Overcapacity Excuse (and others, too)
If a dinosaur airline
executive claims the sun is shining, you better bring an
it be due to stupidity or dishonesty, the latest excuse for
the dinosaur airlines' financial disaster fails to stand up
to a factual examination.
The dinosaur airlines have a
new excuse to explain away their financial failures - the market
is suffering from 'overcapacity' - or so they'd have us believe.
This excuse is just that.
A weak excuse and one which fails to hold up when confronted by
Spare no tears for the
dinosaurs. They're either too stupid to understand - or
too dishonest to admit - the real reason for their failures.
Let's hear the excuse first
Most of the dinosaurs have
been referring to excess capacity in recent months as a major
contributing reason for their losses. Indeed, their chorus
of claims has sufficed to fool some of the more gullible
journalists and analysts into accepting what they say at face
value and repeating their claims as if they are established
Here are three recent
In announcing his airline's
filing for Chapter 11 two weeks ago, ATA Chairman, President,
CEO and 69% shareholder in the company (wow, what a busy guy; he
probably spends much of every day having business meetings with
himself, but I wonder how he balances his conflicting duties to
the company, to himself, and to the other 31% of shareholders)
George Mikelsons said
extremely high fuel prices, which continue to escalate, and
declining fares have necessitated that all airlines,
including ATA, re-examine their business
At the same time America
West's Chairman and CEO, Doug Parker, said
We are disappointed to
see our string of profitable quarters come to an end. These
results are driven by an extraordinary increase in fuel
prices and excess industry domestic capacity
United's CEO, Glen Tilton,
also used the excuse last week to explain away his airline's
dismal third quarter loss, by saying
Excess capacity has led
to the lowest fares in more than a decade
What is Excess Capacity?
Excess capacity simply
refers to a situation where there is too much of something
compared to the demand for it.
For example, if an
electrical supply utility can supply 150 MW of electricity, and
its customers only need 125 MW, then it has excess capacity (of
In the case of an airline,
excess capacity occurs when there are more seats available on
flights between two cities than there is passenger demand.
For example, perhaps there are 1500 seats a day on flights
between Des Moines and Omaha, but perhaps, on average, only 1200
people a day fly between these cities.
On the face of it, with the
example above, it might seem that there are 300 seats a day of
excess capacity on this route.
But the situation is not
that simple. There are (at least) two other factors to
Elasticity of Demand
The first factor is what
economists and marketers refer to as elasticity of demand.
If the average price of a ticket for a flight between the two
cities in the example above is $150, then we see a matching
demand for 1200 seats. But if the price drops to $100,
perhaps the demand might then increase to 1500 seats, or even
1800 seats. So the actual underlying demand, against which
capacity must be measured, is not a constant. It varies
tremendously based on price.
It is not uncommon to see
the amount of travel more than double when a discount airline
starts offering low fares on a route. Although dinosaur
airlines have long pretended that demand - particularly for
their most expensive fares - is close to constant (ie inelastic)
the demonstrated reality contradicts this belief/hope.
A low cost carrier might be
delighted to sell tickets at $100 each, whereas a high cost
dinosaur might find that this price is below the average price
they need to exceed to cover their costs.
It is undesirable and almost
impossible for an airline to fly its routes with 100% full
flights. This would be possible if people bought airline
tickets one by one; flight by flight. But people don't do
this. The airlines themselves force their passengers to
buy tickets itinerary by itinerary, in complete roundtrip
A typical roundtrip often
has four or more flights in it. If you are flying from
home, through a hub, to your destination, then from your
destination, back through the hub, and home, there are four
flights. More complicated itineraries may have six or
eight or more flights in them.
The interesting challenge
becomes that if any one of the flights you're booking is full,
your entire itinerary collapses, because (and again due to the
airline rules) you can't mix and match flights on different
airlines to build your complete itinerary. If you can get
three flights on Delta, but the fourth flight is only available
on United, you're either going to change all your flights to fit
a different itinerary on DL or UA or perhaps a totally different
airline. What this means is that one single full flight
has 'cost' the airline in question sales of seats on three other
Nearly full flights make fares
This operational issue gets
even more subtle. Because airline pricing varies roughly
based on how full flights are, a nearly full flight on one
sector of a four flight itinerary, while still having available
seats, might force up the total ticket price by an extra $100 or
$200. Remember the elasticity of demand? That means
that many people will either choose different flights, or a
different airline, or just give up on their hoped for travel
entirely and wait for a later time. In this case, a nearly
full flight on one sector cost the airline the loss of all four
As a quick rule of thumb,
once an airline starts averaging higher than 70% loads, it is
starting to lose business. It is getting in to a region of
vanishing returns. This is the reason why most airlines
historically try and budget for a break even load factor
somewhere in the 60%-70% range, because they know it gets very
hard to achieve loads much above 70%.
Difficult is not the same as
impossible, and some dinosaurs have been enjoying load factors
in the upper 70s during the last year or so.
Unfortunately, their cost models have moved so far from where
they should be (for a while United had to average above a 100%
load factor just to break even - an impossible circumstance
unless you had people standing in the aisles on their flights!)
and so loads which should normally have caused the airlines to
be massively profitable have instead barely staunched the flood
of red ink pouring onto their balance sheets.
Excess Capacity Summarised
To summarize the 750 (!)
words above into 100 words below :
Excess capacity is not the
percentage gap between how full an airline's flights are and
100%. Maximum capacity is a vague inexact number, but
less than 100%. Any time a typical hub and spoke
airline is flying with loads averaging much above 70%, they
are beating the odds and their loads are operationally
Market demand is not a
constant nor is it an exact number. The market demand
for seats increases or diminishes based on price and
schedule convenience. Therefore, neither is any
measure of capacity a fixed or exact number either.
Excess Capacity Rebuttal
The simple fact is that most
airlines are enjoying passenger load factors way above typical
historical percentages, and very close to the maximum levels
that can operationally be supported. When was the last
time you flew on a three quarters empty plane?
Not only are planes being
flown with more passengers than almost ever before, passenger
numbers in total are also increasing. The LA Times says
2004 will be the US travel industry's best year since 9/11, with
domestic travel spending totaling $592.6 billion, a 6.9%
increase on last year.
The International Air
Transport Association is similarly optimistic. International air
passenger traffic is up 17.7% in the first nine months of this
year compared to last year, and cargo traffic is up 14.1%. IATA
says that North American traffic is up 16.6%.
And as for actual planes and
flights, flight numbers are only now returning back to pre 9/11
So, by all measures - more
passengers than ever before, no more flights than back when the
airlines were making huge profits with the same or fewer flights
and the same or fewer passengers, and a greater percentage of
seats sold on every flight - there is no tangible confirmation
of what the airline industry is claiming.
Let's look at some specifics
American Airlines -
the world's largest carrier, and so a fair measure of
capacity issues - reported its October traffic on
Tuesday 2 November.
For October 2004 AA
reported the highest ever October load factor in the
company's history - 74.9%. And, as further proof of the
nonsense beneath the excess capacity excuse, the
company's second highest October factor was in October
last year (70.2%). There was not excess capacity a year
ago, and there doubly is not excess capacity today.
only did passenger numbers grow, but at the same time,
AA reduced its domestic capacity by 2.6%.
In total, AA boarded
7.5 million passengers in October.
Last week America
West announced their October traffic data. Revenue
passenger miles were at an all time record high, and
11.7% up on last year. And their load factor was also
up, both for the month (a new record of 79.4%) and for
year to date.
Executive VP Scott
Kirby had obviously not been clued in to the new excuse,
because he said 'We are pleased to report our fourth
consecutive month of record load factors'.
So how do four
months of record load factors (ie fewer than normal
empty seats) equate to excess capacity?
Delta's October load
factor increased to 74.1% in October, up from 72.9% the
year before, with an 8.3% growth in system traffic and a
smaller 6.5% increase in capacity.
Even floundering US
Airways, laboring under the negative of its second
Chapter 11, reported that its October load factor of
75.6% was the highest October load in its entire
If there is so much
overcapacity in the industry, how to explain
ultra-successful Southwest Airlines' plan to add 34 new
planes to its fleet in 2005?
isn't worried about overcapacity - quite the opposite -
it sees opportunities for further growth and expansion!
Even a dinosaur such
as Northwest is adding capacity next year. It is
recalling 200 furloughed pilots in the first half of
2005 due to a forecasted increase in flight activity,
and has also added ten new Airbus A330s to its fleet in
2004, with plans to add seven more Airbus planes in
Surely NW wouldn't
be doing this if it believed the marketplace already had
too much capacity?
is significant because Southwest is a mature and
profitable airline, and so its growth broadly reflects a
credible opinion of growing market opportunities by an
established airline. And NW's growth shows that
dinosaurs too believe they need to add more capacity.
In addition, startup
carriers are also continuing to add more planes.
In total, for the
three years through 2008, low cost airlines have either
ordered or placed on option 550 new planes. That
is about the same number of planes as United operates in
Whether this shows
there is a current shortage of capacity, or whether it
indicates that there might be an overcapacity - but in
the future, not in the recent past - is a matter for
Updated statistics for entire
The Bureau of Transportation
Statistics has now released (Mar 05) data for the entire 2004
year. Total revenue passenger miles increased 9.9% in
2004, while available seat miles increased by only 7.3%, meaning
that average load factors increased 1.8%. Too much
capacity? Nope. Flights are more full now than a
year and more ago.
So What is the Problem?
Two things - quite possibly
related - happened at the end of the 20th century.
Businesses and individuals
realized that it made no sense to pay millions and sometimes
billions of dollars for dot com lunacies. Dot com ventures
with no hope of ever achieving a profit, and no real strategy
other than to hyper inflate an idea and then sell it on via IPO
or buy-out found their cash sources dry up, and the ridiculous
stock prices on chronic loss making companies collapsed down
closer to the zero level where they should always have been.
Common sense proved
contagious. Businesses and individuals also realized it
made no sense to pay $1000+ to fly somewhere at short
notice, when the alternative was to pay vastly less on an
advance purchase ticket with a discount airline, or just not to
fly at all. This common sense flowed through to prospects
and customers, who also stopped expecting people to drop
everything and fly instantly to meet them, no matter what the
The Big Thing that is/was Not
9/11 had little or nothing
to do with either of these developments. The dot com
bubble was already bursting in 2000, and airlines were painfully
transitioning from being massive profit earners to finding
themselves once more in familiar financial problems before
How the Airlines Responded to
As recently as 2002,
dinosaur airline executives could still be found proudly
proclaiming that their customers would happily pay as much as a
30% premium to fly on their airline. Two realities were
overlooked in these bold statements - often times, the extra
cost was much more than 30%; and, no matter what the cost
differential, many customers were demonstrably no longer willing
to pay a premium at all.
At the same time, the
dinosaur airlines weakened their so-called premium services.
They cut every corner and cost they could to cheapen their first
class, as well as of course accelerating the decline of their
regular coach class product, making the difference between their
service and those of competing new airlines less and less real.
Meanwhile, new startups like
JetBlue were actually providing superior service and comfort,
and at measurably lower cost, than the dinosaurs. Many
passengers who had formerly been key dinosaur airline frequent
business travelers abandoned the dinosaurs and switched to the
lower cost and similar or often better service on new airlines.
The dinosaurs found that
their market had changed two ways while they were not paying
attention. First, the small discount airlines had become
big - and in some cases too big to painlessly squash. And,
secondly, the dinosaurs themselves had been so weakened by the
drop in revenues that they could no longer afford to lose the
hundreds of millions of dollars a fare war would cost them if
they did choose to try and force the new carriers out of
The Emperor's New Clothes - Air
Air fares have always been a
carefully maintained illusion. It doesn't directly cost
much more than one tenth of any fare (even the lowest) to fly a
person on their itinerary.
As long as the airlines all
said with one voice 'the cost for this ticket is $1000' and as
long as no passengers chose to question that statement, the
illusion was maintained and protected - just like the fable of
the emperor's new clothes.
But when on the one hand you
have new upstart airlines saying things like 'no-one should ever
have to pay more than $299 for any fare, ever' (Southwest
Airlines said this when capping all their fares at a maximum of
$299 one way in August 2002), and when on the other hand, you
have passengers saying 'it doesn't make sense to pay $1000 and I
neither need to nor want to' then the illusion collapses.
And that is exactly what
People are no longer willing
to pay overly inflated ridiculous fares for basic bare bones
utilitarian travel on dinosaur airlines.
The new discount airlines
have reached a critical mass in the marketplace where their
fares are now influential in setting the public's perception
about what all fares should be.
The major airlines have had
to drop and drop and drop still further their airfares to
the point where their impossibly inefficient structures can
no longer be supported by the reduced income being
The dinosaur airlines are
saying their low prices are due to over-capacity. Wrong.
Their low prices are due to the public not being willing to pay
ridiculously high prices any more.
Neither Labor nor Fuel is the
Let's look a bit further.
The other two common excuses recently offered by dinosaurs to
explain their losses are high fuel costs and high labor costs.
Are these any more real?
Some interesting insight was
exposed in the second US Airways bankruptcy filing in mid
September this year. In their filing, they disclosed that
their overall operating cost per available seat mile,
excluding fuel, in the first half of 2004 was 10c a mile.
Compare this to a former
dinosaur that transformed itself - America West. They paid 7.3c
a mile. JetBlue pays 6.4c and Southwest pays 5.7c.
What does this tell us?
It clearly shows that even after ignoring fuel costs, a dinosaur
airline such as US Airways (admittedly one of the worst) has way
higher costs than more successful airlines.
Now, let's continue the
exercise and take out the labor costs. This shows US
Airways had a cost, excluding fuel and excluding labor of
5.8c a mile. America West's cost is 4.7c, JetBlue is 3.8c
and Southwest is 2.7c.
Two conclusions :
First, if everyone at US
Airways worked for free, the airline's operating costs are
still higher than what Southwest pays, including Southwest
paying full labor costs!!!
Second, if we exclude labor
and fuel from all four airlines, and look at the remaining
costs - which in a grossly oversimplified manner can be
considered to partially represent how well the airline is
managed, US' costs are 23% higher than America West, 53%
higher than JetBlue, and more than double the costs at
Southwest, its new head to head competitor.
What does that leave as
possible explanation for this amazing discrepancy? There
are a number of factors, but they all fall under one umbrella
statement - bad management.
Do you now see why the
unions are reluctant to give still more money back to their
employers? No amount of giving back is going to solve US
Airways' problems. Labor costs are admittedly high, but
the other costs are higher, both in absolute dollar terms and in
percentage terms, than those at Southwest.
As long as management blames
over capacity, high fuel and high labor costs, they are ignoring
a massive remaining factor and one which surely they have the most
direct control over. Themselves.
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12 Nov 2004, last update
28 Nov 2012
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