Southwest Airlines plans to rein in capacity growth this year and next in an effort to grow profits amid a slowing U.S. economy, CEO Gary Kelly recently told investors. Meanwhile, the carrier is flirting with new forms of revenue generation, which could include a new fare structure and seating assignments, a revamping of its frequent flyer program and new amenities onboard, including inflight food and Wi-Fi sales. Analysts said these, along with Southwest's recent expansion of participation in global distribution systems, are attempts to court higher-yielding business travelers.
Although most analysts are reserving judgment on the ultimate effect of Southwest's capacity cuts, they said the move should give Southwest—a price leader in the markets it serves—the ability to increase fares.
"For both fourth-quarter 2007 and full-year 2008, we currently plan to grow available seat miles year-over-year by approximately 6 percent, or about two percentage points less than previously reported," Kelly said. "We also plan to implement a variety of revenue-enhancing initiatives by the end of 2007 that will set the stage for continued profitability."
Southwest will eliminate 39 roundtrip flights from its schedule, in many cases limiting frequency, but in some cases abandoning citypairs. For example, by the end of the year Southwest will cut its single daily departures to Oakland and Los Angeles from Baltimore, and will abandon the Philadelphia-Los Angeles route, among others. The carrier is focusing on cities it deems growth markets, noting that it has added 46 new roundtrip flights from such cities as Denver and New Orleans. The carrier said next year it plans to add 19 new aircraft to its fleet, "15 fewer than was previously reported."
"Southwest cut its growth plan, which was widely expected, but the cut was not severe—in line with company practice of gradual change," UBS airline analyst Kevin Crissey said. "This should aid pricing. Otherwise, the initiatives will take time for the impact to be felt."
Calyon Securities airline analyst Ray Neidl said, "The operating model is not broken, as some say, but needs modification now with tougher competition from revitalized network carriers and low-cost carriers."
Southwest in recent years has bulked up its domestic operations as network competitors have scaled back domestic growth, favoring international expansion. As measured by available seat miles, Southwest grew capacity by 8.8 percent last year and by 10.8 percent in 2005, according to its annual reports. Southwest's domestic capacity growth still trumps that of its legacy competitors.
"Growth in capacity largely comes from Southwest and Continental and a little bit from the other low-cost carriers," TRX Travel Analytics vice president Scott Gillespie told attendees at BTN's Corporate Travel World conference in May. "The other network carriers, other than Northwest, which was break-even, have all shrunk."
Kelly was among the first airline CEOs to suggest a softening of domestic demand during the carrier's first-quarter earnings
(BTN, May 7), but initially maintained the carrier's growth forecasts, before changing course last month. "Given the slowing U.S. economy and fuel-cost pressures, we are taking these steps to adjust our capacity growth rate, which will help to restore profit growth," Kelly told investors. "If we find that conditions change, we will reevaluate our growth plans for future periods. In this economic environment, we simply need to take less risk and grow more slowly."
Southwest is facing higher expenses, but is a lean operator and has little fat to trim, said UBS's Crissey in a research note. As one of the lowest-cost operators in the United States, there is no "low-hanging fruit"—namely, non-fuel costs—left to pick, Crissey said. Furthermore, Southwest is having difficulty coping with rising fuel costs amid hedges that are rolling off, Crissey noted, and the carrier "is having trouble raising fares given the weaker demand environment."
Southwest said it is looking to new forms of passenger revenue to offset the difficult operating environment—many of which could prove palatable to the corporate market, analysts said.
Kelly gave a sneak peek of a initiatives Southwest expects to launch later this year, adding that the carrier is targeting an additional $1 billion in incremental revenue "over the next few years." The carrier in the fourth quarter plans to "enhance its low-fare structure," amend its frequent flyer program and "unveil a new boarding/seating method."
Crissey said Southwest is cutting its least-profitable routes, changing its fare structure and targeting business travelers, enabling it to charge higher fares. Specifically for the corporate segment, Southwest is participating in some GDSs, albeit in a limited way
(BTN, May 21), and plans to improve its loyalty program. Crissey also noted a few other possibilities the carrier will pursue, from bulking up its international codeshares "to help fill planes" to offering inflight wireless Internet access and potentially selling food on board.
JP Morgan airline analyst Jamie Baker said Southwest "will begin to layer in more structured fares catering to business travelers." Crissey said UBS looks "favorably on the plan for a fare structure change but reserves final judgment regarding the opportunity for additional corporate travel—we'll let corporate travel managers weigh in. We have concerns about travel manager response to Southwest's product, seating practice, and lack of international and New York presence."
Baker added, "Participation in ATPCo would mean other airlines could better understand LUV pricing, leading to less discounting and greater yield stability."
Though Southwest only alluded to planned changes in its seating method, analysts concluded the carrier would institute assigned seating. "Later this year management will formally announce what we think will be a move to some sort of assigned seating," Baker said in a research note. "Once systems are upgraded, management will likely add international flying (Mexico and the Caribbean to start) to the network." The carrier already has been flirting with assigned seating in San Diego, Southwest representatives said.
Southwest is exploring new revenue streams that don't "create hard feelings from our customers," vice president of marketing, sales and distribution Kevin Krone earlier this year told Business Travel News
(BTN, May 7). Krone said Southwest would avoid following other airlines in monetizing offerings that currently are free. "We don't want to convince ourselves that Coke actually is an add-on," he said.
Kelly, during the carrier's first-quarter earnings call in April, said it would solicit requests for proposals to offer inflight wireless Internet access, and said Southwest is seeking to outfit a prototype with such service by early next year.