Forget 2019 - US Airline Capacity Should Target 2017 Instead

Most stories about airline demand talk about if or when demand levels will return to 2019 levels. This is intuitive, as 2019 was the last full year of normal airline operations and customers generally feeling comfortable about flying. But the airline version of ‘building back better’ should aim higher by going back a bit further - to 2017, to be exact.

Airline industry profitability is closely tied to airline capacity. When demand is ahead of supply, airline prices are stable and can support the industry’s high average cost of capital. This has happened a few times in the last decade, but the industry has a bad habit of growing too quickly and destabilizing the pricing environment. I worked with an executive who once said “the root of all evil in the airline industry is excess capacity.” He was right, and yet the industry continually finds itself in a prisoner’s dilemma where each company’s perceived optimal decision is to grow faster than their competitors even though total industry profits end up suffering as a result.

Consider what happened in the US Airline industry between 2017 and 2019 using data from Airlines for America:

2017 2019 Difference

Capacity (ASMs) 1.15T 1.25T 8.7%

All-in Average Price $378 $367 (2.9)%

This capacity increase came during a time when domestic GDP was also growing at a high rate, and many airlines consider their capacity and revenue forecasts as a function of GDP. So while this may be rationalized by some, clearly the industry lost pricing power as the average fare dropped by 3%. Labor costs did not go down, airplanes did not get cheaper, and average oil prices rose 11% over these two years. So what happened to industry profitability? :

2017 2019 Difference

US Airlines Net Profit: $15.5B $4.6B (70.3)%

Without even maintaining pricing from 2017 but realizing cost increases the industry saw a 70% drop in profits during these two years. So why is everyone so eager to return demand and capacity to 2019 levels? Putting that many seats back into the air chasing uncertain demand would be suboptimal for sure. Airlines are managing capacity now for flights that will generate positive cash flow, and this is a lower hurdle than net profitability but the right metric for today. As airlines think about capital deployment and what “being smaller for a while” means, 2017 provides a good high water mark for when the industry was better balanced between supply and demand. It’s unclear when demand will reach this point, and at what price, but talking about “getting demand back to 2019” should stop as this has likely negative effects on airline capacity.

Some may try to blame the faster growth of low-cost carriers for the industry’s capacity issues. This argument is false, however, as over 80% of the industry capacity is driven by the four huge US airlines: American, Delta, Southwest, and United. The industry cannot maintain any kind of capacity discipline unless these four choose to let that happen. Correspondingly the 20% left, all lower cost than the big four, can’t grow fast enough to mess things up for everyone. If the big four airlines grow by 5% in a year, that’s the same amount of aircraft as if the next five largest airlines grow by over 21%. In an efficient market, more efficient capital replaces less efficient capital over time too, so the lower-cost carriers should be growing at a faster rate. Trying to address industry capacity without the big four is like trying to address the national budget without including transfer payments and the military.

The airline industry is in a period of unprecedented change. Customer confidence that flying is safe and that the biological risks can be properly managed has not happened yet. There is no capacity or demand level that makes the industry profitable again until this happens. As airlines manage for cash flow and think about how their fleet plans should change given the uncertainties of future demand, bringing a clear target into focus will be helpful. That target should be the $15.5B profit year of 2017, and all-in prices approaching $400 per person. The industry is far from this today of course, but aiming toward a lesser goal will just put the industry back into its excess capacity spiral.