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Airlines from the busiest markets in the world have stated that there was too much capacity on the market, but that masks a bigger problem – bad for investors and flyers alike. 


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Airlines Are Repeating The Same Matra – Too Much Capacity

Over the last couple of months, airlines in the busiest markets in the world have revised their earnings projections mid-quarter to reflect “too much capacity” on the market. In essence, revenge travel coupled with inflated prices kept going, and growing well after most economists suspected it would end. Some quarter, which appears to have been Q2 2024, it had too be too much and it was.

There’s no sin in trying to capture all of the available market, and no one knows the future. But what does too much capacity really mean? It’s another way of saying, not enough customers. Kind of. As this site pointed out in prior weeks, the US (the busiest air market in the world) has set several records in the second quarter and early into the third quarter for passengers passing through US security checkpoints. Adding more capacity allows both record passenger numbers and excess seats at the same time. That’s easy to fix as long as that’s the case. But what happens if excess capacity isn’t the reason for the decline?

The carriers are in lockstep on the capacity note, but that doesn’t mean they are telling the full story.

The Problem With The Capacity Theory

If there’s too much capacity on the market the solution is simple and quick. Reducing capacity is not an impossible market force. The easiest way to start is by reducing frequencies between hubs and major leisure routes. Then we move on to downguaging aircraft from 737-900s down to 737-800s or 700s, from A321s down to A320s or A319s, from 777s to 767s – all of these subject to the range limitations of the aircraft.

It’s true that airlines can’t take flights entirely off the schedule in some cases where they’ve sold tickets for the future and offer limited frequency, but correcting a small capacity problem in the range of 5-6% as most carriers have indicated, is far from impossible.

That’s where this excuse falls apart.

The explanation in board rooms with investors could be, “everyone in the industry kept the growth streak going and we didn’t want to be left with full planes and unrealized potential. Everyone found out the market limit in the same quarter at the same time and we have dialed back our capacity growth measures to align with the market.”

Excess capacity can be overcome by reducing that capacity or by lowering prices to drive demand (unless your Scott Kirby and don’t believe in elastic demand.) There’s no reason to forecast anything besides a gentle recovery in Q3. But airlines haven’t been doing that. Lufthansa, for example, has gone from matching last year’s €2+bn in profit to looking at breaking even.

Shareholders Will Lose

Having too much capacity is the same as having not enough customers. The problem is they both look the same right now. If a restaurant adds a bunch of seats to the patio and buys too much food, it will take a loss and can pull the chairs back off the patio. But that’s a different problem to solve than fewer customers coming through the doors. They have different remedies.

Shareholders lose when management isn’t honest about the problems it faces. It’s clear the consumer wind is turning, if not (nearly) every airline would have revised down its earnings for the quarter, not the year. Lufthansa was on pace to match earnings from last year, around €2.2bn, now it hopes to break even for the year.

“Lufthansa Group lowered its outlook for the year, saying that its flagship carrier is struggling to break even. It cited negative market trends and aircraft delivery delays for the shift.

The company, which also includes Austrian Airlines, Brussels Airlines, Eurowings and Swiss, expects its adjusted earnings before interest to fall in the range of €1.4 to €1.8 billion ($1.52 billion to $1.96 billion), down from its previous guidance of €2.2 billion ($2.4 billion).” – Skift

There are too many solutions for 5% excess capacity that don’t involve that level of revision. JetBlue is offering LOAs to staff members (voluntary “Leave of Absence”) and has cut its schedule by 10%. It appears to be taking the “capacity” issues much more seriously.

Consumers Are Not Inelastic

The biggest issue with not calling this what it is – an economic slowdown in discretionary spending – is what it will lead travel suppliers to do. While some carriers have reported price deterioration, others will claim that’s not necessary. Afterall it was simply an over exuberance in supply, not a shift in consumer appetite.

That means the goal will be to keep prices elevated. United Airlines CEO Scott Kirby all but said this as Matthew pointed out. Kirby learned that consumer demand was inelastic, that dropping prices won’t move the needle, and if that’s the case, why do it? Matthew and I agree that this is absurdity at its finest. He gave an example of opting for a virtual meeting rather than paying $1,400 for a domestic first class seat from LAX to Pittsburgh. I remember taking mileage runs to Hong Kong in business class for not much more than that just a few short years ago.

And that’s the point.

I have no plans of going to Barcelona next week, but if I found roundtrip deals in business class for $1,200 my family and I are clearing our schedules and packing our bags. At $5,000 per person, it’s a hard pass. The same goes for my business trips. If it’s crucial to my business, yes, Kirby is right, that specific business demand is inelastic. But the pandemic forced every professional to use video conferencing software and it’s a far easier and cheaper crutch than choosing to spend exorbinant sums for trips that aren’t truly imperative.

That all seems logical, but what does proving consumers are price sensitive and that demand is elastic have to do with any of the rest of this?

By blaming the issue of filling seats solely on too many seats on the market it solves for the wrong problem. The way to solve that is to remove the seats from the market. But that means that the current nosebleed prices remain.

That’s bad for consumers in the short term and the long term.

If airlines are less likely to adjust prices to meet demand and rather adjust supply instead, I fear it could leave travel out of reach for some just when we’ve experienced peak travelers. It means that airlines may be more likely to reduce service and options than compete on price and carry more passengers and that’s not an exciting future for avid flyers.

Conclusion

Airlines are all giving the same answer: too much market capacity. But the forward reaction to earnings across the board tells another story. They see lower demand beyond the capacity fixes they can make but refuse to call it anything other than a capacity concern. It seems to suggest that while some have mentioned the market “softening”, they may be intent on holding prices higher for longer and making cuts to fares more shallow than in the past. This will result in fewer choices going forward for more money.

If management truly doesn’t see the writing on the wall, responses will be worse than higher prices. In a business with razor thin margins that could mean that newly inked deals for flight attendants and pilots could see more LOAs or worse.

What do you think?

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