AA’s looser frequent-flier program makes it easier for customers to redeem miles and could set a new standard for other carriers

For many road warriors, the frequent-flier programs operated by airlines were the ultimate “wallet on a string” trick: Travelers found it easy to accumulate the miles but impossible to redeem them. And even when they could, they found that even the simplest free trip required “spending” double or triple the miles they anticipated.

But American Airlines’ (AMR) recent decision to allow members of its AAdvantage loyalty program to redeem their miles for one-way tickets — and for just half the miles of a round-trip flight — may have marked a turning point in how the major carriers treat their best customers. American’s move shows the extent to which airlines now realize that these loyalty programs have become more than just a cheap-and-easy way to reward their best customers, but are now arguably their biggest profit centers — and may be critical to their survival. And after years of milking these programs, airlines may start taking more steps to ensure that travelers don’t become jaded and drop out.

Setting a New Standard

“American Airlines has changed the dynamics of reward offering in the United States,” says Jay Sorensen, president of The IdeaWorks Co., a Shorewood [Wisc.]-based airline industry consultancy. “The other major carriers will have no choice but to match this.”

Industry experts say the move by American, which boasts 62 million loyalty members, will reverberate through the airline industry for some time to come. While other carriers may have no choice but to match American’s new offering, how quickly they can do so isn’t clear. Rob Friedman, president of American’s AAdvantage marketing programs division, says it took slightly more than a year to reprogram its computers to handle one-way redemptions, and presumably should take rivals the same. “This gives us a tremendous ability to leapfrog our competitors,” says Friedman, who called it “one of the most significant enhancements we’ve made this decade.”

What all this means for travelers is that it could become easier — and cheaper — in coming months and years to use the collective 20 trillion miles they’ve banked with airlines. And the changes that Plano [Tex.]-based American announced in mid-May could be just the beginning. Under terms of the new program, American is allowing members of its AAdvantage program to book a one-way trip for just 12,500 points, half the 25,000 points required for a round-trip ticket, which was the minimum redemption before the changes.

One-Way Ticketing

That’s a good deal if you’re a parent driving your kid back to college, and will leave him or her your car before flying back. Or if you want to put together a trip with three legs — say, visiting one relative in Florida, then another in Texas, before flying back home. Or even to book a round trip where one of the legs occurs during a “peak” period when many flights are normally full [to get a guaranteed seat during peak periods, you’d need to use 25,000 points to guarantee yourself a seat, using an AAnyTime award] and the other leg is during an “off-peak” period [when 12,500 points is enough to get you a MileSAAver seat].

Under the old system, you’d have to “purchase” a premium AAnyTime award for both legs, burning through 50,000 miles. Now you simply reserve two one-way trips, using a total of 37,500 points [25,000 going one way, and 12,500 coming back].

Some travel gurus think the change should also just make it easier to find free seats, period. That’s because under the old system, a search of the availability of a free seat on a specific round trip could be rejected if one of the back-and-forth legs was unavailable. Indeed, Randy Petersen, founder of Colorado Springs-based Frequent Flier Services and editor of the WebFlyer Web site, says his research shows that 87% of rejected requests were because of the unavailability of one segment.

But by effectively unbundling each of the round-trip legs, frequent fliers can keep searching until they find a flight with available seats. American’s Friedman notes that the airline redeemed 155 billion miles in 2008. With the changes, he expects even greater redemptions this year. “By offering this flexibility, we think customers will use their miles for more kinds of trips than before,” he says.

Use ‘Em or Pay for ‘Em

There could also be a financial benefit for airlines to run down that massive backlog of unused miles as well. New international accounting rules require foreign-based carriers to value those liabilities at higher levels that reflect the fair-market value of the miles, a switch that forced Australian carrier Qantas (QAN.AX) to reduce earnings by $29 million last year.

And if the U.S. standard-setters at the Financial Accounting Standards Board adopt that same practice — as experts expect around 2012 or so — then U.S. carriers could be forced in coming years to take large, one-time revaluation charges on their unused miles as well, notes Paul Munter, an audit partner with KPMG, the international accounting firm. “It appears momentum is moving in that direction,” says Munter.

For the airline industry, which has long been accused by critics of making it harder and more expensive for customers to claim free seats, the move may mark a watershed moment. And that reflects how important frequent-flier programs have become to the industry, and the degree to which airlines want to keep their loyalty-program customers engaged — and loyal.

Third-Party Sales

Tim Winship, a former airline executive who developed frequent-travel programs for Singapore Airlines as well as Hilton Hotels, estimates that the three largest carriers — Delta (DAL), United (UAUA), and American — each now generate roughly $1 billion in annual revenues from the sale of frequent-flier miles to hotels, rental-car companies, and even utilities, which in turn offer the points as inducements to their customers. Petersen notes this revenue stream is almost pure profit for the carriers, since the marginal cost of transporting a free passenger is nothing more than a can of soda, bag of peanuts, and the incremental fuel costs [a little less than 3% a mile at current prices, or about $38 for a round trip between Chicago and New York, or less than a tenth of the $500 to $1,000 an airline will collect from selling the points a customer needs to exchange for a free seat].

“This is a very profitable business, maybe more profitable than the flying itself,” says Winship, who now runs the FrequentFlier.com Web site.

But American’s changes aren’t good news for every member of its loyalty program. For some expert travelers, the new policies will end one of the quirks of the old system that enabled fliers to hit more than one destination on a single redemption. Specifically, American is no longer allowing “free stopovers” outside of the U.S., a trick that allowed savvy travelers to game the system by booking a free ticket from, say, New York to Madrid, but routing the trip through London and scheduling the connection from London to Madrid for a separate day. That was an expert play that allowed these travelers to spend a couple of days meeting with clients or even the Queen Mum before actually taking that connecting flight from London to Madrid. Under the old system, travelers could do that on a single redemption [and maybe book your return flight through Frankfurt, and spend a couple of days at Oktoberfest for good measure].

American now requires travelers to book two separate one-way tickets each way if they want to stop over for a day or two in London and Frankfurt. Travel experts say this loophole was exploited by a relatively small number of fliers. In the end, their sacrifice may be a small price to pay for the broader benefits to the rest of the traveling public.