‘Not just a pie in the sky’ : an investigation into the cash-equivalent value of loyalty currency and the impact of a frequent flyer program on its members

Abstract

This thesis examines three interrelated aspects around Frequent Flyer Programs (FFPs): the cash-equivalent value (purchasing power) of loyalty currency, the impact of FFPs on consumer behaviour and surplus, and the taxation issues surrounding FFPs. Unlike most previous research on FFPs, this research uses data from an actual FFP, specifically the Virgin Australia Velocity Rewards program, to examine these aspects. The focus on one specific FFP and using its detailed data is a contribution to FFP literature in itself. No prior research has investigated the impact of a specific FFP on its members. The first aspect investigated is the estimation of the cash-equivalent value of Velocity Points, the loyalty currency of the Velocity Rewards program. Using publicly available Velocity Rewards data the cash-equivalent value of a Velocity Point in 2010 is estimated to range between AU$0.0066 and AU$0.0084. This range excludes the value of status benefit to the status member. The Velocity Points gained by a FFP member per flight equate to an in-kind discount on an average airfare of 3.3 per cent for Red members, 3.96 per cent for Silver members and 4.63 per cent for Gold members. The second aspect under consideration is whether the Velocity Rewards program can impact its members such that they fly more and/or spend more with Virgin Blue. This aspect is investigated with a proprietary stated-preference dataset from the Velocity Rewards program spanning three years from 2006 to 2008. A particularity of this dataset is that the FFP changed in 2007 from a simple bulk discount program to a complex status-tier program. By taking advantage of this ‘quasi’ experiment provided by the dataset across two very different program structures, it is shown that members change their consumption behaviour particularly when close to the next status tier threshold in order to achieve higher tier status. This is an expected reaction to frequent flyer programs and is what the airlines aim to achieve. Members buy more airfares and at higher prices. This thesis shows that under the new status-tier structure, the consumer surplus of FFP members has decreased by around 6 per cent. This implies that the introduction of the status-tier structure has been a successful strategy for Virgin Blue. The status-tier structure has allowed for a noticeable increase in the efficiency of Virgin Blue to extract additional consumer surplus from Velocity Rewards members. A detailed survey undertaken in 2010 among a representative sample of over 3300 Velocity Rewards members confirms the impact of the FFP on consumer behaviour. The most interest finding of the survey is that a large proportion of leisure and business travellers admitted a willingness to pay a higher fare – a FFP premium- to fly with Virgin Blue because of their Velocity Rewards membership. The average FFP premium is estimated to be around 8 per cent and is statistically different between leisure and business travellers. The cash-equivalent value of a Velocity Point as encapsulated in the FFP premium is estimated to range between AU$0.0108 and AU$0.0153, depending on the FFP status of a member. The final aspect considered in this thesis is the taxation of FFP rewards in Australia. Although it has long been recognised that FFP rewards earned on employer-funded business flights should be subject to taxation, this is currently not taking place. One of the main arguments against the implementation of taxation is the lack of a monetary tax base. This thesis argues that the cash-equivalent value of loyalty currency can be estimated with public data and is appropriate as a tax base. The legal hurdles to FFP reward taxation in Australia are also addressed. This thesis makes the following contributions to the knowledge on FFPs: • It is shown that a cash-equivalent value of loyalty currency can be estimated. • It is shown that Velocity Rewards impacts consumer choices, willingness to pay and consumer surplus. • It is shown that Velocity Reward members admit paying a FFP premium and that the magnitude of this premium can be estimated. • It is shown that taxation of FFP rewards in Australia is possible. Finally, the majority of these insights were gained with data that have not been available to researchers previously.