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Southwest Struggles As Legacy Airlines Establish Solid Business Models

Baruch Feigenbaum
December 6, 2013, 10:24am

In its 40th year, Southwest, the original low-cost carrier’s profits are declining. The airline is struggling to integrate AirTran cities into the Southwest network. And many longtime travelers feel the airline is losing its identity.

Since its founding in 1967 Southwest has served as an innovative discount carrier. It has earned a profit every year, reduced the costs of air travel and led many of its legacy competitors to declare bankruptcy. Southwest thrived because of its low costs largely from operating one aircraft, 737, with one class of service, Coach. 

But times have a changed. The 12 original legacy carriers have merged into three major carriers—Delta, United and American. Further they have emerged from bankruptcy with lower costs and better business models. Gone are the days of multiple carriers each operating seven flights per day between Cincinnati and Kansas City with all losing money. Gone are the days of ever increasing airline salaries and half empty airplanes. In other words legacy airlines are finally doing the one thing Southwest has always done—using a competent business model. 

While legacy airlines have finally found a strong business model, Southwest is struggling with its model. Legacy airline profits soared in the 2nd quarter. Delta made $688 million and United made $484 million. U.S. Airways and American which recently merged to better compete made $325 million and $228 million. Southwest earned a modest $223 million which is not bad but far less per person than they made even 2 years ago. In 2010 the profit margin was 4.54%; in 2012 it slipped to 2.44%. 

At the same time Southwest has morphed from an ultra-low cost carrier to an ordinary airline. Its prices are often no longer the cheapest. On a random sample of eight airports Southwest alone was never the cheapest airline. Sometimes its fares were equal to a competitor and often they were more expensive.

Route

Delta

United

American

Southwest

Atlanta to Baltimore

$238

$238

$446

$238

Los Angeles to San Francisco

$116

$118

$116

$116

Chicago to Tampa

$365

$376

$359

$359

New York City to Orlando

$262

$262

$316

$279

Kansas City to Seattle

$249

$271

$415

$271

Dallas to Minneapolis

$216

$389

$340

$231

Las Vegas to Nashville

$335

$381

$295

$319

Miami/Fort Lauderdale to Philadelphia

$272

$254

$277

$271 

That Southwest no longer has the cheapest fares is not breaking news. A March study by Topaz International which sampled 100 routes found that Southwest did not have the cheapest fares 60% of the time, although there was some controversy in the routes Topaz chose. 

To increase profit, Southwest has changed other policies including adding fees that have not endeared it to customers. Southwest changed its frequent flier program to make its points less valuable, adopted fees to board early or choose certain seats, cut leg room on its planes and enacted a fee for passengers who miss a flight and do not call to cancel. These are all concepts legacy airlines have adopted for the last few years. 

For the time being, Southwest does not charge baggage fees. This can amount to a savings of $120 per round trip. The airline continues to charge baggage fees on its AirTran routes and some analysts believe it is only a matter of time before Southwest enacts baggage fees. 

The problem is as Southwest’s competitors have become leaner and the airline has grown to become the biggest domestic carrier, a number of Southwest’s operating procedures may no longer be the best practice. One example is the lack of a First of Business class. First class tickets are typically two to four times more expensive than Coach seats creating a large profit margin for the airline. Additionally, frequent fliers who fly Coach are often upgraded to First class based on their status. All else being equal, frequent fliers are going to choose an airline with First class over one without simply because of the upgrade opportunities. 

Southwest has grown by flying to three types of cities. The first type is medium-sized metro areas between 800,000 and 2.5 million such as Austin, Baltimore, Oakland, CA and St. Louis. The second type is heavy tourism cities such as Las Vegas and Orlando. The third type is secondary airports at metro areas with more than 4,000,000 people such as Chicago-Midway, Dallas-Love Field and Houston-Hobby. 

But for Southwest to keep growing it needs to add service to either smaller cities or larger cities or both. When Southwest acquired AirTran it had a chance to keep some of the smaller cities in AirTran’s network but it has already eliminated Atlantic City and Sarasota and will be pulling out of Branson and Key West. So keeping smaller cities does not appear to be Southwest’s choice. 

Therefore, Southwest’s most likely expansion candidates are large cities. But it has not had a lot of luck in primary big-city airports. It has yet to gain much of a presence in New York or Los Angeles. It tried expanding in Philadelphia but got pummeled by USAir and quickly retreated. In the next post we will examine how Southwest is faring in Atlanta.


Baruch Feigenbaum is Transportation Policy Analyst


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