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So Southwest Is Mortal After All

Rogue5

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October 16, 2005

So Southwest Is Mortal After All
By MICHELINE MAYNARD

WHILE other big airlines have been suffering through a disastrous slump the last few years, Southwest Airlines has been like a speed skater on a dark river, deftly avoiding ruts and leaping over barricades that tripped up its less-nimble competitors.

It kept its employees happy and their compensation fat when other airlines could do neither. It expanded into several major new markets while others were quitting some cities altogether and reducing service elsewhere. It capped prices to deal with the intense fare wars encouraged by the Internet. It hedged its fuel costs while others watched helplessly as prices doubled in a matter of months. Most important, Southwest remained profitable throughout. And in that way, it served as a beacon for competitors who were losing billions of dollars and trying to retrench under bankruptcy protection.

Now, though, it's beginning to look as if Southwest is not immune to the airline industry's troubles after all. While it continues to have low overall costs and the highest market capitalization of any carrier, obstacles like stubbornly high fuel prices and more aggressive low-fare competitors are posing new challenges to Southwest, threatening its ability to maintain its momentum.

"There are clearly headwinds ahead," Laura Wright, the chief financial officer of Southwest, said in an interview last week.

Herbert D. Kelleher Jr., its chairman and co-founder, was, as usual, more colorful and more blunt. "It's all hands on deck; the ship is being shelled," he said in an interview last week.

Most critically, the hedging contracts that have protected Southwest from spikes in the price of oil will offer less protection starting in January. Paying market prices for a third of its fuel needs could add as much as $600 million to its bill next year, according to an analysis by the federal Bureau of Transportation Statistics. That is almost twice the $313 million profit that the airline made in 2004, and well above the $440 million analysts expect it to earn this year.

For its part, Southwest predicts that its fuel bill will rise less - about $500 million - next year. But, Ms. Wright admits, the airline does not see that much in excess costs that it can easily cut.

"They're not in the same boat as everyone else, but they're sticking a couple of toes in the same boat," said David Strine, an airline industry analyst with Bear Stearns. "They are feeling the same pressures as everyone else."

To be sure, Southwest executives are keenly aware of the challenges. "We're going to have to be aggressive and innovative or we're just going to have to lose money like everyone else," Gary C. Kelly, the chief executive, said in an interview Friday. But, he added, he is proud that his airline's record of 33 consecutive years of profitability did not end as the rest of the industry was falling apart over the last few years. "This is a testament to the fact that we were prepared," he said.

Staying prepared is now the key. Beyond next year's fuel bill, Southwest is planning for the day when things get even worse. The airline is already looking at 2010, when its fuel hedges completely disappear, leaving it with a fuel bill that would be $1.4 billion higher than in 2005 - an increase equal to 20 percent of its current revenue - if prices stay the same as they are today.
"That is a hurdle," Mr. Kelly said. "My message is and will continue to be, 'We have five years, guys, to address that challenge.' And that is a blessing - that's not a curse; that's a blessing." As a sign of his confidence that Southwest can meet the challenge, he has not backed off his pledge that earnings will grow by 15 percent next year.

Meeting that goal while being squeezed between rising costs and growing competition will not be easy, of course. To figure out a way to do it, Mr. Kelleher has pitched in his considerable expertise, actively advising Mr. Kelly and Southwest's president, Colleen C. Barrett.

While they remain in charge of day-to-day affairs, Mr. Kelleher is dealing with matters like schedules, service and how to deploy Southwest's fleet, particularly after Hurricane Katrina interrupted flights to New Orleans, where Southwest is the biggest carrier.

MR. KELLEHER is also spearheading Southwest's fight to overturn a federal law that effectively limits the number of states Southwest can fly to from its home base at Love Field in Dallas. Last week, Seattle rejected its request to switch from the Seattle-Tacoma International Airport to smaller, cheaper Boeing Field, which is closer to the city center. It was a rare political setback for the airline, which is accustomed to being welcomed by cities eager for more service and lower fares.

Without a doubt, however, the fuel prices are the most pressing problem. Jet fuel costs are roughly 50 percent above 2004 levels, and spiked an additional 25 percent in the days after Katrina struck refineries on the Gulf Coast. Both Northwest and Delta blamed the run-up in fuel prices for triggering their Chapter 11 bankruptcy filings last month.

Southwest's fuel costs now average $15 a passenger, according to a study by the federal statistics bureau that will be released this week. That compares with $9 a passenger in 2000. And the 67 percent jump came despite Southwest's hedging strategy, which locked in the price of 80 percent of its fuel in 2004 and 2005. Without those hedges, the airline, which will report its third-quarter results Thursday, would have recorded operating losses in three of the last six quarters, the bureau's analysis showed.
This year, when fuel prices have ranged well above $2 a gallon, Southwest has been paying an enviable 99 cents a gallon, according to the bureau's estimate, and that should help Southwest post strong earnings this week. But for 2006, Southwest has locked in the price of only 65 percent of its fuel, meaning the rest will be bought at market rates.

The most logical and traditional way to make up the shortfall would be to raise fares, a tactic that Southwest has minimally employed this year, increasing ticket prices by $1 and $3 at a time. Analysts say Southwest could easily charge more for cross-country flights, which increasingly seem like a bargain compared with the cost of gas to drive the same distance. But Mr. Strine, the Bear Stearns analyst, said the airline must be careful not to antagonize passengers, whose primary reason for choosing Southwest has always been that it was cheaper to fly than big airlines.

Ms. Wright agreed that the balance was delicate between covering costs and keeping passengers happy. "Our low-fare brand is who and what we are," she said.

Fuel is not the airline's only cost concern: wages and benefits have risen significantly since 2000, due in part to generous contracts negotiated with pilots, flight attendants and mechanics over the last few years. Five years ago, its per-employee compensation was about $64,000; this year, it is paying nearly $90,000 per worker. Ms. Wright said the compensation included profit-sharing payments and reflected raises given to pilots in 2002 after a five-year wage freeze.

Offsetting those numbers is the airline's heralded productivity. Since 2000, the number of passengers carried per employee has increased; Southwest employs only about 70 people per aircraft, compared with more than 100 per aircraft at traditional big airlines. Indeed, its employee ranks have dropped from a peak in 2003, even though Southwest has expanded service to major cities like Philadelphia and Pittsburgh. "They treat their people really well, and in return, they have really productive people," Mr. Strine said.

But it may need more. Northwest and Delta are seeking cuts in wages and benefits while they reorganize under bankruptcy protection. US Airways and United Airlines have already won cuts from their employees during their stints in Chapter 11. Now Continental and American, a unit of the AMR Corporation, are cutting their labor rates, without seeking bankruptcy court protection.

That means Southwest must look at its labor costs, too, said Betsy Snyder, an airline industry analyst with Standard & Poor's Ratings Services. "It's not inconceivable at some point," she said, "that they could go to labor for some relief."

The first inkling of that could come next year, when Southwest's contract with its pilots will open for discussion.

Politics is another matter under discussion - with one loss and an even bigger fight yet undecided.

On Tuesday, Southwest was given a firm "no" in its efforts to jump from Seattle-Tacoma International Airport to Boeing Field, a move the airline painted as a bid to avoid an expected increase in the landing fees at Seattle-Tacoma.
 

Rogue5

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But the bigger fight looms in the other Washington, before Congress, where Southwest is getting ready to fight its crosstown rival, American, over repeal of the Wright Amendment. Named for a former House Speaker, Jim Wright, the amendment limits direct flights from Love Field in Dallas to seven states. Passed in 1979, it was intended to encourage growth at fledgling Dallas-Fort Worth International Airport, American's home base.

But the amendment means that Southwest cannot operate flights from Dallas to other airports where it has a large market share, including Chicago Midway, Baltimore-Washington International, Las Vegas and Phoenix. Until Mr. Kelly became C.E.O. last year, Southwest merely put up with the situation, but with its growth at stake, the airline has decided to fight.

So far, the main beneficiary of the Wright Amendment, American Airlines, has fought back. Last week, American released a study saying that if the amendment were repealed, airlines would cut hundreds of flights at Dallas-Fort Worth, reducing service to cities in Texas, Arkansas, Oklahoma and Missouri. "A change of such magnitude can unleash unintended consequences that ripple throughout the transportation system," said Will Ris, American's senior vice president for government affairs.

Neither analysts nor Southwest executives say they think the issue is make-or-break for the airline. But Mr. Kelleher, who helped start up Southwest in San Antonio in 1972, said Love Field was the only airport where flights were restricted, even though the industry was deregulated in 1978.

"It seems clear that something should be done and very hopeful that it will be done and it would be very helpful to us if it can be done," Mr. Kelleher said, "but if it doesn't happen, life has to go on."

BUT it does not have to go on in Dallas. Southwest has no immediate plans to move, though Mr. Kelleher said that "inevitably, as we grow bigger across the rest of the country, and Dallas remains the same size, we might have to begin casting about for a place that's more efficient to operate."

Efficiency, after all, is the airline's watchword. And flexibility and determination have always been a vital part of its culture.

Kevin P. Mitchell, chairman of the Business Travel Coalition, which represents corporate travel departments and business travelers, said, "They always have a way of winning, even if they lose."

Copyright 2005 The New York Times Company
 

SWA GUY

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I'm sure I've never heard of anyone at WN say we are invincible. In fact, I've only ever heard people at WN say we always need to plan for the bad times during the good times.
 

pilotyip

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I think I read in a issue of ATW, that in 1998 SWA payroll was 36% of revenue, today it is 42% of revenue.
 

Mesa Beer

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Mesa is invincible! You will pay us to fly your routes. You will pay us to fly your routes. You will pay us to fly your routes. Ah $hit.
 

JetSpeed219

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Mesa Beer said:
Mesa is invincible! You will pay us to fly your routes. You will pay us to fly your routes. You will pay us to fly your routes. Ah $hit.

All your base are belong to us?
 

FlyBoeingJets

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Vladimir Lenin said:
nothing lasts forever...next!

This is a chance for SWA's labor groups to continue to break the airline mold. Maybe not "forever" but at least keep profitability for the foreseable future.

Will labor groups respond and do what is necessary to keep SWA profitable?

Or will they, particularly pilots, do what has been done at some other airlines? Which was fail to respond in time to keep the company healthy.

I predict a positive outcome.
 
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kelbill

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Payroll has jumped up as a percentage, no doubt. But taking that one stat and making hay with it is misleading at best.

1. We pilots have gotten some nice raises recently.
2. Revenue growth and profits have tanked since 9/11. Even with little or no raises, payroll's percentage of expenses would have increased.
3. We and the company are now becoming leaner and meaner, meaning when revenues pick up, which they are slowly but surely doing, payroll percentage will drop a lot.
4. I forget the exact number, but with buy outs and internal transfers, our employee per plane ratio has plummeted. When the industry cycle turns around, watch out.
5. And finally, are we to assume that our increase payroll percentage is a slam on SWA, but the drop in payroll percentages elsewhere due to 40% paycuts is a positive?
 

Lear70

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I predict they will raise prices.

One of the few management teams that employs actual good business sense in their daily operations is certain to understand that the BULK of their retained profit margin MUST come from increased prices.

To take it from labor would jeopardize the good will they've worked SO HARD over the years to create and retain. They may ask for some increased productivity and ask to exchange a small percentage of pay for stock or profit sharing but it would go against the business model they've had since day one to come asking for large pay cuts.
 

BeCareful!

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There's a fresh new batch of airline "talent" hitting the job market. It's many former USAir guys and gals. Perhaps SWA can hire them to help hammer out some "competitive" labor agreements!
 

pilotyip

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kelbill no intent to slam. You forget to add the raising fuel prices that will also reduce the percentage of payroll costs, plus pilots are not leaving SWA like they did up until 2001 and pilots are creeping up the pay scale. But that alone does not tell the whole story on the health of a company. Your answer made sense, but a change in a ratio like that compared to ROI and profit margin can send a message. My concern was you can only pull so much milk out of a cow, then it goes dry. Employees at other airlines have pulled too much milk out of their cows with raising expectations that can not be meet.
 

kelbill

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Pilotyip,

We pilots are in the midst of some productivity discussions (actually a vote coming up) and the fact that we have more senior pilots and more vacation will increase our expenses no doubt. Your fuel costs example of artificially reducing payroll costs is accurate. So when/if fuel prices go down does that make our inevitable payroll percentage rise a red flag to Wall Street? It will go up as well at all the airlines, to include those in BK. Very few pilots left SWA pre2001, let along post2001. And retirements here are just now starting to kick in big time, so I don't see a big problem with payroll in the near future. SWA doesn't sit on its laurels, and we are doing what we can to stay competitive and profitable. Wall Street is smart enough to know that we can only control so much with BK, Wright, and heinous fuel costs (even with hedging). We are on track to make more money this year than last (ROI, Net Margin, total $ all going up) so I don't worry about the cow going dry. I don't hold my breath that someone will liquidate either.
 

AA717driver

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kelbill said:
4. When the industry cycle turns around, watch out.

The problem is that we have been in an economic growth mode for the past few years. The airline industry cycle hasn't turned around. You will probably have to wait out the next downturn before the industry gets any better.

That said, SWA is MUCH better suited to weathering a storm than the other airlines. That is due primarily to its cooperative spirit between labor and management.

Hey, Arpey, there is no PDP at SWA! Wonder why...? :rolleyes: TC
 

SirFlyALot

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kelbill said:
Payroll has jumped up as a percentage, no doubt. But taking that one stat and making hay with it is misleading at best.

1. We pilots have gotten some nice raises recently.
2. Revenue growth and profits have tanked since 9/11. Even with little or no raises, payroll's percentage of expenses would have increased.
3. We and the company are now becoming leaner and meaner, meaning when revenues pick up, which they are slowly but surely doing, payroll percentage will drop a lot.
4. I forget the exact number, but with buy outs and internal transfers, our employee per plane ratio has plummeted. When the industry cycle turns around, watch out.
5. And finally, are we to assume that our increase payroll percentage is a slam on SWA, but the drop in payroll percentages elsewhere due to 40% paycuts is a positive?

SWA has been able to maintain its profitability over the last several years due in large part to an absolute cost advantage over other airlines. The cost advantage consisted mostly of 1) the fuel hedges, and 2) inefficiencies at other airlines. SWA was able to charge less than other carriers and people, as we all know, generally go for the lowest price offered. Now, however, the fuel hedges are going to begin to go away and other airlines have dramatically improved their efficiency. SWA's cost advantage is eroding. SWA has become leaner and meaner but most other airlines are becoming leaner and meaner more quickly than them simply because there was much more "fat" to shed.

At the same time, the strength of competing low cost carriers is increasing thanks to the prowess of JetBlue and AirTran. As these two carriers in particular continue to grow, they are going to become even more efficient due to economies of size, and SWA will feel increasing pressure from them. On a percentage basis, they are both growing more quickly than SWA. The latest stats I saw at a stage length of something like 700 miles showed AirTran with lower non-fuel costs than SWA and JetBlue with very slightly higher non-fuel costs.
 

JohnDoe

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quote:
"The problem is that we have been in an economic growth mode for the past few years. The airline industry cycle hasn't turned around. You will probably have to wait out the next downturn before the industry gets any better."


Finally, somebody with some sense to see this isn't a "normal" downturn in our industry.

This is a good point that a lot of people seem to be ignoring when they talk about how this is only a cycle of good/bad times for the airlines. Our economy has supposedly been in "recovery" for a couple of years now, yet the airlines are continuing to head toward the bottom (three chap 11's in the last month alone). By the time they finally reach it, it will be time for the next decline in the overall economy.

Has there ever been a time in the "downturn" where 4 of the largest airlines have been in chap 11 at once? Not to mention including the bankruptcies of numerous other carriers. Even "regionals" are joining the party.
 

Immelman

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I would hope that certain posters in this (http://forums.flightinfo.com/showthread.php?t=47976&highlight=hedging) thread would take a step back and see how hedging really works... option contracts for fuel are like anything else... you can't get the cheap stuff forever if the price of the commodity goes up.

I hope SWA responds to this with reasonable fare increases.. sure, it may hamper their growth, but it would be a good thing for the entire industry don't you think? Maybe reasonable fare increases will better the odds that my seat-mate on my next SWA flight has recently bathed and has decent breath ;)
 

kelbill

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More banter,

"SWA has been able to maintain its profitability over the last several years due in large part to an absolute cost advantage over other airlines. The cost advantage consisted mostly of 1) the fuel hedges, and 2) inefficiencies at other airlines. SWA was able to charge less than other carriers and people, as we all know, generally go for the lowest price offered. Now, however, the fuel hedges are going to begin to go away and other airlines have dramatically improved their efficiency. SWA's cost advantage is eroding. SWA has become leaner and meaner but most other airlines are becoming leaner and meaner more quickly than them simply because there was much more "fat" to shed."

Sounds good on paper, but I'm not buying. Our cost advantage, ex-fuel, is great regardless of the hedging. We've always had a cost advantage, the fuel situation just worsened the situation for the other guys. Fuel hedges are going away, but they aren't gone, and we are ready for it. Failing to pay one's retirement bills (for most of the majors), bankruptcy, and the like are not signs of leaner or meaner, but rather just leaner. And I'm sure the other folks are not even pondering asking for their pay cuts back should times improve. What will that do to the fat situation? We don't compare ourselves to the others, we just try to be as efficient as we can, and let the profits follow.

"At the same time, the strength of competing low cost carriers is increasing thanks to the prowess of JetBlue and AirTran. As these two carriers in particular continue to grow, they are going to become even more efficient due to economies of size, and SWA will feel increasing pressure from them. On a percentage basis, they are both growing more quickly than SWA. The latest stats I saw at a stage length of something like 700 miles showed AirTran with lower non-fuel costs than SWA and JetBlue with very slightly higher non-fuel costs."

I treat those two as our major competition. That being said, you can't have it both ways. As these guys mature, as we already have (4500+ pilots, 420+ planes) they will be the ones running up on increased vacation (reduced productivity), increased payroll (no 12 year captain pay at JBLU yet, but its coming), and increased MX costs. And of course, the dreaded U word will rear up at JBLU no doubt. U as in union. Our pay rates are now at or near top, whereas they have a way to go, and it would be blind to assume they won't be growing salaries at a quicker rate than us to catchup. I see them getting less competitive cost wise in the future. And JBLU debt rating is junk class I believe, so we are being a little dishonest in our comparisons. I'm not slamming JBLU or AAI, I'm just responding to the comparison.
 

FlyBoeingJets

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kelbill said:
Pilotyip,

We are on track to make more money this year than last (ROI, Net Margin, total $ all going up) so I don't worry about the cow going dry. I don't hold my breath that someone will liquidate either.

As long as CASM is competitive the percentage being labor is just nice to know information. It is a weakness only if it can be exploited by a competitor. Traditionally, once you let the high wage genie out of the bottle you can't put it back in. That is what can bite SWA in the future with Wallstreet. This year, of course, will be good. But what about after that?

Those not in BK will benefit from the reduction in capacity due to lease renegotiations at NWA and Delta. USAir will get rid of 50 planes too. Fares will go up and mask any CASM issues from lack of hedges and higher than average wages. But this holiday period will not last long.

When the others in the top 6 get their act together SWA will have competitors with lower non-fuel costs than they've had in two decades (leases, work rules, and pay).
 
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