Airline Rewards System Commitment and Term Paper

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ONE: This article is fully appropriate to review because Binggeli, et al., writing in the McKinsey Quarterly explained that a survey of 17 major airlines worldwide revealed that "even the most sophisticated" among those carriers have "only a rudimentary understanding of who their most valuable customers are or could be." Nor do those airlines understand which free rewards programs "are most effective in ensuring loyalty. Indeed, many airlines cannot identify "their most valuable customers" because their frequent flyer programs are "little more than a general ledger system" that basically tracks how many miles a traveler has accrued and how many he or she has spent.

TWO: Meanwhile, how does an airline known which of its rewards programs is making a profit? First of all, according to Gujarathi in Issues in Accounting Education, it's appropriate to explain that Sun Airlines Incorporated (SAI) records free rewards as a liability, and it is included in accounts payable; SAI's incremental costs are tallied to include the cost of providing service for what would otherwise be an empty seat. SAI redeemed 1,357,00 awards in 2002; 1,148,000 in 2001; and 878,000 awards in 2000. The awards reflected 12% of SAI's "total revenue passenger miles in 2002, 11% in 2001, and 9% in 2000.

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There are two methods used in the accounting for free travel awards; one is the "incremental cost method" which assumes that free travel award passengers "do not displace revenue-paying passengers," and that the earnings process is "substantially complete at the time the paid flight is taken." The second method is called "deferred revenue" and it works like this: the free travel awards earned by FFP are basically just "discounted tickets," Gujarathi writes. The airline therefore defers a portion of the sales price of a ticket purchased by rewards travelers until the free travel award is used.

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