Quarterly Reports: Dollars In The Sky

when you turn your frequent-flier miles into tickets or cash, are you getting your two cents' worth?

The Plane Sat shimmering on the runway. Or the runway sat shimmering on the plane. Or perhaps the plane, an American Airlines DC-10, was the first of the vertical-take-off-and-landing jumbos--a jet that would simply rise into the sky without a runway.

Something must have been special about the plane, because it was packed to overflowing with passengers paying the $336 one-way coach fare from New York to Dallas, while not 200 yards away sat a half-empty Braniff 727 offering the same trip for $109.

In truth, not everyone on the American jet was paying the $336 one-way coach fare. I, for one, had a $249 ticket ($498 round trip). By buying the ticket weeks earlier and sticking to my travel plan, I had been able to nab the bargain fare.

Sure, that bargain fare was more than double Braniff's step-right-up, no-restrictions fare, but not everything is a simple matter of money.

For one thing, the American flight was scheduled to depart ten minutes ahead of Braniff's. Other things being equal, it would likely arrive ten minutes ahead, too, and time is money.

For another, wide-body aircraft are generally more comfortable than 727s. But not this time. When I checked in at the Admiral's Club--90 minutes early--I was told that the flight was almost fully booked, with only center seats available. Could I use one of my gold upgrades, I asked, to sneak into first class? (Yes, the kid's not just an American AAdvantage traveler, he's AAdvantage Gold! AAnd a stockholder!) Not a chance.

What's more, it was already too late to secure anything but a center seat for the flight back from Dallas the following day. It seemed that now that you could fly there for $109, no restrictions, on Braniff, people were positively banging on American's door for a seat at $336.

So I walked.

Not to Dallas, naturally, but to Braniff. And flew to Dallas for less than half the special fare on American--less than one third the full fare--and was surrounded by empty, cool leather seats.

Hours after I returned, Braniff announced that it would be shrinking its fleet from 30 planes to ten and selling off nine of its 12 gates at Dallas to American.

But before that, as I started to take my first tentative steps toward Braniff, the nice lady at the Admiral's Club said softly--the line calculated to stop me in my tracks and sit me back down in the center seat--"You know, you won't get your AAdvantage miles for the flight."

There it was. She'd called my bluff. As it happened, in this case she lost the hand. But the power of her words was a testament to what has got to be the greatest stroke of marketing genius of the decade, the frequent-flier incentive programs. It is the genius that packed the American flight at three times the fare and left Braniff coughing in its exhaust. (It's not so much that folks consciously paid an extra $227 each way to get their 1388 AAdvantage miles. It's that they didn't want to know about alternatives. Shop around to save their employers a few hundred bucks? Uh--my other phone's ringing.)

I wavered. I am a man who has earned eight free trips on American Airlines, so I know about frequent-flier miles. I know about flying to Seattle via Dallas, at a cost of an extra three hours and no movie, to be able to fly there on American. I am a man who actually turned down the chance to be in a United Airlines TV commercial and $5000 worth of free travel because I don't fly United. I am, further, a man who loves games and who managed to earn two free trips on Pan Am (I do fly Pan Am), plus a first-class upgrade, by flying a total of 9050 actual miles but playing his cards right and accumulating an additional 41,082 "bonus" miles. ("That's impossible," said my young cousin and good friend Adam Aron, who happens to run Pan Am's frequent-flier program. "Check it out," I suggested. "That's amazing!" he said after confirming my claim.)

So I'm hardly one of those guys who are down on frequent-flier programs because they neglected to sign up at the outset. No, I was in there flapping my greedy little wings from the start.

But $249 for a center seat versus $109 in suburbia?

It's time, I deeply regret to say, to take a second look at the frequent-flier programs.

Just how much is a frequent-flier mile worth?

There are a lot of ways to figure this, and the answer will vary from airline to airline. But on most, the goal to shoot for is 50,000 miles or thereabouts (40,000 on Pan Am, 70,000 on Eastern), because at that level, you get two free round-trip coach tickets.

So, very roughly, figure that 50,000 miles equals two round-trip tickets to Hawaii. (Even if you'd rather go to St. Martin, you will find yourself on Maui out of a compulsion to hit up the airline for the longest trip in its route system. Californians choose St. Martin.) Two round trips to Hawaii--again, very roughly--equal $1000. Sure, you could spend a lot more than that, but if it were your money, you wouldn't. You'd shop around for one of the supersaver fares and maybe get seven nights in a tiki-tacky Waikiki hotel thrown in, to boot. So what we're talking here--$1000 earned by flying 50,000 miles--is two cents a mile.

Or maybe less, depending on how you figure it. If, for example, you accept Eastern's offer of a lifetime membership in its Ionosphere Club for 100,000 miles (there admittedly being some question whether it's your lifetime or the airline's that's the limiting factor), you are making a simple trade of 100,000 miles for a $650 membership. Two thirds of a cent per mile.

Pan Am will fly you coast to coast and back four times in return for just 70,000 miles. What's that worth? If it's worth $3752 (the price of four full-fare Pan Am round trips to the Coast in coach), then each frequent-flier mile is worth more than a nickel. But if four round trips to the Coast are worth $952 (the price People Express charges), then each is worth just under a penny and a half.

As a rough rule of thumb, say the miles you accumulate are worth two cents each. By paying American an extra $227 to fly you from New York to Dallas, you get 1388 frequent-flier miles worth $28. Not a bad deal--so long as it's not your $227.

The obvious need to concentrate

"When it comes to investing," I was going to say in the United Airlines ad I didn't do, "I'm a great believer in diversification. But when it comes to frequent-flier programs, it makes sense to concentrate all your miles on one airline. A good reason to make that airline United is that United flies to more of the top 100 business destinations than any other airline."

And, indeed, that is a good reason. One hundred thousand miles spread over a dozen airlines is worth nothing. The same 100,000 miles on a single carrier can buy you two first-class trips to the moon. It obviously makes sense to concentrate on a carrier whose route structure most closely overlaps your travel patterns.

But by the time United launched its frequent-flier program, I'd already accumulated thousands of miles on American and so was not about to switch. I and (by now) more than 1,000,000 others. Whoever was responsible for dreaming up this program at American should have been given a $1,000,000 bonus (no one person was responsible, American insists), for American was first onto the field and has by far the largest frequent-flier program. Frequent travelers, who account for more than half of airline revenues, used to switch carriers for trivial reasons--a flight left 15 minutes earlier or was showing a better movie or was $11 cheaper. Airline seats were essentially a commodity, one very much like another. "Brand loyalty" was modest at best. But not anymore. Airline seats may still be very much like one another (they are! They are!), but now even a couple-of-hundred-dollar price differential is not always enough to break the bond.

Who has the best plan?

My own primary carrier is American. Its award program is hooked up with Frontier, Avis, Sheraton and others; its service is tough to beat.

Pan Am, hooked up with Republic, Hertz, Sheraton and others, is my second. It flies from New York to Florida, which American doesn't, and its award program is even more generous. Service isn't always as efficient as American's, but there's a certain richness and tradition to it, all the same. This past October, for example, I reserved a first-class seat to the Bahamas. Annoyingly, the airline called twice to nudge me into buying my ticket early, lest I lose my reservation. Couldn't I buy it at the airport, I asked? How crowded could an October midweek flight to the Bahamas be? But Pan Am prevailed, and when I got to its Boeing 747, I was the only one in first class. Seat 1B. Eventually, another man and a woman got on and, naturally, the computer assigned them the two seats directly behind me. The woman began reading the paper out loud over my left ear. After 20 minutes of this, they began to hum. I started gathering my things to move, but, in truth, they were humming very well. I don't know who the woman was, but when I turned around to glare a little, I saw that the man was Luciano Pavarotti. Somehow, one can more easily picture Pavarotti flying Pan Am than Eastern.

That said, Eastern actually does a better job, I think, than many people give it credit for (though closing its Concourse D Miami Ionosphere Club one crowded recent Friday afternoon was not, in my view, the paradigm of perceptive scheduling). Eastern is, in any event, my third carrier. Its award program, hooked up with TWA, Hertz, Marriott and others, is not lush, but I need Eastern. Neither American nor Pan Am flies between LaGuardia and Boston or Washington, as I do; New York Air flies those routes but has no frequent-flier plan (Eastern credits you with 1000 miles each way, so it's actually a little lusher than it appears); and People Express, the airline that answers all calls with a busy signal, leaves from Newark. The cab fare to Newark is more than the flight to Boston.

All the other major airlines have frequent-flier plans--TWA's is terrific--but once you've chosen sides, there's little incentive to switch.

Tax Consequences

What makes these programs all the more irresistible is the fact that your average frequent flier, being in or close to or perhaps even above the 50 percent marginal tax bracket, would have to earn $1000 to have enough, after tax, to buy a $500 ticket to Hawaii.

For tax purposes, frequent-flier awards are considered discounts from the price of the tickets used to earn them. If you buy nine tickets and get the tenth free, bully for you: That's no more income than is the fourth bar of soap you get free with the first three. Similarly, if a company buys $4000 worth of tickets to send you around the country and receives a free ticket valued at $400, it owes no tax on the $400. It's just gotten $4400 worth of tickets for $4000.

But if it buys $4000 worth of tickets and you get the $400 free ticket, then you are supposed to declare the value of that ticket as income and pay tax on it.

So far, the Government has had the great good grace not to bother with this, any more than it attempts to tax the value of personal phone calls made by employees on company phones at work, or other modest perks of modern life.

And rightly so. Here you and your companion were about to take a weekend in Tarrytown at a travel cost of $18; but, since you've got these free first-class tickets, you decide to go to San Diego instead. You never would have gone there for the weekend on your own $2240 (the cost of the trip in first class). So are the tickets really worth $2240?

It would be different if travel-award winners had their choice of the ticket or the ticket's value in cash. Then the ticket could be said truly to have the cash value and might, indeed, be taxed as income. Contest sponsors often offer cash equivalents to winners who would find it awkward to accept the $12,000 piano, say, and be stuck having to pay $6000 in tax.

Airlines could never afford to offer meaningful cash equivalents, because, to the airline, the real cost of the $500 ticket it's giving away may be around $35 for a couple of meals and a few extra gallons of fuel.

If the IRS ever did start aggressively taxing frequent-flier tickets, one possibility would be to base the tax on the lowest fare then prevailing--on any carrier--on the assumption that if it were your money for a vacation, you'd look for a cheap fare. And then to tax only half that amount, in recognition of the fact that, were the ticket not free, you might very well not have taken such a trip at all. And then to lower that sum by the degree to which the tickets were earned with personal travel as opposed to employer-financed travel. And then to charge the tax only if the free ticket is actually used (some expire worthless).

Such a system might be reasonably fair, only what kind of madman would keep track of it all? It's crazy!

And how would you tax a first-class upgrade--an award that turns a supersaver seat into a seat on the same plane that may theoretically be worth $1000 more but that actually buys you just a couple of free drinks, a wider seat and hors d'oeuvres?

How to Sell Your Miles--or Buy Mine

Having said that it's impossible to assign a cash value to frequent-flier miles, I must now tell you that a handful of enterprising travel companies have been doing just that. Israel Eiss (Travel Enterprises, Inc., 23 Jones Street, New York, New York 10014; phone 212-691-6638) began making a market in bonus tickets back in 1981, almost as soon as the programs began. Before that, he was a translator. He and three part-time employees use a "fluctuating, confidential market-bid sheet" as a guideline in buying and selling frequent-flier tickets. Want to go first class to Europe or beyond for half the going rate? Eiss can arrange it. Right now, for example, he is paying $600 for first-class awards to Hawaii and reselling them for around $800. That's more than the lowest supersaver but a heck of a lot cheaper than the $1784 first-class fare you'd normally pay.

Eiss says the airlines aren't publicly supportive of his efforts but that they have no gripe. "Their basic interest is to reward their frequent travelers and provide incentives. It doesn't do them any good if a guy can't get some benefit from the awards. And it's the guys who get the most awards who have the least free time to use them."

Except for Pan Am, most airlines do allow you to transfer your awards to whomever you want. But you have to do so before you accept the award. Once your name is on the ticket, it's nontransferable.

I called another market maker (AGCO, 10111 Colesville Road, Silver Spring, Maryland 20901; 301-681-8200) and said I had two frequent-flier awards for sale. A very pleasant young woman asked how many miles I had on which carriers. I conjured up 70,000 miles on Eastern, entitling me to two round trips anywhere in the U.S., and 50,000 on American, entitling me to two round trips anywhere in the U.S., including Hawaii and the Caribbean. She consulted her price sheet and offered to send me a check, on the spot, for $525 for either one. I would then be obligated to forward my award certificates. I didn't try to negotiate but probably could have. AGCO owner Alan Gross, a social-psychology professor, says AGCO tries to match the competition.

The Coupon Broker, for example (Suite 125, 1780 South Bellaire Street, Denver, Colorado 80222; 303-759-1953). Like AGCO, The Coupon Broker has been around since 1979. That's when United, trying to rebuild traffic after a debilitating strike, began offering coupons worth 50 percent off the next flight to anyone who flew United. They were bearer coupons, meaning that anybody could use them. A big business (in the world of small enterprise) grew up when brokers bought such coupons for $20 or $30 apiece from onetime travelers and resold them a day or two later for $80. In any event, the young woman I spoke with at The Coupon Broker offered $600 for my 70,000-mile Eastern award and $750 for my 50,000-mile American award. Fifty-thousand-mile awards on United and TWA were worth $600 and $950, respectively, she said. If I sent her my signed award certificates, checks would go out by return mail. (This is less risky than it sounds, because even having relinquished your award certificate, you remain in control. The broker fills in someone else's name on your certificate, but the airline sends the ticket, in that name, to you, the award winner. You then forward the ticket to the broker.)

Economic Loony Tunes

The result of all this has been to downgrade the importance of price in the purchase of business travel. If we know nothing else, it's that people love to play games and to get things free. So if it costs the employer an extra $227 to earn $28 in frequent-flier credits, it's well worth the money. Hey, the ticket says Coach--what more can the boss ask? (A few employers require bonus awards earned on company travel to be turned back to the company, but that policy is neither popular nor widespread.)

There is no moral to this story. The frequent-flier programs are great for the participants, not so great for the infrequent fliers who, in effect, subsidize them. They're great for the airlines that got into them early and execute them well; not so great for the airlines that have lagged behind or bumbled the fine tuning (one lost a bundle last year when, by giving its award recipients a deadline for using their free tickets, it crowded vast numbers of nonrevenue passengers into seats that otherwise would have been occupied by paying customers). Neither are they so great for the shareholders of companies whose employees are wasting time in airports waiting for flights on the carrier of their choice or paying more than they have to.

Ultimately, a commodity will be provided cheaper and more efficiently if price competition is strong. These programs weaken price competition. But the airline industry is still an awfully competitive, efficient one, so it's hard to care.

But don't take my word for it. I've got just 12,000 miles to go for another two free tickets.