Ai Editorial: Being incisive with financial predictions for managing FFP’s liability

Interview with Len Llaguno, Founder, KYROS Insights

6th May, 2020  

The role played by smart assumptions in managing FFPs' liability in these uncertain times can’t be undermined.

According to KYROS Insights, astute liability management entails a couple of aspects - an understanding of the past and confidence in the future. So what does it take to craft smart assumptions for travellers' behavior and manage liability?

Managing a loyalty program's liability is an arduous task these days, especially considering that airlines, as an industry, is facing liquidity crisis.

Acknowledging the same, Len Llaguno, Founder, KYROS Insights highlighted that airlines have to find a tantalizing balance between letting a loyalty program member redeem their loyalty currency so that they remain engaged and satisifed, vis-a-vis the burden same puts on an airline's financial condition and adversely impacts their plan to sustain cash flow to tide them over this period.

"For any airline struggling with cash flow, every redemption that comes (for example) on a gift card, is going to deplete the cash reserves. And possibly getting the airline one step closer to bankruptcy," said Llaguno.

So those who are responsible for FFPs are in a precarious state. It is exemplified by the fact they are possibly going to end up with two sub-optimal situations – one in which they decide to pose restrictions on redemptions, which isn't prudent, and second if they don’t put restrictions, then any increased pressure in terms of cash flow, too, is a hard-hitting issue to cope up with. 

"No matter how one looks at it, both are awful decisions to choose from (at this juncture)," Llaguno said. At the same time, he also cautioned airlines. "If the current economic situation is being used as an excuse to devalue the loyalty program, then that’s an awful idea.  This is only going to hurt the long-term prospects of the program and key aspects such as the retention of members, and eventually result in a bad economic outcome," said Llaguno, who mentioned that airlines can be given a benefit of doubt at this stage as the liquidity issue is for real.

He also pointed out that the critical aspect is going to be the communication plan. Any unfavourable or unattractive decision being taken with a pragmatic reasoning needs to be conveyed, and would only ease the burden to an extent. Being honest, as usually it pans out, is the best approach. 

Significance of segmentation in smart assumptions

A main issue that has emerged with data, analytics and making assumptions is – there is no practical or observed data to evaluate how things are going to shape up.

"Any model that has been worked on has utilised historical data. That data didn’t feature an occurrence like a pandemic or similar to what is happening today. That’s where the professional judgement comes in and is going to fill in the gaps in those models. We, as actuaries (specialists armed with data and statistics and use the same for predictions), have handled liability management for over a decade, and accordingly using our expertise along with intuition in coming up with reasonable assumptions. Plus, the plan is also to leverage companies’ business understanding and gathering as much relevant information as possible," said Llaguno.

"For any smart assumption, the way to do is to segment members based on their expected future behaviour, and set different assumptions for different segments," he said. One category features those who are possibly or likely to expire their loyalty currency, and at the other end of the spectrum, the category segments those members who are most likely to redeem their currency or are among the highly engaged FFP members. And typically, as KYROS works on segmentation, there are eight segments of members in between.

Gearing up for expected future behavior

Llaguno referred  to tiers is an example of the past behaviour. “It is a way of assessing what a member has done up to a particular period of the year and that results in a tier status. It is not explicitly saying or making any prediction about what members in that tier are going to do in the future. And that’s the difference when you create profiles based on the expected future behaviour. Members in that profile are expected to show uniformity in their behaviour, say a couple of years into the future. And once you get to that level it becomes really powerful, and now you’re able to identify a member and based on the understanding of their behaviour start feeding that into how you are going to engage with them. One can be more proactive, for instance how to target them.”

He further added, “And that is absolutely possible to do and we have leveraged actuarial theory and machine learning for success. It allows to make predictions for 1-2 years horizon or more into the future. The theory works on an aggregated level and when the actuarial theory is combined with machine learning, it allows one to get granular with predictions - allows to predict at an individual member’s level.”   He continued, “It needs to be considered that models are not strictly going to do an apt job in this scenario. It is imperative to have an infrastructure in place to monitor, and evaluate assumptions and adjust these professional judgments over time. Assumptions are going to be wrong, irrespective of how smart or good they are. There is need to course-correct as you learn.”

Being relevant to members

Tiers are important motivators, but only if attainable. And that is going to be different for every single member. And increasingly the current tier qualification standards are just not attainable for most members. And even for those who normally qualify are going to find it tough in the coming year because of the pandemic.

“The way we think it needs to be handled is - make one global change making tier status easy to achieve for people but then also use predictive analytics and the rich data that loyalty programs create to build models to help understand how to send offers to individual members. For instance, “we have reduced the tier qualification but here is the extra bonus for you to make it easier to reach the status”.  That way you are making the tier qualification status for each individual member unique or may be at a segment level. So tier is going to be leveraged as a motivator in the most effective way. Because there is customisation for each individual, customising their qualification standard based on the unique circumstances of each member. And obviously one doesn’t want everyone to qualify otherwise it would be overloaded with volume and then devalue the value of the tier status. So lot of nuances there for execution. It can be a powerful tool in driving the desired behaviour and accelerate the recovery when it eventually happens the recovery when it happens,” said Llaguno.

Putting a value on a member 

Llaguno highlighted that program managers need to put a value on each member.

“Value your customers, put a number on them that represents their expected future profit for the organisation (a bottomline number) - model the expected revenue, cost of goods sold, marketing cost, acquisition cost and the redemption cost to be incurred for members for every point they earn. Then one can get to bottomline profit number. Select some horizon. Getting to this point, which most airlines don’t, is incredibly insightful,” he said.

He added, “Because you soon realise that 20% of your members are going to generate 80% of your profits over the next 2 to 5 years. The problem today is that loyalty programs and airlines don’t know who that 20% is. And it’s not that who you think it is. Your highest tier members are absolutely some of your most valuable members and that’s not really surprising but the interesting part is lot of high value members in lowest tiers. And the problem is airlines and loyalty programs Have no way to identify them today and if you’re able to build models predict expected future profit that gives you the ability to identify them today and be more proactive engaging with them, sending personalised offers etc. And that activity allows you to focus your time and resources on Members that really going to move the economic needle and maximise the likelihood of capturing that profit from those members and potentially grow profit from members.”