registered member of QFF when they joined Velocity. Whilst Velocity has significant growth potential still ahead, increasingly the focus for both airlines will be on growing average revenue per member which will be driven by redemption or engagement rates within the programs.
Figure 5. Members who are part of both QFF and Velocity (FY)
SOURCE: VENTURE INSIGHTS Analysis, Roy Morgan Research’s Single Source survey (base: 50,000 interviews p.a.)
Appearance of technological disruptors
The travel industry is no stranger to technological disruption – recent examples include the rise of online booking intermediaries, and the rise of the sharing economy. The airline and broader travel industry realised the disruptive potential of online booking intermediaries too late and now pay millions of dollars in fees to online booking intermediaries every year. However, if existing players can identify and adapt to technological disruptors early, they can turn these disruptors into opportunities rather than viewing them as threats. Two technological disruptors with potential impact on the airline loyalty program industry in the short to medium term are blockchain and the increasing sophistication of big data analytics.
Blockchain has been touted as revolutionary in its support of cryptocurrencies, but its usefulness extends into many other fields. One potential use case for blockchain is in the loyalty program space. Blockchain has the potential to create ‘one wallet’ for loyalty program points, and simplifying the conversion of points from one program to another. How this would work is that consumers would own a ‘master’ rewards wallet with certain ‘master’ rules. Airlines (and other businesses such as supermarkets, retailers, etc) would join as sub-wallets under the master wallet, layering on additional rules. There would be an underlying points currency that facilitates transfer of points between different sub-wallets. In this way, airlines can more easily form partnerships with other businesses and members can earn and spend points across multiple businesses with ease. The blockchain architecture, with its decentralised ledger, allows this to be done reliably and securely, thus improving the value proposition to members and making for a more seamless experience. One example of this in practice is the Loyyal platform, having recently closed a Series A capital raise in June 2017, which advertises itself as ‘the universal loyalty and rewards platform, built with blockchain and smart contract technology’. Another example of the willingness to use blockchain architecture is the S7 airline (Russia’s biggest domestic airline) which now uses blockchain to issue tickets. Airlines should invest time and money to explore integration of their loyalty program into a blockchain architecture or risk being left behind by competitors.
Increasing sophistication of big data analytics
Although the concept of big data has been with us for some time now, the increasing power of computers and rise of artificial intelligence means there will be new ways to harness the data coming from loyalty program usage. It will be crucial for airlines to have the right big data strategy to be able to best make sense of customer habits and trends and turn them into meaningful ways to engage with them and their experiences. Big data is also transforming expectations around personalisation. Sophisticated analytics, aided by artificial intelligence, can enable real time personalisation of loyalty programs – e.g. programs dynamically generating offers and adjusting points based on individual patterns of behaviour.
Qantas has taken the initiative in this space with its Red Planet analytics business which was launched in 2014. Red Planet is a marketing and data analytics company which leverages experience in analysing transactions and data for Qantas Loyalty to offer services across Media, Analytics and Research to other businesses. Red Planet’s clients include ANZ, American Express, NAB and iSelect. Virgin Velocity has also been active in this space as shown by its acquisition of analytics firm Torque Data in 2015. Torque Data offers ‘predictive analytics, campaign automation and data visualisation services’ with clients in the media, consumer goods, financial services, travel and telecommunications industries.
Evolving credit card partnership landscape
Historically, credit card providers have been key partners of Australian frequent flyer programs, purchasing large amounts of wholesale frequent flyer points which are then offered to their customers. However, due to a regulatory cap on interchange fees imposed by the RBA which took effect in July this year, credit card providers now have less to spend on their rewards programs. This has a direct impact on demand for wholesale frequent flyer points. With ~35% of all credit card spend in Australia earning QFF points, it is estimated that this shift in the credit card landscape may reduce QFF’s revenue by up to $200 million. One way Qantas has tried to offset this is to launch its own credit card, but this potentially creates conflict with its credit card partners and it remains to be seen how successful this move will be.
Reaching the next phase of growth
Given decelerating members growth coupled with the increasing intensity of competition within the industry, existing players will need to think of the best way to maintain growth and stay ahead of the competition.
Focus on member engagement and improving value proposition
Firstly, opportunities exist for existing players to focus on increasing member engagement with the aim of growing average revenue per member, rather than relying purely on growth in members to drive increases in revenue. Airlines can do this through improving the value proposition of their loyalty program (both the ‘spend’ and ‘earn’ sides of the equation) including continuing to build strong partnerships (as Velocity did by introducing BP as a partner in 2015) as well as maintaining the attractiveness of the core rewards program (e.g. ensuring there is no shortage of award seats and optimising the dollar per point value to members).
Harness opportunities created by technological disruptors
Secondly, airlines can look to harness opportunities created out of the latest technological disruptions in the industry. This might come in the form of investment in disruptive start-ups (e.g. Qantas Accelerator Program supporting Leezair) as well as fostering innovation within its own business. Airlines can also explore potential integration of their loyalty program under a blockchain architecture which improves the value proposition to members and allows for a more seamless experience, as well as look at ways to make the most out of the customer data that they collect through their loyalty programs.
Consider monetisation of the loyalty program
Lastly, airlines can get value out of their loyalty programs while boosting growth through a full or partial sale of their programs. Virgin has already sold off 35% of its program to Affinity Equity Partners, which has proven successful so far given the strong growth experienced by Velocity since Affinity’s purchase.
There are numerous reasons why airlines may want to spin off their loyalty programs:
Unlock cash to grow other parts of the business
Bring in expertise and relationships to fuel further growth – e.g. Affinity brought in its relationships and expertise to help Velocity when it purchased part of Velocity
Reduce constraints on the loyalty program and enable them to explore new growth opportunities – e.g. expand to a wider set of partners
Conversely, airlines should be mindful of the following risks in spinning off their loyalty program:
Loss of control – e.g. power to change aspects of the program, adjust value of points, etc.
Negative impact to customer relationship – the spun-off entity becomes an intermediary between the airline and its customers which could have a negative impact on the relationship – e.g. ability to access the same level of customer data for analytics
Virgin’s partial sale of its Velocity program seems to have struck the right balance between the benefits vs. costs of a spin-off. Selling only a minority stake allowed Virgin to retain control of its program while still freeing up some cash and benefiting from Affinity’s relationships and expertise in the area. As with Virgin, Qantas could explore a partial sale of a non-controlling stake to a party with expertise in the sector to free up some cash for other parts of the business while at the same time allow its loyalty program to reach the next phase of growth.
Other airlines around the world have also monetised their loyalty programs to a smaller or larger extent – for example Air Canada spun off its entire Aeroplan frequent flyer program into a separate entity that is now managed by AIMIA (a marketing and loyalty analytics firm).
In conclusion, the airline loyalty program space in Australia has been a fast-evolving one over the last decade. Strong growth in membership and revenue has been witnessed historically, but the industry is undergoing a significant shift as the saturation point approaches, with increasing intensity of competition, the appearance of technological disruptors and the evolving credit card partnership landscape. In light of these trends, airlines will direct their attention to options to maintain growth, stay ahead of the competition and position their loyalty programs for the next phase of growth; focussing specifically on increasing member engagement to grow revenue and harness the opportunities created by the latest technological disruptions. Moreover, there is also potential to monetise the value of their programs while boosting future growth through a partial sale of its loyalty program to an aligned investor with expertise and connections to offer.
 Australian frequent flyer membership defined as membership in Qantas Frequent Flyer or Virgin Velocity.
 Based on ABS statistics of the total number of Australian adults over the age of 15 years of age (19.3m in 2015, projected to be 19.9m in 2017 based on 1.5% p.a. population growth).
 Roy Morgan Research’s Single Source survey based on 50,000 interviews across Australia each year. Refer to http://www.roymorganonlinestore.com/Browse/Australia/Travel-and-Tourism/Air-Travel/Air-Travel-Loyalty-Programs/Airline-Loyalty-Program-Members-Profile.aspx for more information for further details