The perils of selling air travel like an all-you-can-eat buffet

So yesterday’s post was on Spirit airlines and unbundling of air travel. Today, courtesy of the LA Times, we have a story of what happens when airlines let customers buy a bundle (The frequent fliers who flew too much, May 5). Specifically, the story is about American Airlines’ AAirpass program, which allowed holders unlimited travel.

When American introduced the AAirpass in 1981, it saw a chance to raise millions of dollars for expansion at a time of record-high interest rates.

It was, and still is, offered in a variety of formats, including prepaid blocks of miles. But the marquee item was the lifetime unlimited AAirpass, which started at $250,000. Pass holders earned frequent flier miles on every trip and got lifetime memberships to the Admirals Club, American’s VIP lounges. For an extra $150,000, they could buy a companion pass. Older fliers got discounts based on their age.

“We thought originally it would be something that firms would buy for top employees,” said Bob Crandall, American’s chairman and chief executive from 1985 to 1998. “It soon became apparent that the public was smarter than we were.” …

In 1990, the airline raised the price of an unlimited AAirpass with companion to $600,000. In 1993, it was bumped to $1.01 million. In 1994, American stopped selling unlimited passes altogether. …

In 2004, American offered the unlimited AAirpass one last time, in the Neiman-Marcus Christmas catalog. At $3 million, plus a companion pass for $2 million more, none sold.

If unlimited travel weren’t enough, AAirpass holders got access to “elite” agents who could work various scheduling miracles for them — whether that was booking multiple reservations in case they missed their flight or making sure they got out during a snow storm.

There’s no way this could work out poorly for American, is there?

Well it turns out that AAirpass holders were really heavy users (e.g., flying to London 16 times in 25 days) and rather abusive of the system (e.g., using their companion ticket to make sure they had extra space). Some even took advantage of the arbitrage opportunity American presented.

When bond broker Willard May of Round Rock, Texas, was forced into retirement after a run-in with federal securities regulators in the early 1990s, he turned to his trusty AAirpass to generate income. Using his companion ticket, he began shuttling a Dallas couple back and forth to Europe for $2,000 a month.

“For years, that was all the flying I did,” said May, 81. “It’s how I got the bills paid.”

Enter American’s “revenue integrity” team.

In September 2007, a pricing analyst reviewing international routes focused the airline’s attention on how much the AAirpass program was costing, company emails show.

“We pay the taxes,” a revenue management executive wrote in a subsequent email. “We award AAdvantage miles, and we lose the seat every time they fly.”

What followed was an attempt to identify the worse abusers and revoke their AAirpass. Needless to say, litigation ensued.

There are a couple of aspects of this that are interesting. First, how did American not expect to lose money on this deal? Once you book the revenue, these customers are guaranteed to be money losers. Any time they book and squeeze out a customer ready to hand over more cash, they are costly. This is true whether customers are going to Europe every weekend or merely going to New York every month. It’s kind of remarkable that it took 25 plus years for this to sink in.

The second has to do with bundling as a funding mechanism. Bundling works when there is a limit to what people can consume given the price. A restaurant doesn’t generally lose money on a buffet because there is a limit on what people can eat at one seating. Airline travel would seem to be the same except that a customer can consume a seat without actually flying. If booking a reservation is free, why not have a standing round trip to Paris booked for every weekend? Except that if the reservation is not booked in a timely fashion, the airline loses that capacity. Further, once the purchase price is sunk, there is an incentive to consume the most costly routes. All of these make the program suspect even before throwing in passengers selling their companion ticket.