United Airlines has a bit of a mess on its hands, and there’s a simple economic reason as to why.
The airline is in hot water after a passenger was dragged from a United Airlines flight for refusing to give up his seat.
United’s stock has fallen on Tuesday after a video of the incident caused an uproar on social media.
While the incident may seem like a perfect storm of social media outrage and empathetic understanding after a customer service disaster (not to mention some follow-up public relations missteps from United and its executives), Bespoke Investment Group laid out the simple economic case for why the incident occurred — and why it could happen again.
In a note on Tuesday, Bespoke said that the incident is an example of “what can happen when productive capacity is met in any industry.” Essentially, despite an ever-increasing demand for air travel, the industry has only expanded its supply of planes slowly in order to maintain a low number of unused or empty seats.
This mismatch of supply and demand has ended up with crowded, even overbooked flights, but also makes business sense for the airlines to continue.
Let’s break that down.
First off, it is clear that even as airlines have increased the amount of flights being offered, the demand has been rising to meet that supply.
Bespoke pointed out that the total number of available airline miles have surged since 2008, while capacity — basically how full the flights are — has remained steady. This indicates, at the minimum, sufficient demand for the increased air miles.
“Scheduled airline seat miles have been rising steadily since 2014, while load factors (basically, the percentage of seats filled) have been steady near 85% for domestic flights,” said the note.
Put another way airlines have been increasing the number of flights they offer but how full those planes are has stayed at an elevated level. Even more simply: flights are crowded.
In turn, simple economics would indicate that higher demand than there is supply would lead to an increase in prices. This is also borne out in the data according to Bespoke.
“The cost of air travel plunged for almost 30 years as the industry was de-regulated and competition reduced prices,” said the note. “Since the post-9/11 airline industry restructuring, however, air travel’s prices have risen faster than inflation as flights have operated at higher capacity.”
Basically, instead of increasing the supply of flights and plane seats, the industry has increased prices.
The increased demand despite higher prices means that airlines are struggling to accommodate passengers and flights are crowded.
The solution? More planes. If you have more seats and more planes with the same number of airline miles flown then you can spread out fliers and alleviate overbooking.
Instead of following through with more capital spending to meet this demand, Bespoke said the industry has been skimping on substantial capital expenditures for years.
“In the early 2010s airlines were spending less than 5% of revenue on capex,” said the note. “While that figure has been rising, it would need to rise quite a bit more to expand capacity inline with demand for airline travel in the US.”
To reduce the overcrowding and overbooking issues on flights that led to the United incident, the airline industry’s capex would have to outrun demand. This would ease the capacity burden and give more breathing room for passengers.
Unfortunately, a high capacity is generally more profitable for airlines — flying from New York to Los Angeles still uses the same amount of fuel no matter how many seats are filled. Thus, the more seats that are filled, the better it is for the companies.
The worry for airlines is that they could commit to a massive increase in capex, and that a recession would hit or demand would drop for some other reason.
So instead of getting ahead of the problem, airlines waited for new demand before responding with new planes. Thus, it is unlikely that the overbooking issue will be alleviated anytime soon.
“In other words: crowded flights and occasional conflict over seats is likely here to stay,” concluded Bespoke. “Bad for travellers, but good for the airlines.”
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