Most of my experience of the travel industry is as a consumer not a provider :-) but here goes!
Most over booking happens because the TOs know that not everybody who's booked will actually travel in the end. So they take more bookings than beds/rooms in the expectation that as usual they will have a certain % of cancellations. This enables them to keep their prices low because it reduces the chances of them having unfilled seats on the planes and empty hotel rooms they still have to pay for. But sometimes they get their sums wrong or the pesky customers don't cancel in the same numbers as in previous years. Hence why some people get bumped from their chosen holiday at the last minute.
Common sense would suggest that this should be done on the basis that those who booked earliest will be the last to be bumped but this doesn't always happen. A friend who is an industry insider has hinted to me that this is because those who book earliest are also those who are most likely to cancel - the longer the booking has been sitting on their books the greater the chance that someone's circumstances will change and they'll have to cancel. Whereas the people who only booked last week to go in a fortnight are statistically much more likely to actually go on the holiday as booked. But I doubt that most TOs will ever admit to this because it helps them with their forward projections so much more if we can all be enticed into booking and paying our deposits 12 months in advance.
The other reason that over booking happens is because the hotel withdraws/reduces the rooms they are prepared to hold on reserve for that particular TO. This could be because eg the TO has consistently not filled all its room allocation and the hotel has been left with rooms on its hands. Even if the TO still pays for the room it still represents a loss to the hotel because those phantom guests won't be spending in the bar etc either. So paradoxically, those TO who prefer to be cautious and not overbook but absorb the cost of paying for rooms they might not fill might still end up being 'overbooked' because the hotel insists on re-negotiating the contract and sells the rooms they usually expect to be left with on their hands to another operator or to DIYers.
Or it could happen because the TO is late in paying their bills and/or still owes the hotel money. Non-payment of previous bills generally gives them the right to unilaterally cancel any contract they might have with a TO and 'overbooking' for this reason can send alarm bells through the whole industry and is often a pre-cursor to a TO collapsing.
The third reason I am aware of is that the hotel isn't overbooked at all but the TO has started to receive a higher than usual number of complaints about that hotel and decides to play safe with trying to persuade guests to go somewhere else. If they can offer you a comparable holiday that you accept then they don't have to pay any compensation to you but they they run the risk of having to pay out refunds and/or compensation if they continue to send people to a sub-standard hotel that generates lots of complaints. Rather than waiting until you arrive in the resort and demand that you be moved to alternative accommodation, they'll try and head off the problem by doing the re-allocation before you even arrive. But of course few TOs are ever going to admit that to you either!
In many ways, all of the above arise because the TOs are trying to maximise revenue whilst at the same time keeping their prices down so that they are cheaper than their competitors and so that you book with them rather than another TO. It's an almost inevitable consequence of the mass package tourism business and it's why I rarely book a package more than 3 months in advance (but then I accept that I have a lot more flexibility than those with young children) and even then prefer to deal with smaller specialist TOs where I get to deal with someone individually. It's a lot harder to treat someone who's struck up some sort of personal relationship with you than it is with a largely anonymous customer who gets directed to you by the luck of the draw of the call centre.
So these days the bulk of my holidays are booked on the basis of using small lettings agencies that give personal service and booking my flights through my small local independent TA unless I can get a really cheap deal with one of the lo-co outfits. Even when using hotels I similarly try and go DIY and deal direct with the hotel - again in my experience those who book direct are less likely to be bumped by the hotel because they want to get your repeat business if they can as well as future word-of-mouth recommendations from you. I mightn't always get the cheapest deal this way but I will have dealt with and got to know a real person who in my experience will care more about whether I have a good holiday or not than some benighted person working from a script for one of the big boys.
SM
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