If you’ve listened to airline executive speaks in recent weeks about financial results or their forecast for the industry, you’ve probably heard one theme more than any other — overcapacity (well, unless you’re listening to a Delta earnings call, in which case you probably heard “premium”).
In this post I wanted to talk about that in a bit more detail. What does that term really mean to airlines, and what are the implications of the overcapacity narrative for consumers?
We’ve gone from not enough planes to overcapacity
Once global travel meaningfully restarted after the pandemic, full service global airlines were on a roll, thanks to strong premium leisure demand and the “revenge travel” concept (as much as I hate that term).
Airlines may have only been operating at a percentage of their pre-pandemic levels, but yields were excellent, thanks to limited capacity. Of course as more capacity has been restored in the industry, yields have decreased a bit.
In late 2023 and early 2024, the biggest theme among airline executives was how they’re furious at Boeing for the company’s failure to deliver new aircraft, plus they’re angry at Pratt & Whitney engine issues for leading to Airbus jet groundings. Airbus has also had some delivery delays, but nothing nearly as significant as the other two issues.
For example, in January 2024, United CEO Scott Kirby wasn’t happy about the 737 MAX delivery delays, stating that “we’re still going to be the fastest growing airline, but we’re not going to be as fast growing as we planned.”
Now in recent weeks, that narrative seems to have shifted drastically. Airline executives now talk about how the industry is dealing with overcapacity. That’s an interesting claim to make, when we’re still seeing a record number of people traveling, especially in the United States.
Furthermore, surely airline executives realized that capacity would increase in 2024 compared to 2023, as many airlines globally still had some of their fleet grounded after the pandemic… no?
So how do you in a matter of months go from being angry at aircraft manufacturers for not delivering planes fast enough, to arguing that there are too many planes flying, all while travel demand has continued to be quite strong in terms of raw numbers?
What does overcapacity mean, really?
When airline executives say there’s overcapacity, are they arguing that there’s too much supply, or not enough demand?
Broadly speaking, network carriers are having no issues filling planes, but the problem is maintaining decent yields. Almost all airlines saw yields drop from 2023 to 2024, meaning that people are paying less for their tickets than before. That shouldn’t come as any surprise, given how many planes globally were still grounded in 2023.
So when airline executives warn of overcapacity, I have to make one of two assumptions:
- They’re essentially attempting to signal to their peers that they want to cut capacity in order to raise fares; think of it as a legal form of collusion
- I think they’re basically acknowledging that the cost structure in the airline industry has become so high that they need to be able to raise fares in order to continue building on their profits
What’s interesting is how different airline CEOs view the demand for air travel, which is also directly what informs their perception of what constitutes overcapacity. During United’s Q2 2024 earnings call, CEO Scott Kirby made it clear (as he has many times before) that he believes the demand for air travel is inelastic.
When talking about the airline revenue to GDP ratio, Kirby notes how that ratio has declined due to overcapacity in the industry. Here’s how he explains that:
“The reason that happens is because demand for air travel is inelastic. Like the very first project I worked on when I was an analyst at American Airlines was estimating demand elasticity, it is inelastic, every bit of analysis you look at says that demand is inelastic. But when airlines get over their skis on capacity, they rush to get the load factors up and they lower prices and that lowers overall revenue. So it really is just as simple as this ratio goes down when supply exceeds demand.”
Can airlines really artificially raise airfare?
Several airline executives are essentially signaling to one another that they’ll cut capacity this fall and beyond in order to be able to raise fares. If you’re like Kirby and truly think the demand for air travel is inelastic, then I suppose that makes sense.
However, I’d argue that executing this strategy is easier said than done for a few reasons:
- You have some very desperate ultra low cost carriers at the moment, which would be delighted to add capacity within the Americas, and shift around their networks for any areas where legacy airlines try to raise fares
- Airlines have very high fixed costs, and choosing to reduce capacity is much more costly than before the pandemic, given much richer labor contracts that can’t be renegotiated, among other things
- It’s one thing if airlines had this narrative while also retiring older aircraft and shrinking, but United is still going full steam ahead with adding aircraft, and for that matter, airlines want a big fleet for peak season
Are airline executives acknowledging a new reality?
As I always say, I don’t envy the jobs of airline executives. The airline industry is so essential to the world (people love travel, it’s vital for economies, etc.), and it’s also an industry of passion… but my gosh, it’s a really bad business.
Under the best of circumstances, it’s low margin. But it’s also highly cyclical, with high fixed costs, the inability to easily adjust capacity, and that doesn’t even account for all the outside factors that can impact the demand for air travel.
At the end of the day, airline CEOs work for Wall Street. Even the best run airlines aren’t actually good long term investments. But of course airline executives always have to sell the dream that the only way the industry is going is up, and that the problem is that Wall Street just doesn’t understand airlines.
If you ask me, this overcapacity claim comes down to a couple main points:
- Airline executives are realizing that growth is slowing down, so they can no longer sell the dream that business travel will be back to 100% of pre-pandemic levels shortly, or that Asia demand will soon recover to pre-pandemic levels
- Airline executives are having to deal with the harsh reality that their new labor contracts are really costly, and those are costs that can’t easily be adjusted down, short of a bankruptcy filing
No CEO wants to say during an earnings call “well, last year was good because everyone was still ramping up, but just realistically I don’t think we’re going to see that again, because this is a crappy industry.” So instead, I think the current narrative is just that capacity cuts will help with the current situation, but I’m not convinced.
You have far too many airlines that are desperate to stay afloat, and which will gladly undercut the legacies. So while the legacies might think their 10% margin isn’t good enough, there are airlines with -10% margins that would be happy if they could improve that to breakeven.
So call me an optimistic (or pessimist, depending on how you look at it), but I don’t think we’re suddenly going to see airfare increase significantly, given how competitive the industry is. Instead, I think airline CEOs will have to find a new way to explain that margins just aren’t great… this is the airline industry, after all!
Bottom line
Currently we’re hearing several airline executives talk about how the industry is dealing with overcapacity. They seem to define overcapacity as no longer being able to achieve 2023 yields. But that seems unrealistic to me, since 2023 was a one-of-a-kind year in terms of strong demand, combined with airlines ramping up operations.
As much as some airlines might try to reduce capacity, I don’t think they’ll be able to meaningfully increase fares, given how many airlines are fighting to stay alive. I think some people are just coming to terms with the long term implications of the new cost structure in the industry, and how those costs can’t fully be passed on to consumers, given the competitive landscape.
What do you make of this airline industry overcapacity narrative, and how do you see this playing out?
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