Why Airline Co-Branded Credit Cards Are So Valuable For Their Partners

By Markets Fool.com

Nearly everyone who's taken a commercial airline flight over the past few years has been subjected to the come-ons: Low introductory rate! Sign-up bonus! Double miles for qualifying purchases!

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The sales pitches, of course, are for credit cards. All major American -- and now a few foreign -- carriers offer at least one, in conjunction with deep-pocketed issuers (the companies extending the credit). This teamwork is called "co-branding."

Airlines don't otherwise involve themselves in finance much, so why are they so aggressive in hawking credit cards? And why are issuers more than eager to jump on board with them?

Living on credit
For airlines, a plane ticket is a typically high-cost and low-margin item, so carriers do their level best to generate non-ticket ("ancillary") revenue. This is why we're charged extra for options like checked baggage, snacks, several more inches of legroom, etc.

The ancillary category has grown sharply over the years; the top 10 airlines in 2007 collectively reaped more than $2 billion in such take. For 2013, that figure was nearly ten times higher at over $20 billion.

One big contributor to the rise of ancillary dough has been credit cards. Carriers sell their frequent flyer miles to partners. Those miles are, in turn, bestowed on customers as rewards for doing business with the partner.

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This is a thriving trade. In 2013, more than half of United Continental $5.7 billion in ancillary revenue came from the sale of miles. And a considerable number of those miles are sold to the issuers co-branding the airline's card(s).

That's only one of several revenue streams derived from the relationship. The issuer typically pays the airline a sign-up bounty for each new cardholder, which can total $100 or more. The carrier can also get a piece of the issuer's overall take (generated from fees and interest on carried balances) coming from the card.

On top of that, the issuer often rebates the usual merchant processing fees when the customer makes a purchase from the airline.

So co-branded cards carry precious few costs while bringing in easy revenue. Considering that, an airline would almost be foolish not to offer one or several.

The easy sell
Issuers are willing to pay for those miles, and hand over a cut of their fees, because a good co-branding relationship can be lucrative for them too.

The first and most obvious benefit is direct access to a wide customer base. A lot of people fly these days -- for instance Southwest Airlinesrecorded 29 million paying passengers in 2014.

Air travelers are not only a huge group as a whole, they're theoretically ideal customers for credit products. Travel by air is not a cheap activity, so those who can swing it (or the companies paying for their tickets) are relatively affluent and willing to spend money.

That's why a typical airline card carries annual fees. United Continental charges $395 per year for its high-end MileagePlus Club card, a Visa product issued by JPMorgan Chase.

All told, carriers make plenty of money for their partners. American Express , which acts as both the issuer and the payments processor for its products, co-brands a set of DeltaSkyMiles cards. That relationship was responsible for roughly 15% of AmEx's worldwide card member loans at the end of last year.

What helps greatly is that travelers often don't need their arm twisted to sign up for credit cards. They're relatively easy to lure with goodies such as mileage rewards for their spending, and bonuses for purchases of the airline's plane tickets, vacation packages, etc.

American Express aside, credit card companies and airlines are usually tight-lipped about the financial figures and client numbers of their co-branded cards.

But we can assume that even a fraction of, say, Southwest's 29 million passengers last year constitutes a nice, big pool of spenders. One that's large enough to contribute significantly to the coffers of both the carrier and its co-branding issuer JPMorgan Chase, with a good little chunk going to payments processor Visa.

Airline cards are bringing in a lot of money for all sides involved in the segment. No wonder the carriers badger us so much to apply for them.

The article Why Airline Co-Branded Credit Cards Are So Valuable For Their Partners originally appeared on Fool.com.

Eric Volkman has no position in any stocks mentioned. The Motley Fool recommends American Express and Visa, and owns shares of JPMorgan Chase and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.