South­west takes a dive: An­a­lysts urge over­haul as air­line cites down­turn

The Washington Times Weekly - - National - By Sean Lengell

South­west Air­lines, the savvy low-cost car­rier that be­came the envy of the in­dus­try, is show­ing signs of los­ing al­ti­tude.

Theair­linere­cent­lyre­port­edthat it­snet­income­plunged77per­centin the third quar­ter to $48 mil­lion (6 centsper­share)com­pared­with$210 mil­lion (26 cents) a year ear­lier.

South­west blamed the down­turn on the dra­matic rise in fuel costs this year, a foiled air­line bomb plot in Au­gust and an over­all soft­en­ing in de­mand for air travel.

But the prob­lems fac­ing the Dal­las car­rier are much more deeply rooted, many air­line an­a­lysts say, and un­less the air­line makes sig­nif­i­cant changes to its lauded busi­ness model,it­facesse­ri­ous­con­se­quences.

“They have huge prob­lems,” said Michael Boyd, a Colorado air­line con­sul­tant who has stud­ied South­west for years.

South­west was able to trans­form it­self from a tiny re­gional car­rier in Texas in the late 1960s into the coun­try’s largest low-cost car­rier by adopt­ing a revo­lu­tion­ary busi­ness model.

The air­line has shunned the tra­di­tional prac­tice of es­tab­lish­ing air­port hubs in fa­vor of fly­ing short and medium-range routes. This “point-to-point” sys­tem al­lows for planes to fly five or six times a day, max­i­miz­ing em­ployee and air­plane pro­duc­tiv­ity.

An­other South­west hall­mark has been to fly to medium-size mar­kets and sec­ondary air­ports in ma­jor cities with lit­tle com­pe­ti­tion. Thus, air­ports such as Mid­way In­ter­na­tional in Chicago and LaGuardia in New York be­came South­west sta­ples.

ButSouth­west’ssys­temap­pearsto have out­grown its use­ful­ness.

“The prob­lem with that model is thatwheny­ouget­toobig,likeSouth­west is right now, it’s not easy to find shorter-haul,high-den­si­ty­mar­kets,” said air­line an­a­lyst An­thony Tan­gorra, chief ex­ec­u­tive of Lat­i­tude Trans­port Ad­vi­sory. “They’re run­ning out of [mar­kets] that fit their model.Asamat­terof­fact,youcould say they’ve run out.”

South­west has been forced to fly to busier, more com­pet­i­tive air­ports — such as Philadel­phia In­ter­na­tional,Pitts­burghIn­ter­na­tional,Den­ver In­ter­na­tional and Wash­ing­ton Dulles In­ter­na­tional — to main­tain its self-im­posed 10 per­cent an­nual growth rate.

“They have to go into mar­kets now where, in­stead of gen­er­at­ing traf­fic with low fares, they’ve got to go in there and claw [pas­sen­gers] from other car­ri­ers,” Mr. Boyd said.

South­west’smono­lithicfleeti­san- oth­er­prob­lem,an­a­lystssay.Theair­line flies only Boe­ing 737 planes — medium-range air­craft that gen­er­ally are too large or too im­prac­ti­cal to fly into smaller re­gional air­ports.

“They’re­be­tweenarockand­hard place be­cause, as it stands to­day, the real growth nodes are places like Greenville-Spar­tan­burg, like Charleston,S.C.,likeShreve­port,and they can’t ac­cess those places with their planes,” Mr. Boyd said.

With­dozen­sofnew737­sonorder, South­west isn’t ex­pected to ac­quire the smaller planes it would need to serves­mall­er­mar­ket­sany­time­soon.

De­spite the chal­lenges, many in­dus­try watch­ers ex­pect South­west to over­come its hur­dles by over­haul­ing its busi­ness model and rein­vent­ing it­self.

“They’re get­ting to be in a pretty tight spot,” Mr. Tan­gorra said. “But it doesn’t mean they’re go­ing away any time soon, be­cause they still have a very healthy rel­a­tive cost ad­van­tage ver­sus the com­pe­ti­tion.”

Ray Neidl, an air­line an­a­lyst with Ca­lyon Se­cu­ri­ties, says South­west has plenty of op­por­tu­nity to ex­pand routes at its ex­ist­ing air­ports.

“They­mayrunout­of­places­tofly to — maybe by the year 2075,” Mr. Nei­dl­said.“Then­they’lljust­star­t­ex­pand­ing to Mex­ico or the Caribbean.”

Mr.Nei­d­lonOct.24raised­hise­quity rat­ing for South­west to “add” from “neu­tral,” and pre­dicted the air­linewil­lmeetit­spro­ject­ed15per­cent growth rate for next year.

South­west’s ag­gres­sive pol­icy of fuel hedg­ing — buy­ing fuel in ad­vance at set prices — be­fore oil prices sky­rock­eted this year has proven to be a good fi­nan­cial risk.

“South­west is an en­tity unto its own,”Mr.Nei­dl­said.“It’sgotaname, it’s got a prod­uct, they’ve got lots of places to ex­pand. They just can’t get [new] air­craft fast enough.”

South­west Chief Ex­ec­u­tive Gary Kelly un­der­stands the chal­lenges fac­ing his air­line and isn’t shy about mak­ing changes, Mr. Boyd said.

“We’ve been telling other car­ri­ers that they bet­ter watch out for South­west, be­cause the South­west you know to­day will not be the South­west you know to­mor­row,” Mr. Boyd said. “They’re go­ing to be the nas­ti­est com­peti­tor in town in five years be­cause they’re go­ing to fix their prob­lems.”

South­west al­ready has tin­kered with­o­ne­ofitssa­cred­tra­di­tion­sinthe sum­mer­when­i­t­ex­per­i­ment­ed­with as­sign­ing seats on a few flights.

“If they’re go­ing to ex­pand to places where they’re not known, they’re­go­ing­to­haveto[as­signseats]. And they know that,” Mr. Boyd said. “When you’re com­pet­ing with [low cost air­lines] that have seat as­sign­ments,aswellaswider­seat­sand­free TVs,that­look­saw­holelot­bet­terthan the ‘fall of Saigon’ board­ing method where you’re just shov­ing your­self on­board.”

Mr. Kelly said pas­sen­ger reser­va­tions are strong for the fourth quar­ter.

“Al­though[our]rev­enue­mo­men­tum has slowed, de­mand for low fare­shas­con­tin­uedand,over­all,our rev­enue growth [po­ten­tial] is healthy,” Mr. Kelly said.

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