Do Enhancements to Loyalty Programs Affect Demand? The Impact of International Frequent Flyer Partnerships on Domestic Airline Demand

Consumer loyalty programs such as frequent flyer programs (FFPs) may alter the intensity of price competition between firms. The increasing marginal benefits that are built into the reward schedules of FFPs give consumers incentives to concentrate their flying with a single carrier, rather than choose carriers on a flight-by-flight basis. When selecting the airline with which to accumulate points, consumers will prefer the dominant carrier at an airport because it offers the best opportunities for earning points and redeeming rewards. While prior research has not disentangled the marginal impact of FFPs from the other advantages possessed by dominant airlines, this paper uses a novel empirical approach that allows for the identification of the marginal effects of FFPs on airline demand and pricing. In the mid 1990s, domestic airlines increasingly entered into FFP partnerships with international airlines. These partnerships allow members of a domestic airline’s FFP to earn and redeem that airline’s FFP points on flights operated by partner airlines. While these agreements had no direct impact on the quality of individual domestic flights, they did significantly change consumers’ earning and redemption opportunities in domestic airlines’ FFPs. Using earning and redemption opportunities as a measure of the value of earning a domestic airline’s FFP points, this paper exploits time-series variation in the extent and scope of international FFP partnerships to evaluate the economic impact of enhancements to FFPs. Several findings stand out. First, controlling for the other advantages of airport dominance, enhancements to an airline’s FFP are associated with increases in an airline’s market share on individual routes. Second, enhancements to FFPs are found to have a larger effect on routes that depart from airports at which an airline is more dominant and no effect on routes that depart from airports at which the airline is not at all dominant. Thus, improvements to FFPs appear to enhance the advantages of airport dominance, while conferring no benefit to airlines that have only a small presence at the airport. Finally, these results cannot be explained by a general time trend increasing airlines’ hub advantage over the sample period and are robust to controlling for the effects of other forms of alliance activity (such as codesharing) that may accompany the formation of a FFP partnership. *I am grateful to my advisors Susan Athey, Nancy Rose, and Scott Stern. I also thank Rob Clark, Catherine Deri, Avi Goldfarb, Melissa Kearney, and especially Ig Horstmann, for helpful conversations. Severin Borenstein generously provided the DOT DBIA data. I thank Michelle O’Neill at Inside Flyer Magazine, Mary Kandel at OAG, Claire Fairfax at Reed Business Information, and Nina Rose at Northwest Airlines for help in assembling data. This paper was written while I was visiting at the Institute for Policy Analysis at the University of Toronto, whose hospitality is gratefully acknowledged. Financial support from the Kellogg School of Management and the Social Sciences and Humanities Research Council of Canada is acknowledged. Contact: [email protected].