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Pushing 40, Southwest Is Still Playing the Rebel JAD MOUAWAD | The New York Times | 20 November 2010It’s halftime at Southwest Airlines’ annual Halloween party – a ritual meant to celebrate thecarrier’s exuberant employees and freewheeling culture – and Gary Kelly is feeling a bitwistful. “As long as you don’t mind being ridiculed all day,” he says of his Halloweenoutfits, “it’s part of the routine.” Nearby, Mike Van de Ven, the chief operating officer, is rolling on the floor, posing forpictures, and greeting children and parents with a wide grin in his Buzz Lightyearcostume. “This shows you how little we have to do to run the airline,” says Mr Van deVen. “The less we do, the better it runs.” Southwest doesn’t quite fly on auto-pilot, but as it prepares for its 40th birthday next year, itis flush with success. Last year, it flew 86 million passengers, more than any other airlinewithin the United States. It operates 3,200 flights a day, owns a fleet of 544 planes andserves 69 domestic cities from Seattle to Fort Lauderdale, Florida and from Lubbock,Texas to Buffalo. When rival airlines were bleeding billions of dollars, Southwest waschurning out consistent profits as a low-cost carrier – even when fuel prices soared.And in September, in its boldest corporate move since it started flying outside of Texas,Southwest announced that it would buy AirTran Airways for $1.4 billion, increasing bothits revenue and its capacity by nearly 25 % in a single stroke.Yet Southwest finds itself at a pivotal moment. Its success was built on a signature cocktailof low costs, low fares, frequent flights and a rapid expansion into new cities. But withhigh fuel prices, growth has been harder to find, and analysts have questioned whetherthe airline can sustain its singular operating style.Battered in part by Southwest’s growth, traditional airlines have restructured their operationsover the last decade – often through painful bankruptcy proceedings – and havenarrowed the gap.Through mergers and global alliances, Delta Air Lines, which acquired Northwest in 2008,and the more recently merged United Airlines and Continental are now more formidablerivals. They can offer their passengers access to cities across the United States alongwith connections to the four corners of the world – something Southwest cannot do.Newer rivals, meanwhile, often modelled after Southwest, are thriving at the other end of thespectrum. Thanks to efficient operations, lower costs and an attention to customerservice, these carriers – such as JetBlue Airways and Allegiant Airlines – are threateningSouthwest’s dominance in the low-fare trade. “Southwest’s business has become more complicated than the simple model that servedthem so well for 39 years,” says William S. Swelbar, a research engineer at theInternational Centre for Air Transportation at MIT. “They are at an inflection point. Theyare not a young and nimble corporation anymore. This is now a mature company.” No longer the fiery start-up, Southwest now has the best-paid pilots, mechanics and flightattendants in the industry. Its unit labour cost – how much it pays its employees to flyone seat for one mile – rose 22% from 2002 to 2009, while the same measure dropped34% at United, 7% at Continental, 26% at Delta and 11% at American Airlines.Southwest’s 5,600 pilots earned $171,000, on average, in 2009, or 20 to 40% more than theaverage salary for pilots who fly bigger planes at those other airlines. The flip side, saysCarl Kuwitzky, the president of the Southwest Airlines Pilots’ Association, is that thecompany expects its employees to be more productive. Since Southwest typically flies shorter routes and schedules more daily flights, pilots can flyone hour longer each day than at other airlines, he says. This efficiency becomes acrucial component to the airline’s edge. “We work very hard for our company,” says MrKuwitzky. “And we recognize that we succeed if our company is successful.” Despite labour, Southwest still has lower overall costs than its traditional rivals. In the secondquarter of 2009, Southwest’s advantage could be seen in its total costs per availableseat-mile. Those costs were 6 to 14% lower than at US Airways and American. (JetBlueand AirTran, on the other hand, have lower costs than Southwest.)Still, Wall Street remains sceptical. Southwest’s stock price, like those of most other airlines,has languished. It has dropped 18% in the last five years – a generally rough period forthe industry as oil prices surged and the economy slowed. In an investment researchnote, analysts at Morgan Stanley recently asked a provocative question: “Is Southwestbecoming a legacy airline?” “Remember what it was like before there was somebody else up there who loved you?” In an ad from the early 1970s, a Southwest “hostess” – that’s what they were called at thetime – wearing skimpy hot pants stood in the middle of a runway while a low-flying jetwhizzed by and made a simple case for the new airline: We’re affordable.Until then, air travel was largely the province of a smaller, affluent class of Americantravellers and business types. Fares, regulated by the government, were high.Then came Southwest. From its modest beginnings, linking Houston, Dallas and San Antonio,it revolutionized air travel. Since 1971, the year of Southwest’s first flight, the number of air passengers has risen fourfold.Larded with much higher costs, incumbent airlines immediately recognized the threat posedby the scrappy new competitor, which once famously offered a fifth of Chivas Regalscotch to entice customers to pay a $26 regular fare from Dallas to Houston. (That wasinstead of the discounted $13 ticket that was priced to compete with Braniff InternationalAirways, now defunct.) “It was personal,” says Ron Ricks, a Southwest senior manager who witnessed some of theairline’s early struggles to expand into new airports. “But I realize now that it wasn’treally personal for them. It was survival.” The airline also prospered by remaining relentlessly focused on low fares. “Southwest had avery profound impact on the industry,” says Robert Crandall, who led American Airlines inthe 1980s and ’90s. “They disproved the notion that customers preferred service to lowprices. And to their credit, they have sustained that.” In the two decades after airline deregulation in 1978, Southwest developed a “cookie cutter” method of moving into a new city, sharply cutting fares and driving up traffic, says MrRicks. “We are so consistent, it’s boring,” he says.The “Southwest effect” became a major reason that overall fares dropped in its new markets,and the phenomenon was studied in business schools and the halls of government. TheDepartment of Transportation marvelled in a 1993 report: “The principal driving forcebehind dramatic fundamental changes that have occurred and will occur in the U.S.airline industry over the next few years is the dramatic growth of low-cost SouthwestAirlines.” Southwest continues to have that impact when it enters a new airport. After it began serviceto Baltimore-Washington International in 1993, fares dropped by 70% and passenger traffic increased 7-fold. Traffic between Philadelphia and Providence increased by morethan 800%, and one-way average fares fell to $44, a drop of 83%, in the year afterSouthwest entered Philadelphia in 2004.The company started flying to Denver in January 2006. It now has 141 daily departuresthere, reflecting the fastest growth in its network. Frontier Airlines, based in Denver butwedged between Southwest and rising fuel costs, couldn’t keep up. It filed forbankruptcy in 2008, though it kept flying. In Las Vegas, Southwest effectively drove outmost competition from US Airways, which retreated to Phoenix. With 212 daily flights,Las Vegas is now Southwest’s top city.Competitors see Southwest as cold-blooded and ruthless. “Their approach is to search out weak companies and contest them out of business,” saysBryan Bedford, the chairman and chief executive of Republic Airways, which boughtFrontier out of bankruptcy last year. “It’s no different than Wal-Mart plunking a big-boxstore near a local family-owned grocery store; you either respond to the competition, oryou get out.” Robert Jordan, Southwest’s vice president for strategy and network planning, sees thingsdifferently. “We never like to say we kicked somebody out of the market,” he says. “Everybody makes their own choices. But we can go into a new market, charge attractiveprices and, given that people love our products, gain new customers. “At some point, it becomes very hard for others to compete because they can’t make moneyat the prices we charge, and we can.” There’s also the whole Southwest road show that is a feature of nearly every trip: Someflight attendants joke with passengers, others play games and sing, or, in the case of one flight attendant made famous in a YouTube clip, break into rap songs. On one recentflight to Las Vegas, when a flight attendant learned that a couple were going to marry,she dimmed the cabin lights and led the whole plane in a loud toast.Despite the fun and games, Southwest continues to deliver on its basic promise, says WaltRose of New Orleans, who travels on the airline occasionally. “They can get comical attimes – and that’s a major understatement – but we don’t mind it,” says Mr Rose, on aSouthwest flight from New Orleans to Midland-Odessa, Tex. “They are on time, they arereliable, and they fly where we want to go.” As it reaches adulthood, Southwest insists that it can hold on to its teenage ways. “We stillhave an underdog mentality,” says Mr Kelly, the C.E.O. “It’s not a comfortable country-club environment for us.” But some analysts say the airline has been slow to adapt in recent years, by failing to updateits reservation software, for instance, or not scheduling flights to some leisuredestinations favoured by Americans, such as Cancun, in Mexico, or the CaribbeanIslands. That has allowed others, particularly JetBlue, to build a lucrative franchise in theCaribbean. “They were too paralysed in their in-the-box thinking about their airline,” says Mo Garfinkle,an airline consultant. “Maybe they got a little too comfortable in their niche. They didn’tappreciate that the world around them had changed.” While shunning radical change, Mr Kelly rejects the notion that Southwest has been standingstill. He points out that in the last year, the company has been in talks with its pilots toexpand the fleet with Boeing 737-800s. These new planes offer 40 more seats than theairline’s current 737s and will allow Southwest to fly longer distances. The move is significant because it helps pave the way for the airline to fly to Hawaii, and, for the firsttime, to destinations outside the United States.But getting overseas requires a tremendous amount of work for Southwest. Pilots need toendorse the move because it would mean a change to their contract. (Flight attendantsagreed to the change last week.) Southwest also needs to update its software so it can,among other things, sell international tickets and provide passport information to federalauthorities – something that its antiquated system cannot do.While Southwest has ridden out spiking oil prices, it’s still an expense that could hampergrowth, especially as oil prices rise above $80 a barrel again. Initially, the companynegotiated the spike better than most. It bought complicated financial hedges intendedto mitigate the impact of high fuel prices, and gained a precious advantage over itscompetitors as oil prices soared.But the bet backfired in the fall of 2008, when the economy slowed and oil prices collapsed.The company lost $120 million, its first quarterly loss in more than 17 years. (It stillturned a profit, however, for the full year.)Given its low operating costs – and an engrained philosophy not to furlough or lay off employees or cut salaries – Southwest found that it could not cost-cut its way out of thecrisis. Instead, it needed to bolster revenue while keeping its capacity flat. So thecompany followed a wider industry trend, by aiming to attract more business travellerswith more perks and by getting passengers to pay for new services, such as priorityboarding.But here, too, Southwest sensed an opportunity to showcase its difference. While baggagefees generated roughly $1.7 billion for the industry in the first half of the year,Southwest drew the line. It made its “Bags Fly Free” policy a centrepiece of itsadvertising and marketing campaign. “A lot of people have been trying to pickpocket and nickel-and-dime their customers,” saysKevin Krone, the company’s head of marketing. “We don’t think it’s right.” The policy turned out to be a good business move.Southwest’s revenue rose by $1.6 billion in the first nine months of 2010, compared withthat period in 2007, even as its capacity declined by 1%. Part of that growth in sales,Southwest believes, came from new customers fleeing bag fees. Mr Kelly calls his rivals’ approach “a gift.” The policy yielded another advantage. It allowed Southwest to subtly shift the focus awayfrom its fares. Although it still offers low fares to many destinations, Southwest doesn’talways have the lowest fares every day on every flight, says Bob McAdoo, an airlineanalyst at Avondale Partners. “Southwest can offer pretty good prices on their Web site, but if you buy in the traditionalbusiness markets, 6 to 10 days in advance, it is not inexpensive,” according to MrMcAdoo, who says he recently saved $350 to fly from Kansas City to Portland, Ore., bytaking Continental instead of Southwest.To attract more business travellers, Southwest also ironed out its chaotic boarding process,which had often been derided as a “cattle call.” While it still does not assign seats,Southwest set up new boarding groups, giving priority to people who have checked inonline. This allowed it to start charging to be in the earliest group to board.SOUTHWEST’S biggest challenge will be in merging with AirTran, which Mr Kelly described as “the single best idea we have for the next years.”
