Southwest and Its Cost Conundrum. I wake up in Honolulu this morning to CNBC discussing the auto industry and the fact that General Motors’ market capitalization is roughly the equivalent to what it was in 1943. Talk of a pre-packaged bankruptcy filing is spewing. But can that really fix anything? Wouldn’t it be interesting to have the US Government become the Debtor-In-Possession (DIP) financing provider in this bankruptcy case? If the US Government becomes the DIP lender, I wonder just how different their approach would be versus the airline industry's filings for bankruptcy and having to shed legacy costs and make the difficult decisions to downsize? This assumes that the USG would want a globally-competitive industry of course.
While on an airplane for eleven hours yesterday, Southwest announced its intent to codeshare with Volaris, and expand its foray into international markets to and from Mexico. Volaris and Mexico are perfectly logical choices for Southwest to keep operations as simple as possible (read costs down) as it puts its toe into international service. When combined with WestJet, Southwest is well on its way to creating a true North American airline entity that will compete with a United-Continental-Air Canada combination that is currently seeking anti-trust immunity.
Change was fine in a presidential campaign, but when an industry absolutely and positively needs to change, labor is the first to remind us that the old way is the only, and best, way. Keen observers are pointing to the outcry from the Southwest pilots over this most recent announcement. AirlineBiz, AirlineBiz and PlaneBuzz are each reporting on the story as are many others. PlaneBuzz and the comment sections underneath each story in the Dallas Morning News’ blog are being filled with comments different than those read from Southwest employees in the past.
Last October I wrote a blog entitled All Eyes on Texas where I took my own look at the upcoming labor negotiations for each of the Big 3 Texas carriers. My analysis concluded that the hardest negotiations would come at Southwest. Why?: because no carrier needs to change more to adapt to tomorrow’s difficult airline world. In the piece I wrote that Gary Kelly has, by far, the most difficult CEO job in the US industry. His internal communication of needed change is a dramatic departure from: we will grow; here is a sizeable raise if you continue to be productive; be happy. His external communication of needed change is a dramatic departure from the 30-year refrain that operational simplicity and continued growth will be the key drivers to maintain their enviable cost position.
Being a US-centric airline does not even work for Southwest anymore. The company has actively been investing in the necessary IT tools it needs to expand its revenue flows to points across international borders. Southwest on paper has an enviable cost position. But don’t let it be lost that they also have a cost conundrum. Low non-labor costs driven by a model of high productivity have cross-subsidized what are now high labor costs relative to the US industry.
Take growth away, non-labor costs will increase and will further highlight the labor cost situation the company faces. Like any well-managed company, exploring ways to augment revenue, as growth slows, serves all of its stakeholders best. The consequences have played out many, many times in the past. They have taken a no-fee stance and it will be virtually impossible for them to turn back. Also, US Low Cost Carriers have not had great success in selling on the other side of the US border so having a Canadian and a Mexican partner will address that weakness.
To this observer, seeking new revenue sources ahead of a challenging negotiations period, where the cost of labor poses a new challenge, seems to be a most logical path to pursue. When I take a look at ASMs produced per dollar of labor compensation it only highlights Southwest’s need for new revenue sources. Hopefully this fact will be appreciated, and debated, before knee-jerk reactions overwhelm the logic of the move. Southwest just ain’t the competitive animal it has been for the past 30+ years. The airline really does need to change and this path is “doing the right thing” by all involved.