Southwest Airlines remains the most profitable U.S. carrier and plans to maintain strong growth throughout 2005. BTN editors last month spoke with CEO Gary Kelly about the carrier's market opportunities, business travel developments and the fate of the industry.BTN: What is your prognosis for the industry this winter?
Gary Kelly: The big story is the financial disaster the industry faces and what that means. That question has delayed our decision making for next year in terms of routes, because we are just waiting to see what happens. It certainly feels like we are in for much higher energy costs than the experts had forecasted a year ago. Whether it is $50 crude oil, or $60 or $40, I don't know, but it doesn't feel like we'll be anywhere close to $30 any time soon. We are 80 percent hedged this year and next year at some very attractive prices. We will make it through the season just fine, but in the long term we need to be prepared for much higher energy prices than we have had historically.
BTN: Do you think lobbying the government to relieve fuel costs is realistic?
Kelly: No. I think that is a waste of time. Supply needs to match demand. We believe there is plenty of oil in the world. It is just that the developed reserves are depleting. The cost now of developing new reserves is just much higher than it was in the past.
BTN: Moving into 2005, what is your outlook for business travel?
Kelly: I tend to agree with all the theories that increased energy prices are a form of a tax, with the same effect as raising interest rates. My feeling is the economy will slow down in 2005. That has to have an impact on business travel. We have not seen the real surge in business travel following gross domestic product growth over the past 24 months. Maybe we'll start to see a late-cycle effect of that. But, if 2005 is another strong year with GDP in the positive 3 percent to 4 percent range, then I would expect business travel would improve. Yet at what rate, and compared to what supply of seats?
BTN: Considering near-term viability questions for certain carriers, should Southwest be prepared to grow capacity next year by more than the targeted 10 percent?
Kelly: For now, we have a net of 29 aircraft additions to the fleet for 2005, which is a 10 percent capacity growth rate. I would expect traffic growth to match that. If one or several of our competitors downsize or liquidate, then I am sure that 29 airplanes would grow to maybe 10 more, 20 more, 30 more. I don't think we would add more than 60 airplanes. That would be a world record for us in one year.
BTN: Where will growth within your system be most apparent in 2005?
Kelly: With the current competitive environment, we have more opportunities to add aircraft than we have aircraft. It is no secret we are trying to increase our service in Philadelphia. We are at 41 daily flights, which puts into perspective how big Philadelphia is and how aggressive we have been. To add more flights, we will need more gates and we are actively talking to the airport about that, but we have a lot of opportunities beyond Philadelphia. We still are the leading low-cost provider. We can grow, add new markets and be profitable. We are in the enviable position of truly offering something different in the United States—low fares. Others add flights, but they are losing money and don't have the cost structure to support the Southwest version of low fares.
BTN: You have said that a a potential Southwest move into Dallas Fort Worth would be defensive. If so, isn't there a first-mover advantage?
Kelly: Perhaps. It is both offensive and defensive. Our priority, though, is elsewhere. If the landscape does not change dramatically in Dallas, then we can either defer that decision or never make a move over to DFW. For us to be successful, it would take a fairly significant presence. At this stage, we don't want to be at DFW. The only thing that has changed is that Delta has exited the market. There is no compelling reason today to jump on that opportunity. That doesn't mean we won't change our mind in a year, or two, or three from now.
BTN: To what degree have you modeled scenarios in which Southwest picks up assets from failing carriers?
Kelly: It is a fair question. We try to be wise about what routes we take and which expansion choices we make. We modeled a number of scenarios across the United States. We looked at different aircraft types and a number of other things. We have tremendous opportunity to grow Southwest Airlines, certainly in the short term, with our straightforward Boeing 737, either 300 or 700 product, with 137 seats. That is our near-term focus. If other options become available in that arena, that would be our focus.
BTN: Is growth in transcontinental services among your priorities?
Kelly: Not in and of itself. It has not been a strategic decision to be in the transcon market. We put flights between cities that travelers want to go. We have a major presence in Baltimore and in Los Angeles. Customers were flying between those cities, so we met their needs by putting nonstop flights in.
BTN: Is Southwest considering expansion to Canada, Mexico or the Caribbean?
Kelly: There are all kinds of places we could grow beyond the continental United States, and I think we will grow beyond the continental United States at some point, but we have so many opportunities in our own backyard, in areas of core strength, that those must be our focus in 2005.
BTN: What can Southwest do to keep business travelers away from competitors with similar business plans?
Kelly: We certainly want to maintain and grow a very attractive route network. More choices for business travelers always is better, whether it is more frequencies or more destinations. That is a top priority. Equally important would be maintaining the low-fare structure Southwest is famous for, the ease of making changes and the whole friendly approach. We also want to maintain our flexible, generous frequent flyer program. Through our Swabiz product, we have made improvements in corporate bookings and back-office tracking. If you use a Sabre agent, you can book Southwest, and with our new BookingBuilder relationship
(BTN, Oct. 18), it will be easier for non-Sabre agents. While we have a great product for corporate travelers, we continue to make improvements.
BTN: What other lessons have you learned from the corporate community?
Kelly: They are not lessons learned as much as it is an evolution. For example, it has long been a desire of mine to have a more efficient method of booking Southwest. We thought of ticketless back in the 1980s, it just took us a while to offer that technology. That was the foundation for southwest.com. Then we deployed online issuance of boarding passes after we converted from manual boarding cards at the gate. What we have been searching for, over the years, is a way to provide access to travel agents or corporate travel managers that would still fit with our overall strategy. Now, we have better tools available that help us protect our cost structure and product distribution. We do not want to be dependent on third-party distribution systems.
BTN: Do you anticipate taking more steps to make your content more available to corporate travel buyers?
Kelly: We need to continue to be mindful that there are certain things we do not do, which may mean a lack of access for certain customers. If we need to change our distribution approach in the future, we can always make that adjustment. As you know, once we are in, we can't ever get out. Also, we have the opportunity to sell more cars and more hotels, and do more packages. We are definitely interested in fleshing out southwest.com in those areas. On the air side, 60 percent of our bookings are through southwest.com.
BTN: On an industrywide level, can the global distribution systems be maintained as the top sales channel?
Kelly: It is primarily a cost issue. The functionality seems to be good, if not very good, but I read about the better mousetrap, so I don't know. We have a longstanding relationship with Sabre. We are happy with it. It meets our needs. From a travel agency perspective, our bookings only are about 12 percent. As time goes by, they are just a smaller and smaller component for us and southwest.com, which is not GDS-dependent, is a more significant component.
BTN: What are your thoughts about tax reform within the industry?
Kelly: We are heavily regulated and taxed as an industry. There has not been a comprehensive transportation policy that has ever been seriously considered. What you have is a patchwork of things added to aviation over 50 years. The end result is an enormous tax burden on an industry that cannot support it. You have to question the wisdom of that. I have been at Southwest since 1986 and CFO since 1989, and I was working on tax reform in 1991 and 1992. We were going through the same questions. The tax burden got far worse over the past 13 years, so I guess I was not very effective. Post-9/11, there was no question we needed security at the airport, but security at the airport, in a sense, becomes an element of national defense. To actually have a fee for the specific travelers to support this enormous burden is absolutely ridiculous. Meanwhile, the government has stepped in to support insurance coverage, but every year it needs to be extended. Those are two live examples. Even beyond all that, the average tax burden on a Southwest ticket is 30 percent to 35 percent.
BTN: Another area of concern is infrastructure and the inability of the air traffic control system to keep pace with traffic growth. Is that again an immediate concern, as it was before 9/11?
Kelly: Our traffic and operations levels are back to where we were pre-9/11, so my concern is that those problems are looming again. Ontime performance in the industry was not very good this summer. We squandered an opportunity, post-9/11, to deal with some of these infrastructure issues. There is a long-term trend to move to smaller, not bigger, aircraft. That leads to more, not fewer, departures. There is a move in the industry to de-peak the hubs that is bound to help. Yet, over the not-too-long term, you will see the potential for some pretty significant constraints. I am not trying to vilify regional jet strategies, but there is no comprehensive thought to what the needs are and how we find solutions. One reason is that the airports are left to their own individual desires and devices. The airlines are not necessarily efficient either. The hub structure adds many things that may not be needed. Also, you have surplus capacity. On the other hand, at these fare levels, the planes are full. That argues that perhaps we do need all this supply of seats in the market. It's an imponderable. There are too many variables and none of us know what really can fix it. We have wondered if the fix is low-tech: just pour some concrete and add runways in the right places. We certainly also need better technology, perhaps the concept of free-flight. The aircraft routings are longer and less efficient than they were 15 years ago. You would think that reducing time in the air would be an advantage in this puzzle.