Delta Air Lines’ recently announced decision to base frequent flyer rewards on dollars spent rather than miles traveled is a better, more customer-centric way to distribute product benefits, says Wharton marketing professor Peter Fader. When it comes to customer value, Fader notes, “one of the rubrics we celebrate is the notion of RFM — recency, frequency [and] monetary value. [It makes sense to] reward customers on that basis.” With just 4% of Delta’s customers accounting for 25% of revenues, the choice seems clear — if overdue — Fader explains in this Knowledge at Wharton interview.
An edited transcript of the conversation follows.
Knowledge at Wharton: You have written a book (Customer Centricity: Focus on the Right Customers for Strategic Advantage) about the concept of customer centricity that is very relevant to Delta’s recent decision. Can you describe how the theory of customer centricity relates to the current state of the airline industry and what Delta, in particular, is doing today?
Peter Fader: The airline industry is interesting because in many ways, air carriers brought out many of the aspects of customer centricity earlier and perhaps better than any other industry. On the heels of the industry being deregulated in the 1970s and right through to the 1980s, we have the airline industry to thank — or blame — for everything from dynamic pricing to loyalty programs as we know them today. They did some amazingly progressive things. A lot of people can’t even imagine a time without the plethora of loyalty programs that we have today, but they are a relatively recent innovation.
It was very risky on the part of the airlines to take on all these liabilities, build that infrastructure and come up with all of these incentives for people to use the programs. So lots of credit to the airlines — Delta included, of course — for making all this happen. But then, it all kind of stagnated. They started with some really amazing practices; [however,] those practices haven’t changed in the 30 years since the companies first instituted them. The kind of move that Delta is making here makes total sense, and it should have happened years earlier. It’s a shame that it has taken so long for the major airlines to realize that dollars matter more than miles.
Knowledge at Wharton: Briefly explain what customer centricity is and how it relates to what Delta has done here.
Fader: In my book, customer centricity is about the recognition of the differences across your customers. There is no single average customer; there is this wide variety of them, and they vary not only in their needs and what they want from a relationship with a company, but they also vary in terms of their value to the firm. It’s imperative for the firm to figure out who the most valuable customers are, to start taking on tactics to create more value, to extract some of that value for their shareholders, to find more customers who resemble the valuable ones … and bend over backwards to bring them in….
[Customer centricity is] a celebration of differences, as opposed to, “Let’s figure out what the average customer wants.” And loyalty programs are a great way for customers to self-select and [for firms] to provide those kinds of rewards and extract that value. And again, the airlines have been good about developing those programs, but they haven’t been really progressive about changing them [based on] our changing understanding of customers and the needs of a company and its shareholders.
Knowledge at Wharton: So, it makes sense for an airline to want to reward its best customers, with “best” meaning the ones from whom they get the most revenues? That also means that some customers are going to be less well off, right? Who are the winners and losers when a company takes this kind of approach?
“We have the airline industry to thank — or blame — for everything from dynamic pricing to loyalty programs as we know them today.”
Fader: I don’t like to think that there would be losers; I do like to think about winners. I’m not saying this just to be politically correct — I don’t want companies to be “firing” customers and I don’t want companies to … treat [customers] badly. The problem is that today, there are so many companies out there — not including the airlines, for the most part — that are treating too many customers too well…. But, some customers deserve better treatment, and that should be decided on the basis of what they’re worth to the firm.
[Delta’s announcement] is a step in the right direction.… I think that the incentives associated with an airline loyalty program have been a bit out of whack by rewarding people for miles instead of dollars. So, it’s not so much giving people less; it’s giving them more what they deserve.
Knowledge at Wharton: It might be that under the new Delta program, the ultimate beneficiary would be a frequent flyer who takes a lot of short trips and does them on short notice because of business or other reasons. So, they’re paying top dollar for their fares; they are not getting any discounts by reserving way in advance. And they’re not getting many miles because they’re just flying maybe an hour or so away.
On the other hand, there is the bargain shopper who is buying tickets for the cross continental flights at bargain rates. Maybe they do that a couple of times a year and they amass lots of miles from those few trips. Under the new policy, they may not be losers, but they are not going to get quite the level of benefits that they have had in the past. So, it’s a redistribution of the benefits.
Fader: That is correct. And while it might be disappointing to those who are getting a little bit less than they got before, it’s hard for them to complain about it. That is, they will complain about it, but it’s hard to feel a great deal of sympathy for them.
The structures of the program, the way that they were previously set up, were a little artificial, a little bit out of whack, so this is just a recalibrating of programs in an appropriate way. I don’t see this as an example of a company chiseling away and taking away from its customers. I think it is just a fair distribution, and it really does make sense. If you think about the principles or the metrics that are associated with customer value, one of the rubrics that we celebrate is the notion of RMF: recency, frequency [and] monetary value. Let’s reward customers on that basis. Someone who is flying infrequently, and just taking that occasional big flight and often not paying a lot for it, isn’t worth as much as someone who is taking a lot of short fights very often and, indeed, paying top dollar for them. It makes all the sense in the world, and it’s hard to make an argument to the contrary, other than sheer inertia.
Knowledge at Wharton: Is there sometimes a conflict — it seems like there would be — between providing good customer service overall and customer centricity?
Fader: Companies need to be more selective about who gets that red carpet treatment, and this is actually one area where the airlines have been pretty good — which is to say, most people get treated [okay]. It is those consumers who get the upgrades, who get other kinds of benefits that the airline might offer, who are getting that special treatment. And again, that should be on the basis of what the customer is worth.
When I’m talking about worth, I’m not necessarily talking about past profitability; I’m talking about a projection of what we think this customer will be worth in the future. That’s how we want to be giving the rewards out. For the most part, the airlines have been very backwards looking. Let’s reward people based on what they have done, hoping that behavior is a mirror to the future. In some cases, it is. But, I think if we can look at people who are spending big dollars today, as opposed to those who took a few long flights with us, say, six months ago, I think it makes much more sense. And not only will the points be given out in a better manner, but also the benefits customers get will be distributed more appropriately, as well.
“Some customers deserve better treatment, and that should be determined on the basis of what they’re worth to the firm.”
Knowledge at Wharton: What tools are available for making predictions about future spending behavior? What kind of metrics should companies be using?
Fader: It all comes down to the notion of customer lifetime value (CLV). We’re going to look at the flow of transactions, the size of transactions, other interactions that we’ve had with each and every customer, and we’re going to make an educated guess about what we think that customer will be worth in the future. A lot of people look at this as rocket science; some people find it kind of creepy that we’re going to be basing our customer [service] strategies on a prediction of the future, as opposed to the certainty of the past. But, we’ve seen a number of industries where the idea of using data, valuing customers and making tactical decisions on the basis of their projected future value makes a whole lot of sense.
The airlines haven’t been very good about it. Again, it’s ironic that they’ve put in place a lot of the tactics — revenue management schemes, loyalty programs — that enable this kind of management, but they just haven’t had either the analytic horsepower or the guts or the corporate culture that enables the use of CLV as much as other kinds of industries, like, say, financial services or telecommunications. [Delta’s new policy] is a step in the right direction. I think in the long run, it’s going to be good for the customers, for the right kinds of customers, and good for the airlines, as well.
Knowledge at Wharton: Should the other airlines follow suit?
Fader: I really do believe it makes sense for other airlines to be doing this same kind of thing. Again, it took way too long for Delta to step in this direction, but I think all the other major carriers should be doing the same thing. And of course, when they do, the public and policy makers will say, “Oh, it’s just the airlines ganging up on the poor customer.” I don’t think that is the case here. Certainly, those kinds of things are true in other settings, when airlines follow each other around, but, this was a change that should have happened long ago — and better that it happened later than never.
And I think each of the other airlines will [adopt a policy similar to] this; I’m sure that they will refine it in terms of the specific ways that they translate dollars into customer value and the way that they dole out the benefits as a result. So, it’s not going to be the same program for everybody, but it’s just a more sensible way, overall, for them to be managing the relationship with their customers.
“For the most part, the airlines have been very backwards looking. Let’s reward people based on what they have done, hoping that behavior is a mirror to the future.”
Knowledge at Wharton: Are there some industries where the customer centric approach is more valuable?
Fader: I don’t want to suggest that this idea of customer centricity and focusing on certain kinds of customers and treating them differently … is true for all industries or for all companies. And even in an industry where it does make sense — and I think airlines would be included in that group, as well as retail and telecommunications, financial services and others — that doesn’t mean that every firm needs to do it. In fact, a healthy ecosystem would consist of some firms that are doing the customer-centric thing and other firms that are focusing on, let’s call it “performance superiority” … and others that are focusing on operational excellence.
It is not a one-size-fits-all strategy. And in particular, in industries where it’s really hard to observe what each customer is doing, and really hard to target them with individualized messages and treatment and so on, then it’s really hard to do the customer-centric thing. In an industry like, say, consumer packaged goods, it’s hard for a Procter & Gamble to know what each and every consumer is doing, and while they spend a lot of time trying to get a general understanding of what kinds of customers like certain kinds of products and services, it’s hard for them to tailor their offerings quite as well as, say, a retailer can.
Knowledge at Wharton: Could you give some examples of other companies or industries that are taking a different approach?
Fader: Many industries are formed around a blockbuster mentality: “Let’s come up with the next big thing, let’s produce it in great quantities, let’s bring the cost down as we do so and let’s get it out there to our customers as efficiently as possible.” So many companies, so many industries are born into that, and it’s hard for them to move away from it, even if it might be the best thing for them to do.
It’s interesting to look at industries that, again, are born into that blockbuster mentality, but are kind of fighting against it these days, such as pharmaceuticals — there’s a really great example. For them, it’s clearly about blockbusters, but some firms in that industry are realizing that they need to go in a slightly different direction, that they need to focus a little bit more on doing this customer-centric thing instead of just trying to keep inventing blockbuster new drugs and then giving up on them when they go off patent. That would be just one example of an industry that is struggling a bit, that is kind of breaking away, in some ways, from its traditional roots, but not abandoning them completely.
Knowledge at Wharton: What about you personally? Will you be more likely to fly, say, Delta, as a result of this kind of a program?
Fader: What is interesting about the airline industry is that there are so many local, virtual monopolies taking place. Living here in Philadelphia, I am largely locked into US Airways [which has its second largest and primary international hub at Philadelphia International Airport]. That doesn’t mean that I’m being held hostage by them — I could switch. But, because I am at the highest [frequent flyer level] for US Airways and I’m one of those customers who gets treated pretty well, I don’t really have a reason to switch away from them. I’m one of the few people who will stand up and say, “I like the way that US Airways treats me.”
Now, it could get even better if they restructure their loyalty program in the way that Delta has. And while there’s no specific evidence of it, I predict that they will do that as well. So, I have no reason to jump ship and try other airlines out. Although, of course, on occasion, for various reasons, I’m forced to do so, and as a student of the marketing industry, it is very interesting for me to see the way these different programs play out, the way different kinds of customer service policies play out. I think I’m learning a lot from these different kinds of tactics and I’m encouraged by the fact that different airlines are trying different things. I think the industry will be better as a whole. And again, in the long run, I think it can be OK for customers, too.