Accounting for Frequent Fliers
Harvard Business School 9-192-040 Rev. June 22, 1993 Accounting for Frequent Fliers By 1991, almost all U.S. airline companies offered frequent flier programs to their passengers. Under these programs, passengers could become members of a program where the miles they flew would be recorded and accumulated to earn free future flights. The proliferation and growth of frequent flier programs created concerns about the proper way to account for and report them in financial reports. The airlines, the Securities and Exchange Commission (SEC), the American Institute of Certified Public Accountants (AICPA), and the Financial Accounting Standards Board (FASB) had each voiced concerns about measuring the expenses and reporting airlines’ obligations under frequent flier programs. The percentage of revenue passenger miles (the number of miles flown by revenue passengers including free-flight-award passengers; computed by multiplying the number of revenue passengers by the miles they have flown) flown under free travel awards was less than 5% for all U.S. airlines combined. However, on some routes for some airlines (U.S. mainland to Hawaii, for example) the percentage of revenue passenger miles represented by free flights exceeded 12%. And there was some evidence that the problem was growing. Background of Frequent Flier Programs American Airlines first introduced frequent flier programs in 1981. Initially the program was meant to be a promotional gimmick designed to attract more customers. The program’s immediate success in generating repeat business shocked the industry. This success forced other carriers to introduce their own free mileage programs, each promising better and better rewards to customers who would sign up. Through agreements with hotels, auto rental companies, and financial institutions, airlines made it possible for program participants to earn free miles by choosing where to stay, what auto to rent, or what credit card to use. By 1988, frequent flier programs were so popular that airlines owed more than 3 million round-trip domestic tickets to their free mileage program members. These tickets amounted to a minimum of 5.4 billion free miles according to one published report. The question was how, when, and whether participants would use their free miles. The worst scenario for the airline industry would have all their free fliers cashing in over a short period of time, taking up revenue-producing seats on many flights. In 1984, for example, Pan Am forced frequent fliers to use their awards or lose them, and the result was chaos at the check-in counter and a $50 Susan S. Harmeling, MBA ’91, prepared this case under the supervision of Professor William Bruns as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 1991 by the President and Fellows of Harvard College. To order copies, call (617) 495-6117 or write the Publishing Division, Harvard Business School, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
Accounting for Frequent Fliers million revenue loss. By 1991, all airlines limited the number of free travel award seats on some flights and used "blackout" dates during peak holiday travel periods when very limited or no free travel awards could be used. However, controls such as these had to be used cautiously to avoid diluting the promotional value of the programs. Members of a program who had earned a free flight but who then found it hard to schedule could easily switch their allegiance to another airline. The Accounting Issue By 1990, all the major airlines offered similar frequent flier programs. Members of a program would receive miles credited to their accounts