Overview - Southwest Airlines

Southwest – still the leader, but looking at future less certain

“Better quality + lesser price = value + spiritual attitude of our employees = unbeatable.” Herb Kelleher on Southwest Airlines’ success formula

Southwest Airlines remains the standard bearer for the LCC world. It continues to record unbroken quarters of profitability, even as the rest of the industry looks at red ink. Even as heir apparent JetBlue has run into problems and started selling aircraft and deferring orders for others, Southwest keeps churning out positive results and accelerating orders and activating options.

As Southwest is so often used as the “model” for new startups – even many which resemble it in little more than calling themselves low cost and charging low fares until they go bankrupt – this is a good place to address some of the fundamentals which made Southwest so different from its predecessors. Many of the features seem obvious today, especially with the benefit of hindsight and many variants on the theme.

Perhaps what is most interesting about Southwest is that it was not really “discovered” as a desirable model in the US until after September 2001, when legacy carriers began to deal seriously with the prospect of long term lower yields which exceeded their entrenched costs.

But Southwest too is evolving in ways which its originators would have found heretical in the early days. Now it is one of the largest airlines in the US and is increasingly coming up against imitators that are smart, aggressive and well funded. Southwest has had a dream run through a recent period of high fuel costs thanks to its hedging strategy. But those hedge positions are diminishing in scale and will by 2009 be over entirely. This situation coupled with the carrier’s growth rate – it firmed up options for 79 B737s, adding them to existing orders and its current 452-strong fleet – puts the carrier in a dominant position it has not been accustomed to.

Some of the key ingredients of the Southwest success (and yardsticks to measure how the model is changing):

• Innovative labour agreements leading to high productivity. Productivity was traditionally higher than elsewhere, with pilots flying an average of 70-75 hours a month compared with 40-50 hours then or conventional operators. A landmark 1994 10-year agreement with pilots provided stock options in place of wage increases. Pilots taking up the offer benefited from the growth in share value. Each original pilot would now hold stock worth around USD1 million. Southwest also reinforced the loyalty of its pilots by maintaining schedules and not furloughing any of them following September 11 (unlike most other publicly-listed US carriers)

• Minimal distribution costs. Southwest was one of the first to focus on reducing distribution costs, for example using reservation centres to avoid agency costs, and was an early uptaker of the internet as a direct selling option.

• Operation of a uniform aircraft type. Southwest flies only a single type, B737 series aircraft equipped with GE engines. This reduces maintenance costs, allows for lower spare parts inventory and minimises training costs.

• Emphasis on aircraft ownership. Southwest owned or holds on capital leases three quarters of its fleet, with the remainder on operating leases. While this imposes a burden in debt-related areas, it builds a saleable asset base for the airline and reduces the drain on its operating cash flow.

• Use of a ticketless booking system. Southwest was one of the first operators to eliminate paper boarding passes, instead providing plastic, reusable passes to passengers.

• Outsourcing benefits. Southwest was an early aggressive user of external contractors to provide component maintenance, engine support and management of office materials. These arrangements generated direct savings and ensured tight control over inventory (eg flight equipment expendable parts, materials and supplies). Southwest consolidated engine repair work for its B737-300s and -500s with GE Engines under a long-term contract which expires this year. GE is paid on a rate per flight hour basis under terms which substantially reduce maintenance overheads but maintain aircraft reliability. The airline also has outsourced the management of office and industrial product supplies, so that all materials are sourced through one supplier for delivery to all cities in the Southwest network.

• No frills on-board service. Southwest pioneered the “no frills” single class service, serving only peanuts, snacks and beverages.

• High aircraft utilisation. In a US environment which increasingly focussed on hub operations after deregulation, most airlines concentrated on hub connections rather than increasing utilisation. Southwest achieved an average of eight sectors a day per aircraft, and a daily utilisation rate of 11-12 hours, then about 3-4 hours more than its full service competitors. This was partly achieved through focus on high frequency, short-haul, point-to-point routes between high density destinations.

• The growing competition, from revitalised post-Chapter 11 legacy airlines and focused low cost carriers, has led Southwest to enter markets it normally would have avoided, for reasons of congestion, high operating costs or presence of entrenched carrier, and sometimes all three. Hence its recent moves into Philadelphia and Denver.

Outlook – more uncertain than ever before, but it’s still Southwest…

But things are changing. One inherent characteristic of Southwest has been its long term leader and inspiration, Herb Kelleher. Robert W. Baker, VP American Airlines, once said of Southwest Airlines “That place runs on Herb Kelleher's bull****.” Detractors and fans alike recognise that the “bull**** factor” was an important factor in Southwest’s progress, especially in the early days, when his bulldozer-like attitude and legal expertise combined with the model to make possible the impossible. And, even today, attracting publicity and popular support is a

Herb has now “retired”, although his succession team is well ensconsed. In any event, perhaps the days of the Kelleher-charismatic leader are gone, although Richard Branson remains, David Neeleman, with his modern sympathetic style heads major competitor JetBlue, Michael O’Leary follows a somewhat different style at Ryanair and Tony Fernandes in Asia are all natural marketers. But there’ll never be another Herb Kelleher, for sure.

With a cost advantage that will not last long and unit growth that will, Southwest needs to find new areas for revenue, even as LCC competition in the country grows more intense.

It is difficult to see how Southwest will manage these ever-mounting pressures and maintain profitability. But, if there’s one thing that LCC watchers have learned not to do, it is to bet against the carrier that perfected the original business model……

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