Airline Capacity and Price-Setting

How did you change the average ticket price, post-2008 or post-9/11?

What happens is, the pricing is directly related to capacity, in the airline industry. One of the crazy economics about the airline industry is that they have very high average costs. Airplanes are expensive, people are expensive, fuel is expensive, even though it’s less expensive today, but it’s still expensive. Airports are expensive. But the marginal cost is very, very low. If a flight is leaving this afternoon and there’s empty seats, the cost to put you in that seat, versus have it empty, costs me almost nothing. Literally, pennies. If anyone is taking an Economics 101, microeconomics class, you know that in a competitive market, the price drives to marginal cost. Capacity tends to drive pricing in the industry, and so the industry prices to fill its airplanes.

After 2008 and after 9/11, what happened is, it was the rate of capacity coming back, that determined when the airlines could, effectively, charge the rate again. In 9/11, it was easier in a sense. What happened after 9/11 was that it was such a dramatic shock to the system, that the industry reset its capacity. They got rid of airplanes, they retired airplanes that were older. They changed future order books and the industry was physically smaller, for a while. That allowed them to price reasonably, as the volume came back, because they weren’t trying to fill up all these empty seats.

In 2008, it took longer, because not a lot of capacity came back. The volume came back quickly, but it took longer to get the rate back. The rate wasn’t really back till, probably, about 2011/2012. It was a good year or two after the volume was back.

In this case, I think the reason I’m thinking it’s a U U, is because, right now, as we’re recording this, the industry’s capacity is, effectively, like your car idling in the garage, waiting to go out. All the workers are there. All the planes are there. They’re ready to launch all these planes again. Airlines have talked about that, taking on new deliveries this year, and they deferred deliveries that are coming in 2020, because why would you want to take delivery of a new airplane, when most of your fleet is on the ground, anyway? But in terms of the planes that were flying before Covid, they’re all there. There haven’t been returned airlines, there haven’t been big retirements, yet. If demand starts to return, say, by the end of this year, the industry is likely to quickly put capacity back in place, to start getting use of those employees that they’re paying or, in the US, that the government is paying for, until September, at least.

I think what’s going to happen is, I think the industry is going to bring back too much capacity, too quickly and that’s why the prices are going to stay low for a while. That’s great for consumers. Not necessarily great for the margins of the business. So I think the industry is going to have to buy back the traffic first, to get the volume, then spend some time letting demand catch up to the capacity, or trimming the capacity as needed, to get the rate up.