Strategy and Competitive Advantages
The market for coalition and loyalty programs in Brazil has significant room for growth. The Company believes that is well positioned to take advantage of this growth due to the strength of the program, the quality of membership base, exclusive relationship with Gol and the reach of other commercial partners.
The main components of Smiles’ strategy are as follows:
The Company intends to substantially expand its participation in the Brazilian market for loyalty programs. Smiles’ market share is directly related to the redemption of Award Tickets by Participants, and the fact that it is Gol’s exclusive loyalty program, which has significant penetration in the upper and middle income classes, will be the tool for expansion in this market . Smiles intends to use Gol’s market share of around 35.28% to its advantage based on the RPK (Revenue Passenger Kilometer), calculated based on information disclosed by ANAC, and the Operational Contract that guarantees the Company an offer unrestricted for redemption in Award Tickets, increasing its market share, which the Company believes to be 52.16% of the loyalty program market in Brazil.
In addition, the Company intends to strengthen the relationship with banks and credit card management companies, as well as develop other Business Partners in the most diverse sectors of the economy, providing wide and differentiated access to a new and promising target audience.
With the management, administration and operation of the Smiles Program, the Company gained direct access to Gol’s expressive base of customers, who are Participants of the Smiles Program. With the management of the Smiles Program by an independent company, focused on this activity, the Company intends to expand its penetration with this expressive customer base.
The Company believes that expanding its network of commercial partners puts it in a better position to offer to the members additional opportunities to accumulate miles, especially those members who are unable to accumulate sufficient miles to earn reward tickets. Smiles plans to seek new commercial partners in industries across the Brazilian economy that Smiles believes present considerable growth potential, especially in light of the low penetration of loyalty programs in the Brazilian market. The entrance of new commercial partners in the program, together with sales efforts, will further encourage new members to join the Smiles Program. Although the focus is a coalition loyalty program in which commercial partners use the Smiles Program as their loyalty program, Smiles may also add strategic partners that already have their own respective loyalty programs.
The Company plans to continue to diversify reward options other than airline tickets. Smiles also plan to introduce airline tickets that are appropriate to the profile of each member while maintaining Company’s profit margins at target levels. By developing relationships with commercial partners focused on low-cost consumer products, Company aligns new forms of redemption with the needs of the public, popularizing member access by reducing redemption costs. Smiles believes that rewards other than airline tickets have the potential to expand its membership base and increase the volume of miles redeemed by members, as Smiles expands the opportunities for miles accumulation and redemption.
The Company intends to expand Smiles & Money, a tool through which members can buy additional miles in order to redeem them for airline tickets and other products. This product is highly attractive to members, as it permits redemptions for rewards with fewer miles, enhancing member engagement. Smiles also intends to continue to encourage product innovation, such as exclusive flights for Smiles Program members and the sale of miles to recent members.
The Company believes that the Smiles Program’s tradition of innovation will help increase current and future members’ level of engagement to the benefit of the Smiles Program and all its commercial partners.
The Company intends to continue to enhance its operating efficiency through economies of scale. The large investments needed to develop its business were made over the last few years, and Smiles thus believes that is prepared to face this new growth cycle with minimal investment in its infrastructure. Smiles’ team is lean and efficient. Accordingly, its business is highly scalable and has strong operating margins. Smiles believes that the increased participation of retail partners presents an opportunity for growth with minimal impact on costs and investments.
Smiles’ competitive strengths include:
We manage and operate the Smiles Program on an exclusive and independent basis. The Operating Agreement and the Miles and Tickets Purchase Agreement give us full authority to manage the Smiles Program, including determining the miles redemption policy and rewards management.
Our management is separate from Gol’s, giving us the freedom to determine policy for using, redeeming and pricing miles, although we must communicate these policies in advance to Gol. This affords us flexibility to react to changes that can affect our business, such as changes in supply and demand, economic conditions and the business of our commercial partners and competitors. Moreover, we can sell miles to our members within pre-established price, duration and quantity limits.
The agreements give us unrestricted access to seats on Gol flights at competitive prices, access to the lowest prices offered by Gol to its commercial partners and access to a guaranteed minimum number of seats with prices based on the economic cost of transport. As a result, we can offer members reward tickets on all Gol flights at prices in miles that are extremely attractive, given that our price is based on economic cost, regardless of the occupancy rate of the flight and Gol’s effective fare at the time of redemption. In addition, our business model allows us to offer redemption on an unrestricted basis on all Gol flights, since we have access to Gol’s entire inventory at the best prices offered to its commercial partners. Furthermore, we are able to occasionally negotiate promotional seats at discounted prices, enabling us to stimulate demand for both companies and to strengthen the program’s appeal.
We believe that we have created a pioneering business model with independence and flexibility to manage fluctuations in demand and the cost of rewards. These characteristics allow us to manage our operating margins by implementing changes in our portfolio and managing the price of rewards. These changes include adjusting the allocation of seats available for reward tickets, dynamic pricing of reward ticket redemptions and supplying alternative rewards across a range of prices, thus facilitating improvement and effective management of our operating margins.
The Operating Agreement and the Miles and Tickets Purchase Agreement have 20-year terms, automatically renewable for additional 5-year terms unless either party objects at least 2 years in advance of the renewal date, ensuring a secure and stable long-term relationship that allows us the ability to plan our business decisions years in advance.
Our executives have experience in the air transportation, loyalty, retail and credit cards segments, all activities related to our main sources of revenue. We believe that their deep understanding of the airline industry, and particularly their familiarity with Gol, gives us a competitive edge in the pricing process and the allocation of airline tickets for redemption, knowledge that is fundamental to manage our operating margins.
Frequent flyer programs are popular in Brazil due to the strong appeal of reward tickets. We believe that our exclusive relationship with Gol, Gol’s market share in the airline industry and the degree of interest in Gol’s destinations put us in a privileged position to expand both our membership base and the level of member engagement. We also believe that banks and credit card companies that offer reward tickets through their loyalty programs via partnerships with airlines contribute to the growth of the loyalty industry, and particularly our growth.
A variety of our commercial partners are retail companies that are increasingly investing in loyalty. We are focused on developing these partnerships through a coalition loyalty model in order to expand member opportunities to accumulate miles, allowing faster redemption of higher-value products such as airline tickets. In addition, expanding our redemption network is also intended to benefit members who do not accumulate enough miles for airline ticket redemption, as they have the option to use miles to redeem lower-cost products. For our commercial partners, this system allows the resources invested in loyalty to be converted into funds that return to their business through purchases of their own reward products. Accordingly, we believe that the loyalty industry and our business benefit from the growth of Brazil’s retail industry.
We believe that the Smiles Program attracts members with its simplicity, as we allow easy access to and use of our website, simple and clear rules for mileage accumulation in a single loyalty program, outstanding customer service and an extensive network of airlines and commercial partners for reward redemption. We have also created Smiles & Money, an innovative product in Brazil that allows members to combine money and miles to obtain reward tickets.
The Smiles Program offers members an array of benefits including (1) dynamic pricing of reward tickets, (2) a simple and fast redemption process, (3) communication with members and commercial partners through a single channel, (4) the ability to redeem reward tickets up to 330 days in advance, (5) fast mile accumulation due to our broad network of commercial partners, (6) the issuance of reward tickets from partner airlines directly through our website and (7) a longer miles expiration period compared to competing loyalty programs.
In October 2012, we announced the creation of Smiles Shopping, an internet platform for purchasing products with miles that offers members access to nearly 500,000 products and services from our commercial partners. In addition to improving our capacity to manage redemption costs, Smiles Shopping provides more benefits and greater ease to all members, expanding the redemption options for products and services from our commercial partners. Our commercial partners that offer products through Smiles Shopping include high-profile companies across a variety of industries, including Abril, Atlantica Hotels, Centauro, Drogarias Pacheco, Drogarias São Paulo, Fast Shop, Hilton HHonors, Localiza, Marriott, Magazine Luiza, Netpoints, Shell, Polishop, Ri Happy, Walmart, Via Varejo, Claro and among others.
We had over approximately 15,4 million customers at the end of 4Q18. We believe that our solid membership base is an important attraction for our current and potential commercial partners that are interested in increasing their visibility. We believe that our commercial and financial partners benefit from the extent and diversity of our membership base and the agility and efficiency of our marketing campaigns.
Furthermore, the increase in the purchasing power of the Brazilian population reinforces the positive outlook for the industry. We believe that the loyalty program industry in Brazil has potential to grow significantly due to the large number of consumers who are not yet members of a loyalty program, but who are participants in the Brazilian economy with formal jobs and bank accounts.
The Brazilian market currently has two relevant frequent flyer programs that are offered by the two largest domestic airlines: the Smiles Program and the Multiplus Fidelidade Program, offered by TAM Linhas Aéreas. In contrast to markets such as the United States and Europe that have a large number of competing frequent flyer programs, this competitive landscape in a market of Brazil’s size gives us an enormous opportunity to attract more members and commercial partners.
Our business model presents high operating margins, positive working capital and as we are based on a centralized computer platform, ease to expand with little investment. On December 28, 2012, we executed a Back Office Services Agreement through which VRG will provide us an array of administrative and back office services. The Back Office Services Agreement allows us to outsource activities unrelated to our core business at competitive prices, a benefit that we are able to enjoy due to the scale of Gol’s operations.
Our business is characterized by stable cash flows from the sale of miles to commercial partners, including financial institutions and Gol. Our business model brings in revenue from our commercial partners well in advance to the actual redemption of the respective miles, which makes it possible for us to earn revenues by investing these funds.
Finally, our system and database facilitate the pursuit of new business opportunities, such as product development based on the decisions of clients and interests of our commercial partners and the creation of client-based marketing and management services.