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Leeham News and Analysis
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Southwest, the “legacy LCC,” part 2: Bloated labor expense, difficult fleet strategy result in uncompetitive cost structure
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By Judson Rollins
Introduction
May 20, 2024, © Leeham News: Southwest Airlines was founded on the principles of high employee productivity and low labor costs. But 53 years after beginning operations, its labor cost as a percentage of expenses — and per seat-mile — is now the highest among US airlines.
Boeing 737 MAXes parked after the 2019 MAX grounding. Source: Getty Images via AFP.
LNA studied Southwest’s and its US competitors’ 2023 annual reports to comprehensively understand their relative profitability. The resulting picture is less than flattering to the Dallas-based carrier. Southwest is increasingly a “legacy LCC,” with LCC-like unit revenue but a legacy cost structure.
Summary
- Labor costs are dramatically worse than legacy or LCC competitors.
- Fleet and route strategy are crimped by overreliance on the Boeing 737.
- Southwest’s insular management team and culture may be its greatest obstacle to business model innovation and continued profitability.
Labor costs are dramatically worse than legacy or LCC competitors
In 2023, Southwest’s cost per available seat-mile (CASM) was behind only that of full-service carriers American, Delta, and United.
The airline’s labor cost is by far the worst in its competitor set. In previous years, the airline claimed its high staff costs were offset by high utilization. But that advantage has disappeared as Southwest underperforms its peers even on a per-seat-mile basis.
It should be noted that Frontier and Spirit’s labor costs are abnormally low, likely driven by mostly outsourced ground operations. However, as shown in the table above, both carriers have a clear total-CASM advantage over Southwest.
Recently signed contracts will only make the disparity worse in the coming years. Since October 2022, Southwest ratified contracts with eleven employee groups, including a deal with its pilots earlier this year featuring a 50% pay increase over the next five years.
Moreover, Southwest’s fleet utilization is capped by its continued lack of “redeye” (overnight) flying, which means it can’t add marginal flying to spread fixed costs across more seat-miles. The airline finally obtained pilot consent in its latest round of contract negotiations, but technology issues are still a barrier. Chief commercial officer Ryan Green told Aviation Week last month that adding redeyes is “kind of in the, I would just say, ‘couple year’ horizon.”
In addition to cost inflation driven by shortages of spares and maintenance personnel, Boeing’s MAX delivery issues mean Southwest has no choice but to retain aging 737s — and absorb the resulting expense of previously unplanned heavy checks in lieu of retirement.
Fleet and route strategy are crimped by overreliance on the Boeing 737
Southwest has long touted the simplicity of operating just one aircraft type: the Boeing 737. It’s operationally easy to manage, makes crew management more efficient, reduces spares inventory expense, and expedites irregular operations recovery.
However, it means the airline offers just two aircraft sizes: 143 or 175 seats. This reduces its ability to compete in frequency-dependent markets, as it must choose between adding another full-sized frequency and not competing in a lower-demand time channel from a given city.
Exclusively operating 737s also means Southwest is entirely dependent on Boeing. In recent years, that has made the airline effectively a hostage to the manufacturer’s quality problems and inability to deliver aircraft. Besides the potential reputational loss of losing a previously exclusive customer, the airline has limited negotiating leverage with Boeing.
In the current environment, the Dallas-based carrier has few ways to bypass Boeing’s delivery bottleneck – apart from a potential acquisition of A220 operator Breeze. No OEM or lessor can deliver alternative aircraft in the near term, either smaller or larger than the 175-seat 737 MAX 8s Southwest is awaiting.
Southwest’s core struggle: an insular culture inhibiting investment, innovation
Southwest famously promotes most top executives from within the company. The current CEO, Bob Jordan, has been at Southwest for 36 years. Former CEO and 38-year veteran Kelly chairs the company’s board of directors, the vice chair is a retired Southwest chief legal officer, and Jordan is a director.
Promoting from within is a respectable way to build company culture and employee loyalty. But it often breeds an insular culture: blind to competition, deaf to customers, and hostile to innovation.
One needs to look no further than Boeing to see the results of such a management team.
Is it entirely coincidental that Southwest has tied its fortunes so tightly to Boeing’s?
From their 2023 financials:
https://www.southwestairlinesinvestorrelations.com/~/media/Files/S/Southwest-IR/2023-annual-report.pdf
……………………………………………………….2023 2022
Operating revenues per ASM (cents)(g) 15.32 16.04 (4.5)%
Passenger revenue per ASM (cents)(h) 13.88 14.42 (3.7)%
Why the drop?
Active full-time equivalent Employees 74,806 66,656 12.2%
Aircraft at end of period(j) 817 770 6.1%
More employees. More aircraft.
Average passenger fare $ 172.18 $ 169.12 1.8%
Pax fares went up.
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For comparison’s sake:
2018 (pre-you know what):
Average passenger fare $ 151.64
Operating revenue per ASM (cents) (g)(j) 13.75
Passenger revenue per ASM (cents) (h) 12.80
Active fulltime equivalent Employees 58,803
Aircraft at end of period 750
Operating expenses per ASM (cents) (i) 11.74
Operating expenses per ASM, excluding fuel (cents) 8.85
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I wonder how much the holiday debacle cost them in revenue? That’s what happens when you don’t invest in the company and instead use cash for buybacks and dividends.
Easy answer: Southwest flew 14.7% more seat miles year-over-year. Only Spirit and Frontier grew faster; their unit revenue (RASM) fell even further, and investors punished them accordingly.
That average fare increase was less than inflation, and their load factor fell from 83% to 80% — quite a drop.
The Christmas 2022 debacle hurt their reputation even with leisure customers, so it’s quite possible that incrementally impacted their revenue — but adding too much capacity, too fast, is by far their #1 unit revenue problem.
From their financials:
‘In late December 2022, the Company experienced a wide-scale operational disruption as extreme winter weather across a significant portion of the United States impacted its operational plan and flight schedules. For first quarter 2023, these events also created a deceleration in bookings, largely isolated to January and February 2023, as well as additional expenses primarily in the form of reimbursing Customers for costs incurred as a result of the flight cancellations. The financial impact of this disruption on first quarter 2023 results was approximately $380 million on a pre-tax basis.’
pg 73
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Southwest flew 14.7% more seat miles year-over-year.
load factor fell from 83% to 80%
12.2% increase in employee expense.
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So, you increase employee costs by adding staff, along with aircraft, then you don’t fill the aircraft like you were doing.
There’s the problem. Labour cost would fall in line with the other LCC’s like Alaska and Jetblue if they carried 3% more pax.
Why did the load factor fall? Weak routes? Are customers just defecting to other airlines? Is the boom done and how does LF match up against the others? Pre-pandemic, what was the LUV load factor from previous years?
I did a quick google search and Statista (for what it’s worth, has them from 2015-2019 around the 83.5-84% load factor.
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Operating revenues were ~$26 billion. Every percent is a $260 million drop. Add in the 2023 fallout from X-mas and you’re off ~from $1 to $1.5 billion.
The ASM 14.7% increase:
‘The Company received 86 -8 aircraft deliveries from Boeing in 2023 and retired 39 -700 aircraft. ‘
Adding capacity also pushed down their unit cost (CASM). The fact that their CASM is so high relative to other low-cost carriers *AFTER* adding so much capacity tells you just how bloated their cost structure is relative to what most observers think is their peer set. Hence the “legacy LCC” label: legacy costs with LCC revenue.
‘to what most observers think is their peer set.’
That’s the thing, isn’t it?
When people and observers talk about US airlines, it’s the Big 4:
‘The “big four” US airlines – American Airlines, Southwest Airlines, Delta Airlines and United Airlines – have by far the most capacity, accounting for 73% of US airline seats’
https://www.oag.com/blog/biggest-airlines-in-the-us#:~:text=The%20%22big%20four%22%20US%20airlines,under%2078%20million%20between%20them.
How the Big 4 U.S. Airlines Are Preparing for the Holidays
https://skift.com/2023/12/15/how-the-big-four-airlines-are-preparing-for-the-holidays/
The “Big Four” – Delta Air Lines, American Airlines, United Airlines and Southwest Airlines – have been pleading for additional bailouts as Covid-19 continues to crimp travel.
https://www.reuters.com/article/idUSKBN2991JU/
Flight Friday: How Are The U.S. ‘Big 4’ Airlines Faring Compared To 2019?
https://aviationweek.com/air-transport/flight-friday-how-are-us-big-4-airlines-faring-compared-2019
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LUV doesn’t want to be compared to the likes of Allegiant, Frontier and Spirit. Even Jetblue is doing a hybrid thing with Mint class and angling to fly overseas.
They obviously think they can get back to the LF needed to generate better margins, otherwise they would have retired more of their older 737’s.
You brought up an interesting point on how ticket prices haven’t matched the price of inflation and how LF dropped.
So it begs the question:
Has management gone outside of their lane (LCC model) and viewed themselves too much in competition with the likes of the other three legacy carriers, instead of being the best of the group you mentioned here?
Are people just not willing to pay more money (or does their route structure not match the legacy carriers domestically) for a SWA flight, as opposed to a Delta, United or AA trip?
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Delta had a load factor of 84% for 2023. 4 points higher than SWA – who’s model is based on filling up aircraft to the brim. Delta also has a lot of older aircraft in it’s fleet, which they maintain the heck out of.
This is a revenue problem, facing Southwest. Ticket prices that haven’t matched the increase in expenses along with poor LF performance.
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Side note:
Back in the day, my old man worked for a large airline, all his life. He was a regular reader of Aviation Week and eventually I worked for a different carrier, until I moved into something else.
I recall having discussions with him (and seeing articles in AW) about load factors and the general consensus was that you needed to be around 65% to be profitable. If you hit that number, you were good.
Here we are today, where 80% means you struggle.