But Will Profits Last? : Free Flights: Gravy Train for Airlines

Once a month, sportswear executive Elliot M. Lavigne balances his checking account. Next, he reconciles his Pan American WorldPass statement. After all, a mistake on his Pan Am frequent flier account could cost him more than a bank error.

Lavigne, like a lot of executives whose business requires frequent travel, has become a free mileage junkie, accruing “bonus” miles toward flights each time he flies, rents a car or stays in a hotel.

With more than 500,000 miles to his credit, it’s no wonder that Lavigne is Pan Am’s top bonus award winner. A vice president of Perry Ellis Sportswear, he buys textiles abroad and arranges their manufacture in foreign factories.

Linking Business, Pleasure

Last year, he says, he made 10 trips to the Far East, five to Europe, seven to the West Coast and five to Florida. And each time he boards a plane on business, he racks up credit toward trips he’ll take later for pleasure.

The type of frequent flier program that has made Lavigne so bonus-wealthy was inaugurated four years ago by American Airlines simply to lure more passengers. Today, nearly every domestic carrier has a similar program that gives passengers points for their air mileage and rewards them with bonuses ranging from free first class upgrades to tickets on international flights.

Lavigne has become a serious player in the frequent flier bonus game. He flies to Japan via San Francisco to get 5,000 bonus miles. He stays at Sheraton Hotels because they, like many hotels, have boarded the bandwagon and give Pan Am “miles” to their guests. And when he needs a car, he uses Hertz. His company allows him to fly first class, for which Pan Am adds a 50% “bonus” bonus.

Lured by Pan Am

There’s no mistaking that the mileage program lured Lavigne to Pan Am. Before the program began, he recalls: “I flew any airline. They all had about the same schedule, and they all flew to the same place. When the program began, immediately I started to fly Pan Am.”

Lavigne, 32, takes his wife on a trip to the Far East every year. “These are things I would not normally do. How many executives my age could afford a first-class trip . . . worth $4,500?”

Such incentives have reshaped the travel industry. What began as a clever marketing gimmick has become almost a competitive must for domestic--as well as some international--carriers, with an estimated 7 million travelers signed up in the programs. In its 1984 poll of 15,000 readers, Official Airline Guides’ Frequent Flyer magazine (which is targeted to those who fly a lot but is not connected to the bonus programs), found that 93% participated in at least one pro gram, and almost one-third were signed up in four or more.

But, while observers of the highly competitive airline industry generally think the frequent flier bonus program is the most brilliant idea since one-stop check-in, not everyone agrees. Many insist the airline gravy train will not last forever.

The Internal Revenue Service already is examining the programs and might ask Congress to decree that taxes be paid on the bonuses. In addition, many corporations are insisting that they receive the benefits of their employees’ frequent flier points.

Critics maintain that, with all of the dozen major carriers conducting such games now, the programs are no longer moneymakers for airlines. And, they say, the flying public is not really getting a free ride because the programs inevitably raise the price of tickets.

The public, however, is stretching the rules of the game to get something for nothing, the airlines say. According to Frequent Flyer magazine, as many as 20% of all free tickets may be at least partially acquired through cheating.

Pooling of Miles

Some passengers, for example, pool miles within a family under a common first initial to accrue bonuses more quickly.

Airlines, however, are tightening their anti-cheating procedures. They are computerizing their record-keeping and, in some cases, expelling violators from their programs.

United Airlines issued stiff punishment not too long ago when one of its vice presidents, John E. Ruhaak, accidentally discovered cheating aboard its friendly skies. On a flight between Chicago and Los Angeles, Ruhaak overheard a young man trying to impress a young lady by boasting that, though he always flew coach, he filled his Mileage Plus card in for first class. (The airlines always award extra bonus points for first-class travel.)

Ruhaak sat in silence and took down the seat number of the young man. When he returned to his office the next day, he found that the man had pulled the same stunt a number of times.

“He had no way of knowing how I knew,” Ruhaak recalls. “I wrote him a nice letter, and I told him he was out of the system. We took his miles and said goodby.”

Banned Forever

While most airlines are loathe to antagonize passengers, even if they are caught red-handed, United has been tough. The young man’s name ended up on United’s “barred list,” meaning that he has been banned from the airline’s program forever.

Until it got wise not too long ago, PSA was victimized by cheaters quite regularly. Passengers would go to the airport to purchase tickets at an automated ticket machine, which also provided them with a boarding pass. They would then record their mileage credit on the machine, automatically getting bonus credit, even though they never took the flight and turned in the ticket for a refund.

Delta Air Lines computerized its frequent flier program about 18 months ago. Before that, passengers were required to send in copies of their tickets, which could be easily altered.

Eastern said that one person logged 900,000 fictitious miles before he was caught. In an effort to prevent such problems, Eastern now requires passengers to hand in their coupons at flight time--not by mail. Eastern figures that until its recent crackdown, about 4% of its awards were acquired falsely.

There are others crying foul, too--employers. In fact, more and more companies are declaring that, since they paid for the price of the original ticket, they should be the ones reaping the rewards. Besides, they say, the bonus programs waste money by encouraging unnecessary trips and circuitous routes.

Cheaper Fares Overlooked

Employees tend to favor use of airlines in whose plans they are enrolled, frequently overlooking cheaper fares offered by competitors, some employers contend.

Goodyear Tire & Rubber Co. has a policy dictating that any awards resulting from the travels of its workers belong to the company. “If I fly to New York,” says a spokesman, “why should I get the bonus if the company has paid my fare?”

On the other hand, American Telephone & Telegraph is allowing its own employees to get the awards and closely monitors their travel to see that costs are not inflated. AT&T; recently began its own “frequent dialer” version of the airlines’ program, offering users of its long-distance service dollar credit on merchandise from luggage to power tools--and discounts on cruises and airline flights.

Richard Incandella, president of IVI Travel of Northbrook, Ill., says that of the 60 Fortune 500 companies with whom his travel-management company works, only 10 require benefits from programs to be paid back to the company.

TravelSmart for Business, a nationwide newsletter for corporate travel managers, estimates that if a company spends $500,000 a year on air fare, $50,000 “goes down the drain” as a result of not choosing the cheapest flights.

Names Kept in Confidence

Many airline officials insist, however, that if a business traveler makes an extra stop, it is not necessarily more expensive. And although some firms have attempted to get the airlines to divulge the names of employees in frequent flier plans, the airlines have refused, acting much like Swiss banks in protecting the confidentiality of their clients.

Recently, a New York real estate syndication firm, Southmark/Envicon Capital Corp., initiated a class-action suit against seven major airlines. Among other things, the company seeks to turn over to employers rather than to individuals the fruits of frequent flier programs earned while traveling on company business. It charged that the airlines are engaging in “corporate bribery” with their frequent flier programs because they induce employees to take flights, stay in hotels and rent cars that might be more expensive for the employer than other company-paid travel arrangements.

But one consultant has come up with another approach to the problem that it hopes will keep both employer and employee satisfied. Travel Expense Management (recently acquired by IVI Travel), which advises corporations on how to curtail travel costs, has developed a program called Tracking Plus, through which a firm can keep tabs on bonus awards accrued by its employees.

‘We Cash Chips In’

Under the program, employers would require that their traveling employees re-enroll in airline programs through Tracking Plus. The service then reports monthly to companies what their workers have accrued and leaves the actual disbursement of the bonus points to the company for use in future business travel or as incentives to employees. “We cash the chips in,” says James Crueger, the firm’s director of product development.

Those “chips” have gained attention from another quarter: the government. In fact, both the IRS and Congress are considering whether bonus awards should be considered taxable income.

A new IRS policy might work like this: If benefits are earned by individuals during personal travel, or if a company earns them and uses them for business travel, they would be treated as a discount and not taxable. But, if the individual receives free flights on travel paid for by his company, the benefits would be treated as taxable income.

At least one bill that would result in the taxation of such benefits has been introduced in Congress. In an effort to encourage the Treasury Department to tax frequent flier awards, Rep. Harold E. Ford (D-Tenn.) recently introduced legislation that would require airlines to inform the IRS of the names and addresses of the frequent flier bonus beneficiaries and the total value of the awards they received.

Value Hard to Measure

One difficulty with any ruling that the IRS or Congress might come up with is the determination of value. Even the airlines say that it is difficult to put a specific dollar value on an award, since the same bonus coupon issued by an airline for any international destination could, for instance, buy a ticket between New York and London, or a more costly one between New York and Cairo. In addition, fares change depending upon the time of year.

With so many people going to such lengths to reap the bonus rewards, there are others who have begun viewing the “free” miles as tradable commodities. Hence, the spawning of a new business--brokers who buy and sell those miles in the form of tickets. At last count, there were about 10 such discount ticket brokers operating nationwide.

The operators of these businesses are a diverse lot. There is Neil Weisman, president of American Coupon Exchange of Newport Beach, who graduated from medical school but chose bartering in mileage coupons over setting up a practice. Alan Gross, a professor of psychology at the University of Maryland, founded AGCO, another of the brokers, with offices in Pacific Palisades and in Silver Spring, Md.

How Brokers Operate

The brokers operate in a variety of ways: AGCO, for example, is a sort of matchmaker, determining the value of an award and sending the seller a check. In most cases, when the broker finds a buyer for an award, he transfers the coupon to the person who will use it to fly and then trades the coupon for a ticket in the new traveler’s name. Sometimes, depending upon the rules and restrictions of a particular airline, the frequent flier will trade the coupon in for a ticket in the new traveler’s name.

The coupon brokers say they have regular customers who both sell to them and buy from them. Denver’s Coupon Broker, for instance, purchases mileage from an executive who supervises several restaurants in a number of cities and must visit them frequently. For the last three years he has sold the agency about 100,000 miles annually for a total of somewhere between $1,000 and $1,500.

Most airlines accept the fact that business travelers who fly much of the year would rather sell their bonuses than take yet another trip. Still, some airlines take a dim view of the brokering practice, fearing that the sale of coupons through brokers would reduce the number of regular fare-paying passengers through the airlines.

Competition Heats Up

Despite the problems, the bonus programs are multiplying. International carriers--including British Airways, Qantas and Japan Air Lines--have started programs or joined with their American competitors to attract the business of U.S. travelers.

Though there are differences of opinion, it is generally accepted that even among the established airlines, the larger ones are the winners in the game. “The bigger carriers do have a natural advantage because of their size, because of the number of destinations they serve and because of the glamour of the award destinations,” says Thomas G. Plaskett, senior vice president of marketing of American Airlines.

In fact, Eastern and TWA, for example, have combined many of their frequent flier awards to give each a much wider area of coverage and more varied award destinations.

For the airlines that are not quite as big, the frequent flier programs have become essential. “At this point, with everybody offering a plan, it’s just a matter of maintaining market share,” says Richard Moran, director of commercial marketing for Northwest Airlines. Even U.S. Air, which held out the longest, instituted a program in February and already has 256,000 members.

According to Paul C. Auger, vice president of marketing programs for Eastern, between 1% and 2% of Eastern’s total traffic is on either a discount, upgrade or free ticket resulting from its frequent flier plan. Eastern’s three-year-old program has 750,000 active members.

Airlines See Profits

The airlines contend that the bonus programs are especially profitable for them since, for the most part, they are only “giving away” what would otherwise have been empty seats. Pan Am, for instance, says the flights taken to qualify for its WorldPass program account for 25% of its annual revenue.

But there’s a flip side.

“Anytime you give any of your product away, and everybody is doing the same thing at the same time, there is not much to be gained by anyone. If all the car dealers in the nation give 20% rebates, the advantage of the rebates just disappears,” says Louis A. Marckesano, airline analyst with Janney Montgomery Scott in Philadelphia. He feels the system automatically raises ticket prices. “I’m against anything that tends to be a giveaway, because in the long run somebody pays.”

And some take it one step further. With too many of such giveaways in the hands of the traveling public at any one time, the airlines might be creating a dangerous liability for themselves. Cynics, in fact, envision a day when a jumbo jet will leave New York with no paying passengers on board.