Imagine having two wallets – one filled with cash, the other with airline miles or hotel points. Which would you reach for when it’s time to pay?
The answer, according to our new paper, coauthored with Freddy Lim from the National University of Singapore, says a lot about you as a consumer and carries potentially lucrative implications for the multi-billion-dollar loyalty programme industry.
Our study of data from a major US airline reveals that consumers’ decisions about whether to pay with points or money are far more complex – and intriguing – than previously understood. In fact, we identified four distinct types of consumers, each with markedly different attitudes towards loyalty programmes.
Our findings, which were also recently featured in Harvard Business Review, can help companies optimise revenue from their loyalty programmes in a way that benefits both the business and its customers. This can have a significant impact on cash flow, profitability and customer engagement.
The alternative money
Since American Airlines introduced the world’s first “miles”-based frequent flyer scheme in 1981, loyalty points have become something of a second global currency. As far back as 2005, The Economist estimated that the total stock of frequent flyer miles worldwide was worth more than US$700 billion – more than all the US dollar bills in circulation.
Today in the United States, the average consumer participates in more than 10 different loyalty programmes; airlines alone have trillions of points in circulation. Delta Air Lines, for example, had US$7.2 billion in loyalty point liabilities (roughly 10 percent of total liabilities) and US$935 million revenue from redeemed points (about 7 percent of total passenger revenue) in 2020. During the Covid-19 pandemic, several airlines even used their loyalty programmes as collateral for loans.
When it comes to choosing between points and money though, consumers do not all speak the same language of loyalty.
Which type of loyalty member are you?
Using data on more than 29,000 loyalty points transactions by 500 consumers at a major US airline company, we identified four distinct types of loyalty programme members:
- Money Advocates: These consumers will use points when they have to, but they’re always thinking in terms of cold, hard cash.
- Currency Impartialists: They treat points and dollars as essentially the same thing. To them, points are just another way to pay.
- Point Lovers: This group regard their points as precious commodities to be carefully hoarded and thoughtfully spent. They’re the ones who might feel actual pain when parting with their points, even more than when spending cash.
- Point Gamers: The deal hunters of the loyalty programme realm. They’re constantly calculating exchange rates in their heads, waiting for the perfect moment to cash in their points for maximum value.
The four groups essentially speak different dialects of the same language. Two customers might redeem points at the same rate but for entirely different reasons. One might be maximising value, while the other simply doesn’t care much about points and wants to use them up.
In the context of our study, the airline would maximise revenue by giving differentiated, rather than flat-rate, discounts to the different customer groups. For example, if the airline wants to nudge customers to pay with their points, it can maximise revenue by giving 8-percent discounts to Point Gamers and Point lovers and 12-percent discounts to Money Advocates and Currency Impartialists.
On the other hand, if the firm wishes to incentivise money payment, it can maximise revenues by simply providing all consumers with a 3-percent discount.
Keeping them loyal
Our findings get more interesting. We found that people who earned most of their points through actual flights tended to value them more than those who racked up points primarily through credit card spending. In short, points that feel harder to earn often feel more valuable, much like how people value objects they assemble themselves more than preassembled ones – a quirk dubbed “the IKEA effect”.
This has important implications for companies that are increasingly reliant on credit card partnerships for revenue. American Airlines, for one, made US$2.4 billion just from selling miles to banks in 2019, the same year in which their total operating income was US$3.1 billion. Such partnerships may inadvertently devalue loyalty programmes by making points too easy to earn. This could, in turn, undermine the programmes’ effectiveness at driving customer loyalty.
The research also revealed some quirks in how we think about point values. Most people react strongly to good deals on points (like getting more value than usual) but are relatively unfazed by bad ones. It’s as if we have a mental “sale” detector that only works in one direction.
For consumers, our research offers insights into your behaviour and whether you’re optimising your alternative money. Are you a strategic point collector, waiting for the perfect redemption opportunity? Or do you see points as monopoly money to be spent freely? Or are you a point hoarder?
Challenge for companies
As loyalty programmes continue to evolve and points become an even bigger part of our lives, understanding these patterns becomes increasingly important. Points may not be legal tender, but in today’s economy, they’re definitely money – just a different kind of money that we all use a little differently.
The challenge for companies is to balance the easy availability of points through credit cards and other partnerships with maintaining their perceived value. It’s a delicate dance between making points accessible enough to keep customers engaged while ensuring they don’t become so common that they lose their appeal.
“INSEAD, a contraction of “Institut Européen d’Administration des Affaires” is a non-profit graduate-only business school that maintains campuses in Europe, Asia, the Middle East, and North America.”
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