The following appeared in the October 16, 2005 issue of THE NEW YORK TIMES:
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 cofounder, 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.
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
"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.
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.
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.
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.
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.
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.
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
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.
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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 peremployee compensation was about $64,000; this
year, it is paying nearly $90,000 per worker. Ms.
Wright said the compensation included profitsharing payments and reflected raises given to
pilots in 2002 after a five-year wage freeze.
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.
But the bigger fight looms in the other Washington, before Congress, where Southwest is getting
Offsetting those numbers is the airline's heraldready to fight its crosstown rival, American,
ed productivity. Since 2000, the number of pasover repeal of the Wright Amendment. Named
sengers
carried
for a former House
per employee has
Speaker,
Jim
increased;
Wright,
the
Southwest
emamendment limits
ploys only about
direct flights from
70 people per airLove Field in Dallas
craft, compared
to seven states.
with more than
Passed in 1979, it
100 per aircraft at
was intended to entraditional
big
courage growth at
airlines. Indeed,
fledgling
Dallasits
employee
Fort Worth Internaranks
have
tional
Airport,
A Southwest jet in Dallas. The airline knows how to control costs, but it
dropped from a
American's
home
may not be able to tame fuel prices.
peak in 2003,
base.
even
though
But the amendment
Southwest has expanded service to major cities
means
that
Southwest
cannot
operate flights
like Philadelphia and Pittsburgh. "They treat
from
Dallas
to
other
airports
where
it has a large
their people really well, and in return, they have
market
share,
including
Chicago
Midway,
Balreally productive people," Mr. Strine said.
timore-Washington International, Las Vegas and
But it may need more. Northwest and Delta are
Phoenix. Until Mr. Kelly became C.E.O. last
seeking cuts in wages and benefits while they
year, Southwest merely put up with the situareorganize under bankruptcy protection. US
tion, but with its growth at stake, the airline has
Airways and United Airlines have already won
decided to fight.
cuts from their employees during their stints in
So far, the main beneficiary of the Wright
Chapter 11. Now Continental and American, a
Amendment, American Airlines, has fought
unit of the AMR Corporation , are cutting their
back. Last week, American released a study saylabor rates, without seeking bankruptcy court
ing that if the amendment were repealed, airprotection. That means Southwest must look at
lines would cut hundreds of flights at Dallasits labor costs, too, said Betsy Snyder, an airline
Fort Worth, reducing service to cities in Texas,
industry analyst with Standard & Poor's Ratings
Arkansas, Oklahoma and Missouri. "A change of
Services. "It's not inconceivable at some point,"
such magnitude can unleash unintended conseshe said, "that they could go to labor for some
quences that ripple throughout the transportarelief."
tion system," said Will Ris, American's senior
The first inkling of that could come next year,
vice president for government affairs.
when Southwest's contract with its pilots will
Neither analysts nor Southwest executives say
open for discussion.
they think the issue is make-or-break for the airline. But Mr. Kelleher, who helped start up
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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."
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