Mitchell Schnurman: Where’s the advantage in Southwest Airlines 2.0?
It’s not easy to age gracefully.
Southwest Airlines has long defied the odds, but now its workforce is older and richer, and rivals have used bankruptcy to get leaner and stronger. The Dallas airline that always played the upstart underdog is looking more like the legacy carriers it used to mock.
Southwest has high labor costs, stalled growth, and the headaches that come with more congested airports. It’s betting on international service, toiling to integrate an acquisition and struggling with new computers for reservations and revenue management.
Southwest’s business model — built around simplicity — is no longer so simple. It has a raft of fares, add-on fees and higher maintenance costs from taking on a second airplane model.
And the bottom line: Third-quarter profit came in lower than for every large rival, even bankrupt American.
“It’s just a different airline today than it was 10 or 20 years ago,” CEO Gary Kelly told analysts this month.
Times change, of course, and Southwest has adapted remarkably well. It has a four-decade streak of profits and no layoffs, and it’s still one of the nation’s most admired companies. Passenger revenue growth has been huge since the recession, a tribute to Southwest’s ability to expand and dictate prices. It’s increased fares five times this year, following eight increases last year.
Southwest’s big problem is on the expense side of the ledger. Pilots, for instance, are paid twice as much, on average, as a decade ago, the result of good raises and 10 more years of seniority.
In 2001, Southwest’s labor costs were significantly lower than those of its legacy rivals. Last year, Southwest paid more than every other carrier except American Airlines — and American is in the process of slashing that measure with the help of a New York court.
Southwest’s “unit costs have now increased for 10 straight years, and we don’t expect that trend to change anytime soon,” analyst Hunter Keay wrote this month.
Many analysts want Southwest to add bag fees, a valuable addition for most airlines. Charging passengers to check up to two bags could generate $1.2 billion in revenue, estimates Keay of Wolfe Trahan & Co.
Southwest counters that it picks up almost that much in additional business, precisely because it offers the perk. Southwest has also turned “bags fly free” into a branding message that fits its customer-friendly philosophy.
Kelly usually shoots down suggestions to change. But in the conference call, he said Southwest wouldn’t say no to anything — and was looking for any good ideas.
Southwest has several initiatives under way. It’s upgrading the fleet and adding seats, which will save fuel. It’s boosting revenue with a new frequent flier program, early boarding and other seating options. The integration of AirTran Airways, acquired 18 months ago, continues — albeit at a slower pace than expected.
New computer systems are being developed, and Kelly said they’ll help bring international routes with “handsome profit opportunities.”
“Most of our challenges right now are internal — in other words, managing our own transformation,” Kelly said.
Kelly has warned about rising expenses at Southwest. A year ago, after American’s Chapter 11 filing, Kelly sent a memo to employees: “Now, the enemy is our cost creep, our own legacy-like productivity and our inefficiencies,” he wrote.
Southwest’s labor costs began topping the large players’ around 2006. The impact was masked by Southwest’s fuel hedges, which let the company avoid the worst spikes in oil prices. Those hedges expired, and Southwest has been paying industry rates for fuel since 2009.
Southwest also has an edge in nonlabor expenses. But the carrier has moved into crowded airports in New York, Philadelphia and Denver, and those costs are up 27 percent in the past decade, according to federal data compiled by the MIT Airline Data Project.
One final advantage that’s faded: growth. After decades of expansion, Southwest has trimmed seats from its schedule through the first nine months of the year. And Kelly said that won’t change until results improve.
No longer is Southwest offsetting its rising labor costs by adding new, lower-paid employees.
“Peel that away, and there’s no stopping the cost creep,” said William Swelbar, research engineer at MIT.
Kelly has said he wants to cut at least $100 million in overhead and reduce head count through attrition.
The company has to get back to its roots. In 1994, Southwest’s annual report was titled “How to build the low-fare airline,” and the first chapter focused on low costs.
“This is the most important aspect of our business strategy, after safety,” the report said.
