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.
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.
