Total rewards systems and organizational implementation

Airline Rewards System

Commitment and trust are necessary requisites" for a business relationship that is productive (Shugan 2005), an editorial in Marketing Science explains. One way for an airline company to show its commitment in order to get trust from the customer is through rewards.

The impact of Frequent Flyer Miles (FFM) - which has evolved into a "total reward" system - on the performance of airline companies is significant, providing the airline makes the best use of the rewards.

In a an article (Binggeli, et al., 2002) published by the McKinsey Quarterly, the authors say that "effective implementation" of total rewards programs (under the general heading "Customer Relation Management," CRM) can increase an airline's revenue by up to 2.4% per year. That reflects a "bottom line annual impact" of between $100 to $250 million for a large carrier.

TWO: A Management Science article (Kim, et al., 2004) points out that rewards programs give airlines "flexibility in capacity management." That is, when market demand is low, by giving some of their available seating to fliers as rewards, airlines are able to "...commit to smaller available capacities in the future," and as a result, reduce price competition. What one airline loses in present sales may well be compensated for (through rewards-related free travel for customers) in future sales. In other words, rather than adjust their big planes - an extremely high cost of adjustment - the airlines (in times of low demand / fewer customers) give out their rewards to customers and hence adjust their capacities based on market demand.

A a) Firms also of course use reward programs to attract new customers and retain existing customers, Kim explains.

A b) the five elements that determine a rewards program's value are: cash value; choice of redemption options; aspirational value (meaning, exotic travel is more desirable than a cash back offer); relevance; and convenience (ease of achieving the rewards, and the ease of using the rewards). (Atalik, 2005).

B. An article in Issues in Accounting Education (Gujarathi, 2003) explains the dynamics surrounding the costs to the airline of providing earned free travel. What kind of appropriate accounting policy is the best one to implement in order for the airline to determine if indeed a total rewards program makes financial sense.

ONE: This article is fully appropriate to review because Binggeli, et al., writing in the McKinsey Quarterly explained that a survey of 17 major airlines worldwide revealed that "even the most sophisticated" among those carriers have "only a rudimentary understanding of who their most valuable customers are or could be." Nor do those airlines understand which free rewards programs "are most effective in ensuring loyalty. Indeed, many airlines cannot identify "their most valuable customers" because their frequent flyer programs are "little more than a general ledger system" that basically tracks how many miles a traveler has accrued and how many he or she has spent.