Southwest’s Atlanta Decisions are Puzzling

Southwest Airlines is evolving. Yet a Coach-only, 737-only, operating style may not be successful in the country’s most lucrative airports.

Last week, we detailed how Southwest Airlines is no longer the low-fare leader. We also discussed how it has started charging fees to increase its revenue. Today we are going to look at Southwest’s operations in Atlanta—a major metro area with no secondary airport and a large legacy airline hub. Atlanta is a fascinating case study because Southwest bought a successful airline—AirTran—dismantled its hub and spoke network and rebuilt its presence in Atlanta’s around a focus city network.

First a little background: Delta, United and American have hub and spoke networks. Travelers in hub cities such as Atlanta have direct flights to all other cities in the Southeast and many cities around the country. But travelers in spokes must connect through a hub to reach another spoke. Hub cities have flight peaks typically in the morning and evening with smaller peaks in the afternoon. Airlines schedule multiple flights taking off and landing within several hours so travelers can make their connections without long waits. Southwest uses a focus city network that features smaller hubs with more point-to-point flights. Travelers can go directly from a non-hub city such as Kansas City to another non-hub city such as Las Vegas. Since Southwest does more point-to point flying, it does not schedule these flight peaks because fewer people need to change planes. (In reality, focus cities still serve as mini hubs but with 40% connecting traffic instead of 60%. And since the cities are not scheduled as hubs, connecting times can be much longer.)

More point-to-point flying is a definite advantage for some types of cities. While legacy airlines offer direct service to only two or three cities from their non-hubs, Southwest offers direct flights from most cities in its network to multiple cities in its networks. For example, if I live in San Diego and choose a legacy airline, I can fly to a few cities–Atlanta on Delta or Denver on United. But if I choose Southwest, I can fly to those cities and many others including Baltimore-Washington, Kansas City, Nashville, and Sacramento. So instead of having to fly to a big airport and changing planes to fly to my destination as I would on a hub and spoke network, on Southwest I can fly direct to 17 different cities.

This business model works in three types of cities. The first type is medium sized cities such as Austin and Baltimore, which are either too small or located in too poor a geographic area to serve as hubs. The second type is large tourism cities such as Las Vegas and Orlando that do not have sufficient business travelers to serve as hubs. The third type is secondary airports in major cities such as Chicago-Midway or Houston-Hobby where customers enjoy the ease and convenience of flying out of the secondary airport. Not surprisingly these are the types of cities where Southwest flies.

However, if Southwest wants to make it to the big time it has to fly into two other types of cities–superhubs like Atlanta and large airports served by numerous airlines such as New York (Newark, LaGuardia, Kennedy) and Los Angeles. These are just the types of cities that Southwest has been focusing on the past two years. Southwest received several new gates in Los Angeles thanks to the airport expansion and will be gaining six gates at New York LaGuardia thanks to divestitures required from the American-US Airways merger. But Southwest struck gold with its acquisition of AirTran.

When Southwest bought Airtran all eyes were on it to see what would happen with the Atlanta hub. It made three major changes. First, it cut the number of cities it serves from Atlanta by 14 by eliminating service to 18 cities while adding four new cities. It was mainly smaller cities that Southwest cut. And some—Atlantic City, Branson, Key West, Newport News, Sarasota and White Plains —have lost Southwest service entirely. It also eliminated its Atlanta service to other smaller markets that Southwest serves from other focus cities including Bermuda, Bloomington, Buffalo, Portland, Rochester and Wichita. Finally, and surprisingly it pulled out of other airline’s hubs: Charlotte (USAirways), Memphis (a diminishing Delta hub) and Washington-Dulles (United). (It also pulled out of Dallas-Fort Worth but will likely resume flights from Dallas-Love Field.) Cutting flights to small cities such as Atlantic City was not a surprise. Clearly Southwest has no intention of serving these cities either directly or in partnership with a commuter airline. Its decision to cut medium cities such as Buffalo and Wichita is a little more puzzling but Southwest must have felt these were better served by other hubs. And its decision to eliminate service to Charlotte, and especially Memphis was downright bizarre and inexplicable.

Once Southwest decided it no longer intended to serve small cities, it no longer needed AirTran’s 717s. So it made a deal with one of its competitors—Delta–to trade its 717s for some of Delta’s 737s. Clearly, Southwest really wanted to get rid of the 717s. But in trading them to Delta it allowed its major Atlanta competitor to replace some of its regional jets with 717s improving the Delta travel experience. Delta competes with American and United on these routes, not Southwest, so there are no direct consequences. But by operating a more efficient network Delta will have more money to compete with Southwest in Atlanta. So Southwest made a curious decision to indirectly help its competition.

Finally, Southwest dehubbed Atlanta. This sounds a lot more dramatic than it actually is. Since Southwest’s flights are more evenly distributed throughout the day it does not need as many gates. Offering more evenly spaced flights may make Southwest more attractive to local travelers. This decision also has the major advantage of reducing the number of gates needed and the costs of these gates.

Southwest Airlines’ stated goal in Atlanta is to make itself more attractive to local services. But its recent actions do not seem to further its goal.

The best way to build a strong local base is to attract frequent fliers. If I live in Atlanta I am most likely a member of Delta’s SkyMiles or Airtran’s A+ Rewards. (Southwest is integrating customers into its Rapid Rewards program.) If I regularly fly to one of the 14 cities that Southwest no longer serves, my best option is to choose a direct flight on Delta. This works for all of the cities except Atlantic City and Branson. (No airline currently offers direct service from Atlanta to these two cities. By so doing Southwest has steered some passengers to Delta. Southwest probably figures these are small cities so they will not be losing a lot of customers. But business travelers that fly regularly to these cities are unlikely to agree.

Southwest frequent flyer program is less attractive than AirTran’s program. Under AirTran’s program, customers with 3 round-trip Business Class trips or 4 round-trip Coach trips received a free one-way ticket. Under the plan ten or more A+ credits in a 90-day period or 25 in a 365-day period result in elite status. AirTran’s program was one of the most valuable in the industry. Clearly Southwest’s program was going to be a step down. But instead of improving its Rapid Rewards flyer program Southwest recently announced it is planning to devalue it. Starting in March 2014 passengers booking “Wanna Get Away” tickets will need to use 70 points per dollar instead of 60 points. Southwest is trying to convince AirTran customers to continue flying Southwest, while simultaneously devaluing its own frequent flyer program by 16%.

Another way to build a strong local base is to offer a first class. First class seats have a much higher profit margin and upgrades to first class serve as a strong incentive for all to fly the airline. Coach passengers may be upgraded to first class but only if the airline offers first class. Eliminating first class does allow Southwest to fit more total passengers on its planes. But the new 737-800s, which Southwest is placing in operation, could offer a very small first class section and still have the same number of coach seats as its 737-700s. Yet Southwest has no plans to offer first class in the near future.

Southwest’s one positive move is the addition of early morning flights to New York LaGuardia and Washington Reagan National where it is trying to aggressively compete with Delta. Southwest’s earliest flight to New York-LaGuardia is 7:05. But for those who want to leave earlier, Delta has flights at 6:00 and 6:45. In fact while Southwest offers 6 flights a day on 737s (and 717s before they ship them off to Delta), Delta offers 16 flights a day, almost every hour, on A319s, MD88s, 737-800s and 757-200s. Plus Delta offers direct flights to Newark, Kennedy and White Plains. At Washington-Reagan Southwest does operate a 6:40 AM flight while Delta’s earliest flight is 7:20 AM. But while Southwest offers 6 flights on 737s (and 717s before they ship them off to Delta), Delta offers 14 flights a day, almost every hour on MD-88s, MD-90s, 737-800s and 757-200s. And Delta offers direct flights to Washington-Dulles a route Southwest cut from Atlanta. So I do not think the new early flights will lead to a substantial increase in passengers.

How does the Atlanta situation look for Southwest? Not good. Delta’s Atlanta-based frequent flyer numbers have swelled in the past three years while AirTran’s/Southwest’s have declined. Further, Delta’s costs have been decreasing while Southwest’s have been increasing. Southwest has much higher unit costs than AirTran. Many experts have speculated that the real reason Southwest bought AirTran was to shutdown a major competitor. It is easier to compete in Atlanta when you have one major competitor instead of two.

AirTran showed that there is room for a second airline with a major hub presence flying out of Atlanta. And AirTran’s model of offering flight banks early in the morning/late at night, traveling to smaller cities such as Atlantic City that Delta does not serve, and offering a generous rewards program worked. There are likely many other successful models by ultra-low-cost airlines, low-cost airlines and conventional airlines that will also work. Can Southwest’s current operating style work in Atlanta? Southwest leadership is a very sharp bunch but the early returns are disappointing.