Move to Denver Signals Threat
To Southwest's Low-Cost Model
Lean Rivals Match Its Fares
Into High-Fee Airport;
No Frills vs. Full Service
A Hug From the 'Junior Team'
By SUSAN WARREN
Staff Reporter of THE WALL STREET JOURNAL
November 29, 2005; Page A1
DENVER -- Southwest Airlines has prospered by targeting new cities where the competition is weak and the costs are low. But when it starts flying out of this city in January, success won't be so easy.
Southwest will be going up against two entrenched carriers: Frontier Airlines Inc., a rival low-cost carrier based in Denver; and a newly streamlined United Airlines, which controls nearly 60% of the Denver market, and is set to emerge from bankruptcy early next year.
While Denver International Airport has dramatically reduced airline fees in recent years, the city will be one of the most expensive that Southwest serves. Southwest estimates its airport fees here will run between $8 and $9 per passenger, compared with a systemwide average of $5. That's high for an airline that's begun offering tickets for Denver flights at introductory fares as low as $59 each way.
Southwest is weathering the industry's financial crisis better than most other U.S. carriers, and is determined to use that advantage to strengthen its market position before the rest of the industry recovers. It has posted an unbroken string of profitable quarters even as other airlines racked up hundreds of millions of dollars in losses. With Denver, it will be entering its third new city in eight months, its fastest expansion pace since 1999.
But Southwest's days as an industry upstart may be drawing to a close. When it began flying in 1971, it terrorized established carriers with rock-bottom fares made possible by no-frills service and shrewd use of secondary airports. But hard times are driving big changes in the industry. With other airlines slashing costs both inside and outside of bankruptcy court, Southwest is losing its industry lock on low fares.
To cope with higher costs and leaner rivals, Southwest is adjusting its distinctive formula. Moving into Denver is one of the bigger risks the airline is taking as it tries to grow before other airlines catch up. "The low-hanging fruit is gone," notes Stuart Klaskin, an industry consultant based in Coral Gables, Fla. "There are only so many markets that are underserved and overpriced, and those markets shrink every day because somebody else is coming to serve them."
One of Southwest's main cost advantages over other airlines is likely to melt away over the next few years. When oil prices were low, Southwest shrewdly executed extensive fuel hedges to lock in low prices. For the past 18 months, the benefits have been huge, but they will shrink steadily over the next five years. If oil prices remain high, Southwest won't be able to negotiate new hedges at attractive prices, bringing its fuel costs more in line with other airlines.
"We've bought ourselves time," Southwest Chief Executive Gary Kelly said in a recent interview. "The advantages we have are immense, and shame on us if we squander them."
Mr. Kelly plays down the difficulties in Denver. He notes that Southwest already competes effectively against other discount carriers in cities such as Phoenix and it flies out of big airports with lots of competition, such as Los Angeles International. "This is not extraordinary for us," he said. "We're a growing airline, and we're very disciplined. It's just what we do."
Frontier and United already have matched the low fares Southwest announced for its flights between Denver and Phoenix, Las Vegas and Chicago, which are scheduled to begin on Jan. 3. With comparable fares, passengers will be choosing between no-frills Southwest and two airlines that unlike Southwest offer assigned seating and premium features such as first-class sections, more legroom and in-flight entertainment.
For some Denver travelers, that's reason enough to stick with the airlines they've grown used to flying. "My premium status, more leg space -- I wouldn't easily give that up just to save a few bucks," said veteran flier Ellen Cervarich, who was waiting to board a United flight to Chicago in Denver recently. Ms. Cervarich noted that when Southwest posted its new low fares to Chicago, "Within two days, United matched. So there was no need to change to get a low fare."
Frontier and United both will see their financial results squeezed by a fare war with Southwest, airline analysts say. Mr. Kelly argues that his airline's low cost base gives it more "staying power" in a low-fare environment. In other words, Southwest hopes to outlast competitors who may not be able to sustain the rock-bottom fares.
Southwest's operating cost, as measured by each seat flown one mile, is a low 7.85 cents. That compares with 8.68 cents per seat mile for Frontier and 10.43 cents for United, in the most recent quarter. But if fuel prices come down, that advantage could shrink. Excluding fuel, Southwest's cost is 6.31 cents per seat mile, compared with Frontier's 5.86 cents and United's 7.11 cents.
Long Courtship
Denver, which opened a new airport in 1995, had been courting Southwest for decades. But the airline was deterred by the relatively high fees Denver charged for the use of runways, gates and other facilities, due in part to the debt Denver incurred building the new facility. Airport co-manager Vicki Braunagel eventually led a campaign to pay down debt, freeze staff levels and defer big capital projects like a new parking garage and hotel, which allowed the airport to reduce costs to airlines.
Southwest was too busy expanding along the East Coast and Florida to reassess Denver until recently. Its planning department was gearing up its search for new cities to serve in 2006, and Denver already was on a shortlist, says Mike Van de Ven, Southwest's executive vice president of aircraft operations. Lower airport costs, coupled with Southwest's need to grow by expanding into large new cities, quickly moved Denver up the list.
In June, Southwest surprised Denver by accepting an invitation to send a research team to the city. Denver airport officials scrambled to prepare for Southwest's visit, dubbing it "Project Longhorn" in line with the secrecy Southwest demanded.
When Southwest's four-person team swept into town July 11, Denver officials were at first deflated. The Denver officials, clad in dark suits and ties, were surprised to see the Southwest crew dressed in golf shirts and khakis. "I don't think anybody was over 35" years old, says Thomas Clark, head of economic development for Denver. "I thought, 'OK. They've sent the junior team.' "
Mr. Clark changed his mind when the Southwest team began pelting Denver officials with detailed questions about economic growth and plans for development in the region. What are the demographics for winter skiers? What kind of conventions do you have planned for the next five years? "These are questions we've just never been asked by an airline before," said Mr. Clark.
When they were ready to leave, Southwest representatives told Denver officials that they loved Denver, recalls airport marketing manager Sally Covington. The Southwest team even hugged the city officials. But there were no promises about when -- or if -- Southwest would return.
The next month, Hurricane Katrina demolished the airline's careful planning. Southwest had been running 57 flights a day to New Orleans. The storm knocked out most air service to the city, leaving Southwest with 15 jets sitting on the tarmac, unable to generate revenue.
One possible solution was to quickly launch a new city to take up the slack. Ordinarily, Southwest needs six to nine months between announcing service to a new city and beginning flights. To further complicate matters, a strike at Boeing Co. threatened to delay the delivery of new airplanes Southwest had ordered for 2006. If Southwest didn't get those planes, the idled New Orleans fleet might not be available to use in a new city.
On Sept. 29, the month-long Boeing strike was resolved. Bob Montgomery, Southwest's vice president of properties, was dispatched immediately on a two-week tour of the top five airports on Southwest's secret expansion shortlist. Mr. Montgomery arrived in Denver on Oct. 7 to assess whether the airport could support a quick start-up. He found that most of what Southwest needed -- terminal space, gates, baggage handling -- was already in place.
By the following week, Mr. Montgomery had narrowed the list to two cities. One of them was Denver. Southwest's planning team crunched numbers and concluded the airline could keep costs in Denver to less than $9 a passenger. Although that was considerably higher than the $5 systemwide average, it was less than the $10 Southwest was paying in Seattle. The airline figured that despite the presence in Denver of low-cost Frontier, it could set fares 30% to 50% lower than rivals for certain routes, and still make money.
