Subscription Required

Now open to all readers.

By Judson Rollins

Introduction 

May 13, 2024, © Leeham News: Southwest Airlines, previously a longtime darling of investors and leisure passengers alike, struggles to find its footing now that the post-covid US domestic market is returning to normal.

“Bags fly free” is more headache than help for Southwest as it tries to grow unit revenue. Source: Forbes.

The airline eked out a 0.8% operating margin in 2023 and fell to -6.2% in the first quarter of 2024. Investors have lost faith in the company’s ability to return to its previously strong margins.

Southwest “is now a ‘show-me’ [investment],” airline analyst Helane Becker of Cowen recently told investors. “We expect shares to trade in a narrow range until they can return to sustainable profitability and at least high single-digit operating margins.”

After a deep dive into the airline’s cost and revenue performance, LNA believes the company is in a strategic quandary with few ways to offset rapidly rising labor, maintenance, and fuel costs. In short, Southwest is increasingly a “legacy LCC,” with LCC-like unit revenue but a legacy cost structure.

Summary

• The airline struggles to achieve innovations widely implemented elsewhere.
• Unit revenue is comparable to low-cost competitors, but a leisure-oriented network, product, and passenger experience leave little opportunity to increase it.
• Underinvestment in IT and onboard product reduces Southwest’s reliability and alienates much-needed high-yield passengers.

Southwest struggles to achieve innovations widely accepted in the industry

The Dallas-based carrier, launched by industry legend Herb Kelleher in 1971, serves airports in 42 US states and a handful of destinations in the Caribbean and Central America. Its route network is a hybrid of legacy hub-and-spoke and point-to-point operations.

However, the airline’s passenger experience, route network, and scheduling practices haven’t materially evolved since deregulation.

Southwest often delivers customer innovations like baggage tracking years after most of its competitors. But other long-accepted industry practices like “redeye” (overnight) flying have yet to be implemented.

The company often takes years to execute planned initiatives. It took seven years from looking for a manager of ETOPS (long-range overwater flying) to announcing its first routes to Hawaii, then another 17 months to start selling tickets.

Leisure-oriented routes, product, passenger experience hamper unit revenue improvement

Southwest has long billed itself as a “low-fare carrier,” but it is rarely so nowadays, especially in markets served by ultra-low-cost carriers like Spirit or Frontier. Such positioning is also suboptimal for an airline that urgently needs to increase revenue to match its higher — and rising — unit costs.

The airline suffers from a leisure-focused route map, heavy on destinations like Orlando and Caribbean islands but light on key business markets. Its heavy concentration at secondary airports like Chicago Midway, Fort Lauderdale, and Houston Hobby doesn’t help.

Although secondary airports typically offer lower fees and fewer volume-related delays, they’re far from many large corporate offices and even farther from the wealthiest suburbs. As a result, Southwest effectively positions itself as a downmarket, non-business carrier in these markets.

In the map below, blue areas show concentrations of households with income exceeding $200,000 per year, while orange areas have more households with income under $50,000 per year. The green area northwest of Chicago is O’Hare International Airport, while the small green square southwest of Chicago is Southwest-dominated Midway Airport.

Source: ArcGIS Online.

“Bags fly free” is a staple of Southwest marketing. However, this matters disproportionately to the price-sensitive leisure traveler. It has limited appeal to the time-starved business traveler who is only away for a few days at a time and has no desire to wait at baggage claim.

Offering free bags also leaves Southwest in a no-win situation with leisure passengers. Matching no-bag competitor fares would leave money on the table by offering more benefits for less money, so offering free bags all but forces the airline to price itself above no-bag fares.

However, this higher “headline” fare consistently disadvantages Southwest when customers compare fares with other carriers. As a result, it shuns “scraper” comparison websites like Kayak or Skyscanner, believing brand loyalty and free bags are sufficient to drive customers directly to its own website.

Despite management’s promises to investors to grow business travel, Southwest’s product and passenger experience are almost diametrically opposed to this. Corporate travelers consistently shun the airline due to its single-class seating, lack of seat assignments, and unpopular loyalty program.

Its simple passenger experience, while nominally beneficial to operations, means Southwest cannot offer ancillary options sold by most other airlines, like extra-legroom seats or bags.

A lack of assigned seating, once thought to reduce aircraft turn times, is increasingly more of a drag than a benefit. An increasing share of passengers pay for priority boarding but then take aisle seats and obstruct others from reaching the window or middle seats.

Also, Southwest is receiving a growing number of complaints about abuse of pre-boarding for disabled passengers. Complainants allege such passengers say they require wheelchair assistance to board but later deplane themselves independently – a phenomenon referred to in frequent-flyer circles as “jetway Jesus.”

Underinvestment in IT and onboard product reduces reliability, alienating high-yield passengers

For years, the airline famously underinvested in commercial and operational IT systems, leading to a series of embarrassing and expensive operational meltdowns. Jordan’s predecessor, Gary Kelly, prioritized free cash flow and shareholder returns over internal investment, unionized employees repeatedly pounded.

The most recent failure was a December 2022 crew scheduling crisis that led to over 15,000 cancelled flights in ten days. The fallout cost Southwest nearly $1.2bn, including a $140m fine from the US Department of Transportation. However, pilots and cabin crew have continued complaining about the same scheduling issues that led to the 2022 situation.

Southwest’s continued “technology debt” leaves it vulnerable to more frequent and severe outages than other airlines. Just as aviation safety experts point out that “safety improves one accident at a time,” it seems that at Southwest, “reliability improves one meltdown at a time.”

Such unreliability, combined with the airline’s middling on-time performance, makes Southwest much less attractive to business travelers and other higher-fare customers it must attract to increase unit revenue.

The airline has also underinvested in its onboard product and is increasingly falling behind its competitors.

“Consumer tastes are changing,” writes Cowen’s Becker. “More travelers want a premium experience and are willing to pay for it, especially on long flights. In-seat power, larger overhead bins, and Wi-Fi are table stakes, especially for business travelers.”