Southwest Puts Its Money to Work – Announces Intention to Buy AirTran

In March of this year, I wrote a blog titled:   Dear Southwest: Grab Your Bag of Fiction; It’s On.  This widely-read piece was about Southwest’s role in the proposed US Airways – Delta slot swap transaction. “If Southwest wants to gain entry to the few remaining slot controlled airports,” I wrote at the time, “Then it should make the incumbents an offer – one that provides the slot holder a return on that carrier’s prior investment.”

Well today, Southwest announced an investment – a $1.4 billion investment – in purchasing AirTran Airways, lock, stock and landing slots.  And that is what I was pining for in that post.  That is, I believe Southwest should pay, not get something for free or at some rock bottom price for assets the incumbents paid dearly for over the years. With AirTran come slots at New York’s LaGuardia and Washington’s Reagan National Airports.  Along with slots, Southwest gains meaningful entry into the one remaining legacy carrier hub where it offers no service – Atlanta.  It also gains entry into Charlotte, a US Airways hub.

Should Delta at Atlanta and US Airways at Charlotte be concerned with this transaction?  No, and there are a number of reasons why not.  First and foremost, the network carriers already compete with the low cost sector for nearly 85 percent of their domestic revenues.  Whereas AirTran serves 37 markets that Southwest does not serve, some of them smaller, there will be some new competition for passengers in those markets.  But for the most part, those cities already enjoy the low fares delivered via AirTran’s initial entry.  A second consideration is that while Delta and US Airways depend on local traffic at Atlanta and Charlotte, each are major connecting complexes and are not solely reliant on originating passengers.

If you ask me, the losers in this announcement are not the network carriers but rather Frontier and Spirit.  jetBlue will survive just fine.  But Frontier is now confined to one [maybe two] traffic base for all intents and purposes.  And that makes them vulnerable.  As for Spirit, which just announced its intentions to launch a $300 million Initial Public Offering, it is one thing to have a highly fragmented market competing inside their network.  It is a totally different animal to have Southwest and AirTran focused on carrying traffic to the Caribbean. The investment thesis necessary to market the IPO just got tougher.

Southwest Needs A New Reference

In its press release Southwest said: “Based on an economic analysis by Campbell-Hill Aviation Group, LLP*, Southwest Airlines’ more expansive low-fare service at Atlanta, alone, has the potential to stimulate over two million new passengers and over $200 million in consumer savings, annually. These savings would be created from the new low-fare competition that Southwest Airlines would be able to provide as a result of the acquisition, expanding the well-known “Southwest Effect’” of reducing fares and stimulating new passenger traffic wherever it flies.”

So where is the “Southwest Effect” in Akron-Canton?  AirTran serves the market and Southwest serves Cleveland up the road.  There should be significant stimulation in that market area? And in Dayton and Columbus, OH?  Perhaps Southwest is looking far back to a 1993 study.  Ding: the “Southwest Effect” as we knew it is dead.  The truth is today’s stimulation is largely diversion from another market or another carrier.  Fares may still be reduced in certain AirTran markets where the network carriers rely mostly on regional jets, but some markets will more than likely just recapture certain traffic from an airport in the catchment area that offered better fares to a unique geography.

Labor Issues

Some have questioned whether the acquisition will lead to labor troubles down the road. But one thing is for sure: If I was an AirTran employee the first words out of my mouth upon hearing the news would be:  “Ding, cha-ching!”  Like employees at United who are looking forward to enjoying the feel of a new culture, one can be sure that the AirTran employees feel much the same.  For them it is an opportunity to join one of the most admired and beloved companies, not just in the airline industry, but in the entire country

There will need to be union representation elections as a result of the merger as pilots and flight attendants are represented by different unions at each airline.  But it’s hard to imagine any vote going the way of the AirTran unions.  The main difficulty then becomes seniority list integration.  Southwest CEO Gary Kelly told investors that “equitable and fair” will rule the integration process.  That sounds like the words in the Allegheny-Mohawk Labor Protective Provisions and should be music to the ears of AirTran employees.  The question is whether each union will have it’s own definition of what is equitable and fair.  That was the case in Southwest’s most recent acquisition attempt, when the Southwest Airlines Pilots’ Association could not find a formula to integrate Frontier Airlines pilots – and the deal failed.

The integration process has evolved over the years since the Allegheny-Mohawk Labor Protective Provisions were enacted. Over that time, there have been more failures than successes in adopting fairness and equity. But it is incumbent for Southwest labor and management leadership to ensure that career expectations are met for all employees. Simply put, this concept means that the relative seniority in a combined list is not significantly different for any respective employee than it would be in their respective entity today.

Concluding Thoughts

Southwest will celebrate its 40^th birthday next year. It is a mature and maturing carrier operating in a mature domestic environment where it is no longer THE innovator. What I find most interesting in Southwest’s potential bid for AirTran is that the carrier is being forced to act just like the network legacy carriers in seeking a consolidation scenario that would lead to an improved revenue line systemwide.

Let’s give credit where credit is due.  Southwest put its money where its route system was weakest and made a very smart acquisition -- one that recognizes that two carriers will accomplish more together than either carrier could on its own.  The two carriers offer a combined network with minimal overlap that ensures that new revenue synergies will be generated.  With the deal there also will be new international opportunities derived for Southwest’s loyal passenger base.  Multiple fleet types are not an issue as the smaller airframe will allow Southwest to serve some smaller communities.

But I can’t wait to hear the arguments Southwest uses in Washington to gain regulatory approval, particularly as it will be hard pressed to make the argument that acquiring AirTran would further lower airfares in the US domestic marketplace.  After all, Southwest is not the only airline offering low fares, no matter what its boosters in Washington may think.

To make its case, the little ol’ Texas carrier that flies only to secondary markets will probably use the very same arguments to gain approval as did Delta/Northwest and United/Continental used.  Interesting indeed.   

Dear Southwest: Grab Your Bag of Fiction; It’s On

On Tuesday morning a headline in The Washington Post read “Southwest Airlines Feeling Squeezed Out at National Airport”.  Terry Maxon wrote on The Dallas Morning News blog “Delta, US Airways Maneuver Around Southwest Airlines.”  The headline in Business Week read “Delta, US Airways Sweeten NYC-Washington Plan by Boosting Small Rivals.”

As I prepared to write this piece, I began by reviewing the various comments submitted to the U.S. Department of Transportation (DOT) by the air carriers during the comment period set forth following its tentative decision on the proposed Delta Air Lines – US Airways slot swap deal.  When I got to Southwest’s, I thought I was in a time warp.  A time warp whereby many of the same arguments used in Southwest’s fight to repeal the Wright Amendment were being dusted off and employed again.  Another opportune time for poor, little Southwest Airlines to get something on the cheap from the carriers that have invested hundreds of millions of dollars in their respective infrastructures over the past decades.  But here’s the thing:  Southwest is neither poor nor little.

Background

All of these stories of course pertain to a repackaging of the proposed Delta-US Airways slot swap first announced in August 2009.  In the initial deal made between Delta and US Airways, US Airways would receive 42 slot pairs from Delta Air Lines at Washington’s Reagan National Airport and a route authority to Sao Paulo and Tokyo Narita in exchange for 140 slot pairs at New York’s LaGuardia Airport. 

In February 2010, the DOT tentatively approved the deal between Delta and US Airways. The caveat was each carrier had to sell 14 National and 20 LaGuardia slot pairs to U.S. or Canadian carriers that have less than 5% of the total slot holdings at the respective airports. This stipulation materially impacted the value of the deal, so US Airways and Delta went back to the drawing board.

Late Monday, the two airlines announced a restructured proposal.  Only this time, they included provisions providing slots to competing carriers.  Delta concluded deals with WestJet, AirTran and Spirit to transfer up to five slot pairs each at New York’s LaGuardia Airport (LGA).  US Airways will transfer up to five slot pairs to JetBlue at Washington Reagan (DCA).  The inclusion of WestJet, AirTran, Spirit and jetBlue certainly satisfies the DOT’s requirement that divested slot pairs be provided to a U.S. or Canadian carrier with less than a 5 percent share.

Let’s Get Some Southwest Non-fiction on the Table

In its submission, Southwest complains that at LGA, "instead of an airport balanced among three airlines of roughly equal size, the slot swap would catapult Delta into a dominant position more than twice the size of the nearest competitor."  But Southwest does not ever mention anything pertaining to its size within the U.S. domestic market. In 2008 there were only 6 airport markets with more domestic origin and destination (O&D) traffic than LGA.  Southwest is the largest carrier in three of those six markets.  At the 48 domestic airports where Southwest is the largest carrier of O&D traffic, it is at least twice the size of the next largest carrier in 27.

At Dallas Love Field, Southwest controls 94.3 percent of O&D traffic and the second largest carrier has 2.2 percent.  At Houston Hobby Airport, Southwest controls 86.2 percent of O&D traffic versus 5.2 for the nearest competitor.  At Chicago Midway, Southwest has 79.1 percent control while the next largest competitor has 8.8 percent.  At Love Field, Houston Hobby and Chicago Midway the average fares rose at those airports 36.2 percent, 21.8 percent and 29.4 percent respectively between 2005 and 2008.  In each of the 48 airport markets where Southwest is the number one competitor, fares on average increased 17.5 percent between 2005 and 2008. 

Southwest would have us all believe that their presence at an airport is the ultimate discipline on fares and they claim it in every regulatory filing and certainly on every advertisement.  Despite what Southwest likes to say, it is not the same Southwest that sprinkled the “Southwest Effect” on markets in 1992. The claims of low fares stimulating new demand just do not hold today - because everyone offers low fares. 

During the period between 2005 and 2008, wasn’t Southwest enjoying the benefits of a fuel hedging program that provided the carrier with a most significant cost advantage relative to an industry that had largely restructured itself?  I assumed that cost advantage benefit garnered from a fortuitous bet on the price of oil was being passed on to the consumer.  Instead Southwest was raising fares.  In their filing they actually go as far as calculate the cost saving their low fares would bring to each the DCA and LGA markets.  The calculation is performed after including a $25 bag fee on top of the fare of the competition. 

Fiction Fatigue

If Southwest wants to gain entry to the few remaining slot controlled airports, then it should make the incumbents an offer – one that provides the slot holder a return on that carrier’s prior investment.  In a 2006 regulatory filing, Delta described how it took 22 years to build its slot portfolio at LGA.  The Buy-Sell Rule is a mechanism in place permitting such purchase.    

The filing states, “In sum, Delta acquired the right to operate most of the 243 LGA slots it currently operates at LGA through market-based transactions.  Delta acquired them through diligent investment in private market transactions, not by regulatory fiat. Delta has also invested hundreds of millions of dollars in expanding its service at LGA because Delta valued the right to expand its service at the airport, believing it would be profitable to make such investments.  Delta’s decisions to acquire slots in market-based transactions and develop its landside infrastructure at LaGuardia over three decades have permitted Delta to grow steadily and to offer greatly expanded services there to meet consumer demand.”

Carriers that purchased slots at the controlled airports did so expecting they would earn a commensurate return on their expended capital.  Of course that would mean average fares would more than compensate the cost of operating at those airports.  The average fare at LGA in 1990 was $150; by 2005 the average fare had fallen to $136; and in 2008 that fare was $159.  A similar trend can be found at Washington National, although fares in 2008 were higher.

Southwest Is Not Special

Southwest’s growth has caused/forced the industry to reduce costs in order to match the fare offerings from it and the so-called low-cost carriers it helped spawn.  Today, however, Legacy carriers with iconic names like American, Continental, Delta, United and US Airways are also offering low fares to passengers.  Low fares to air travel consumers in smaller communities that the Southwest operating model ignores.  It is these legacy carriers that have invested hundreds of millions of dollars at slot controlled airports. 

If Southwest wants to play, it should have to write the same type of check.  They won’t because the low fare structure at either of these airports will not produce adequate revenue streams to justify the investment.  Instead Southwest somehow believes it is “entitled” to the slots being divested by US Airways and Delta.

Southwest is no longer the only game in town.  It talks about all the money consumers will save as a result of Southwest’s entry into DCA and LGA, subtracting its entry level fares from average fares plus bag fees for the incumbents. Once Southwest is imbedded, there’s a new “Southwest Effect.” As mentioned above, in markets where Southwest is the largest carrier, fares increase the fastest.

Ted Reed at TheStreet.com wrote “Southwest Blasts Revised Slot Deal.”  In his story, Reed quotes Southwest, "Allowing two of the country's largest airlines to collude on trading assets in a way to reduce competition while dramatically increasing their market dominance at two of the United States' most important airports is, on its face, an alarming prospect that should not be permitted."

Who is the largest US domestic airline?  Southwest.

To me the more alarming prospect is allowing Southwest to get something for free – yet again.  Think Wright Amendment and the undoing of a deal because the market had changed and they needed to find a new way to grow.  Simply you have to pay to play, Southwest.  You have the cash.  Make someone an offer they cannot refuse.  The rules to do so are in place.  I have every confidence that neither LGA nor DCA absolutely needs Southwest.  I am confident that JetBlue, AirTran, Spirit and WestJet can do just fine.

It’s On. 

Pondering Southwest’s Potential Play on Frontier

By a multiple, the most widely read swelblog.com post ever read was the piece entitled: Is Republic Changing the Face of the US Domestic Market? I wrote the piece thinking about the regional carrier holding company’s play for each Midwest and Frontier. In that piece, I suggested that technology was a, if not the, most important attribute supporting Republic’s decision to make the play for Frontier: “Now Frontier provides Republic with something it previously lacked: a technology infrastructure that gives it long-term viability in the market. A technology infrastructure not tied to a legacy system.”

Most importantly, the technology would give Republic the opportunity to begin selling tickets directly to air travel consumers, something it does not and cannot do today.

Last week as I was walking off of the eighteenth green at the storied Butler National Golf Club in Chicago with dear friends Jack Ginsburg, Pete Robison and Ro Dhanda, I turned on my iPhone and noted dozens of messages. The news had just broken that Southwest Airlines was considering upping the ante over Republic and will prepare its own bid for Frontier.

For Southwest, the Best Offense Is a Good Defense

History is not clear whether someone actually said that the best offense is a good defense. It is believed to be a misstatement of a quote attributed to Carl van Clausewitz, military strategist and the author of On War, a book, published in 1832, that was required reading for me in a graduate school marketing class. Clausewitz was quoted as saying the best defense is a good offense. Either way, Southwest’s motives for this deal had me thinking.

If Republic is successful in gaining control of Frontier, it would produce, overnight, a new and potentially threatening competitor to Southwest’s domestic dominance. This past April, I made a presentation to the 34th Annual FAA Forecast Conference entitled: Cost Differences Suggesting a New Mid-Term Structure. There, I warned of the difficulty of analyzing cost differences between carriers, particularly in light of Southwest’s unique influence on the market. I believe it is now wrong to include Southwest among the group traditionally known as “low cost carriers” because its sheer size distorts the results. It was clear to me then, as it is more so now, that Southwest is losing the significant cost advantages that have historically been its primary competitive weapon and driver of its organic growth.

My analysis relied on MIT's Airline Data Project. When I prepared the analysis for the FAA Conference, final fourth quarter 2008 data had not been filed but has now been updated. The story remains the same. In order to make an apples-to-apples comparison of cost per available seat mile, adjustments must be made.

First, transport-related expenses (largely the fees paid to regional carriers for capacity) must be removed as there is an offsetting revenue account. Second, fuel cost per available seat mile should be removed as varying hedging strategies make for distorted comparisons. This is particularly true of Southwest where I estimate that its fuel hedging strategy accounted for 53 percent of its cost advantage versus the network carriers for the first nine months of 2008.

I also compared unit costs of the network carriers (American, Continental, Delta/Northwest, United and US Airways) to Southwest and a group of carriers I refer to as Midscales (AirTran, Frontier and jetBlue). Absent removing transport-related and fuel expenses, Southwest has a cost advantage versus both groups of carriers –in the case of the network carriers, a 6.4 cent advantage. When transport-related expenses are removed, then Southwest’s cost advantage is nearly halved. When fuel expenses are removed, the advantage versus the network carriers shrinks to 1.6 cents.

Now consider this: When transport related and fuel expenses are removed Southwest has a cost disadvantage versus the Midscale group. Just imagine what Southwest’s cost disadvantage could be if Republic were to get its hands on Frontier? Southwest non-labor costs are the envy of any carrier, and it still has an advantage versus the network and Midscale carriers. But Southwest now has a labor cost disadvantage against those carriers. In fact, the unit labor costs of the Frontier, AirTran and jetBlue sub grouping are nearly a full penny per seat mile lower than the unit labor costs at Southwest. Pennies in this instance can quickly add up to tens of millions of dollars in cost to Southwest when competing directly.

Adding To the Speculation

Many observers already question whether Southwest would be adding to its burdens and its costs in acquiring Frontier’s airplanes and thereby introducing different aircraft to its famously one-sized-fits all fleet. That can be addressed.

Can the labor issues also be managed? In my view yes, even if that means Southwest buying labor’s favor. Independent unions represent the pilots at each airline, so the always-difficult task of integration would be made easier by the fact there is no national union constitution and bylaws to deal with. Frontier, through its bankruptcy, has moved toward more maintenance outsourcing and that fits Southwest’s current model. And because the Frontier flight attendants are not unionized, there are minimal labor hurdles there.

No doubt, the financial transaction would be accretive to whichever airline ends up making the play. I believe, though, that the most value from Frontier would be garnered only by another airline that could leverage its assets - a local market following and its IT platform – not by financial players that won’t see the same advantages.

Frontier would provide Republic a tremendous opportunity to transform not only itself but the US domestic market. For Southwest, the Frontier play is not so much transformative as it is defensive, by:

1. Removing a local market competitor for a company struggling to find new markets (and there are no profitable 3-carrier markets in today’s revenue environment)
2. Providing a solid technology foundation and expertise in value-added pricing
3. Thwarting future competition by ensuring that Republic remains a capacity provider to the nations’ legacy carriers – at least in the near term.

Ding: The “Southwest Effect” is Dead

The Denver market is unique in that there are few alternative modes of transportation that can compete with air travel because of sheer distances in the western US. Boulder, Colorado Springs and other surrounding cities’ traffic already access the air transportation system through Denver. The truth is today’s stimulation is largely diversion from another market or another carrier.

Many point to the pain a Southwest takeover would impose on United. But there are two sources of traffic: local and connecting. United runs a large connecting operation in Denver. Onboard United airplanes is a traffic mix of 1/3 local passengers and 2/3 connecting passengers.  On the other hand, each Frontier and Southwest are highly reliant on local passengers.  Before we count United dead in Denver as a result of this combination, this fact needs to be examined. 

Fares for local traffic in the Denver market are largely dictated by the competition between Southwest and Frontier. Publicly available data would show that nearly half of Frontier's traffic at Denver is local and Southwest's is near 70 percent. Therefore which direction do you think fares will go if Southwest is successful in taking out an important competitor for Denver local traffic? And after reducing certain duplicative Frontier capacity?  Southwest’s fares will prevail, even though Southwest is not always the low fare provider in each market.

Southwest Showing Its Age

Southwest built its Denver operations quickly at a time when Frontier’s future was in doubt and United was struggling. As Southwest’s organic growth slows because of the anemic revenue environment in the US domestic market, then buying the carrier that competes largely for the same local traffic makes good sense. With a cost structure that no longer sets them apart from the crowd, it is clear why Southwest continually talks of the need to augment its revenue streams.

To be fair, some will say that analysis of Southwest’s cost advantage shrinkage is flawed because it does not account for stage length -- the length of the average flight. But in comparing one airline’s performance and costs to another, adjusting for stage length is somewhat arbitrary.

Rather, what is most important is the relationship of [system] cost per available seat mile to [system] revenue per available seat mile. It is this relationship that finds Southwest struggling at Denver where load factors have been in modest decline as the airline has grown and has been increasing fares from the carrier’s initial offerings. The net effect has been a modest decline in RASM - as CASM has been increasing.

The network carriers are challenged in this regard because of the black revenue hole created by the downturn in first and business class travel on international routes. Just as the network carriers have to adapt for shrinking revenue relative to costs, so does Southwest – without the magic of stimulating a mature market replete with competition from low cost and network carriers alike.

Southwest just celebrated its 38^th birthday. It is a mature and maturing carrier operating in a mature domestic environment where it is no longer an innovator. What I find most interesting in Southwest’s potential bid for Frontier is that the carrier is being forced to act just as the network legacy carriers. Southwest is seeking a consolidation scenario that could and should lead to an improved revenue line in Denver where it has significant capacity deployed and where Frontier, a beloved (not LUVed) carrier in the region is all but assured of emerging from bankruptcy protection with its loyal local following in tow.

Keep tuned. I can’t wait to hear the arguments Southwest uses in Washington to gain regulatory approval, particularly as it will be hard pressed to make the argument that acquiring Frontier would lower airfares in the Denver region.

Funny how things change.

02. It’s Airline Deregulation Bday Week: Triangulating Southwest to the Point of Indifference

Second in a series on Deregulation

There cannot be a discussion on the morphing of the US airline industry over the past 30 years without a few words on Southwest Airlines. The presence of this one airline, and its unique model in the US market, has influenced everything from network development; to labor costs; to non-labor costs; to the fostering of an environment that screams “I luv my job,” – rare in the US airline industry.

As I said in Monday’s post, I believe the industry’s discussion of commercial aviation’s economic impact is backward, I am indifferent about the role of Southwest and the Low Cost Carriers sector in general. But I believe that Southwest has had profound influence on the industry, both good and bad.

Network Triangulation

In the late 1980’s and early 1990’s, the Dallas-based carrier was increasingly recognized as a potential force. In May of 1993, the US Department of Transportation published what is now a highly recognized piece analyzing that force: The Airline Deregulation Evolution Continues: The Southwest Effect. Many know Southwest’s storied beginnings, beginning with a napkin on which the initial route network was drawn: Houston – Dallas – San Antonio. As the name implies, much of its network was confined to west of the Mississippi River until 1995.

In addition to the obvious airport market attributes Southwest looks for before it enters a new city, the carrier employed a fairly rigid network strategy as well. One day, I sat down at a table and mapped out Southwest’s growth city by city over its history. Lo and behold, when the initial nonstop segments were announced from a new airport market, you could bet that new triangles were formed. For example, from Indianapolis, Southwest might announce Orlando and Kansas City service. Southwest made sure before announcing any two new segments from a new city that there was existing service between the two points, just as there was in the case of Orlando-Kansas City when Southwest began service in Indianapolis.

Airline observers often refer to the hubs of the network legacy carriers as “fortress hubs.” Southwest built its own fortresses of sorts through the use of its network triangle strategy, protecting its own flows no matter how small. Over time, the carrier took small hub airports and made them medium hubs – or nodes -- which like fortress hubs serve to protect Southwest’s primacy and discourage competition.

Southwest’s construction of its nodal network provides it with both the flexibility of being a point-to-point carrier as well as a carrier that connects traffic across its system at super nodes like Baltimore, Nashville, Phoenix and Las Vegas. While it serves only 64 of the nation’s 340+ commercial airports within the contiguous United States, Southwest impacts more than 90 percent of nation’s domestic origin and destination traffic.

This calculation is tedious but its methodology is simple. Draw a circle of two hours driving distance around each of Southwest’s 64 points – a clear visual of their strategy that aims to expand the catchment area, or reach, of the airport markets it chooses. Then, envelope multiple airports within the catchment area; each of them becomes a source of demand for the carrier’s lower fares. Southwest service has demonstrated clearly that the highway is an acceptable entry point to access the US air transportation system, but it also has had a negative and profound effect on small airports.

[Editorial question for policymakers: why is access to the air transportation system via the highway acceptable when Southwest is involved and not acceptable if a network legacy needs to close a market because it is not economic to serve a particular airport market?]

Earlier this month, Southwest announced it would start service to Minneapolis/St. Paul making the Twin Cities its 65th node. To give you an idea of the power of the carrier’s "no-connect network", it advertises that modest service between the Twin Cities and Chicago-Midway will provide access to more than two-thirds of Southwest’s entire network.

Great to be a Southwest Employee, Not so great for other airline employees

In recent years, Southwest employees have fared significantly better than their network legacy carrier peers in winning wage and benefit improvements. Today, Southwest workers are, on average, the highest compensated employees among the top dozen carriers. Their secret in providing industry-high average wages is simple. Their model incorporates and employs high productivity across a network of shorter stage lengths and smaller aircraft that should, by definition, make this achievement most difficult. And all of this is made possible through their unique network.

Keep in mind however, that Southwest did not enter the competitive fray burdened by labor contracts with provisions held over from before the advent of jet airplanes. It didn’t have a senior workforce or the labor costs bloated by seniority pay. And it didn’t have a network like those of its competitors that entered the market well before deregulation – in other words one designed by regulators who determined which cities, from which carrier, would get commercial air service with little regard for efficiency. Instead, Southwest got to draw its own lines and routes that define the company today. And they did so with an evangelical approach to labor and employee relations that many believe give the airline an edge in customer service and reliability as well.

Productivity is the Southwest mantra – whether it is labor, aircraft or facilities. Southwest’s non-labor costs have always been a competitive advantage. Many observers believe that unit labor costs are the airline’s most effective weapon, but I argue that is not the case. Instead, it is the relationship of productivity and pay that has provided Southwest with flexibility to pay relatively high wages as it negotiates with its highly-unionized work force.

This is the concept that the unionized work forces of the network legacy carriers struggle to comprehend. Traditional hub and spoke carriers with vast operations cannot achieve Southwest’s level of productivity. But there is a relationship, or an equilibrium, that can be found at each and every carrier. If the will to ”find it” could only be found.

Now, 30 years after the deregulation experiment began, Southwest has grown to be the largest domestic carrier in the US, with low costs and network scope that will continue to pose a significant competitive challenge to other airlines. Southwest may well be the best managed airline in the business, as most industry observers agree. But its success was also helped by the fact that Southwest did not enter the fray with a legacy noose around its neck. Instead, Southwest succeeded because it was small, nimble and could easily adapt and exploit opportunities as the competitive landscape evolved.

Triangulating Labor, Network, and Southwest

In an ideal world, an airline’s network would drive the labor and staffing decisions to achieve the best possible efficiency and productivity for the respective airline. In the real world, the legacy network carriers are often forced to create a network around the labor contracts that have put strict limits on productivity and constraints on how best to serve markets in its system.

Low cost carriers are most often cited as the primary driver of consumer benefits because low fares have opened the skies to the masses. But are they? Have they been? No. Consider that Southwest serves only 20 percent of the commercial airports in the contiguous United States. So how can they, and their low cost carrier peers, be considered the shining light(s) of deregulation? Yes they drove prices down in the larger markets – the only markets the low cost sector serves with few exceptions - and in some small markets indirectly, but the effect was to kill off many small airports in their wake.

Through its efficient and methodical approach to building a company, Southwest puts pressure on incumbents to be just as efficient. We see this most recently as network legacy carriers have reduced wages and increased productivity. But the process has been supremely painful and, in some cases, required a trip or two through the bankruptcy courts, in part because neither management nor labor leaders had the will to make changes necessary to adapt to new competition.

Today, Southwest’s network touches virtually every geographic market of size in the US. As the domestic market is now contested at each and every point, the network legacy carriers are left with two choices: 1) attrit and possibly exit the domestic space; or 2) negotiate a new labor construct that can cohabitate with the likes of Southwest. Neither choice is ideal. But one choice is better than the other.

Concluding Thoughts

Throughout my career, I’ve been engaged in some battles involving Southwest – but only on the other side. I can attest that they are a hard-nosed competitor. But I am a professed network carrier guy that fervently believes the low cost sector receives entirely too much credit for bringing the benefits this industry drives each and every day.

Southwest is often first to cry foul with claims of being competitively disadvantaged when it tries to enter new markets or protests paying for what it believes is its fair share of the air traffic system. But that so-called “disadvantage” has done quite well for Southwest’s leaders, employees and shareholders.

I applaud and admire the airline’s culture and competitive success. But before we give all of the awards, I ask that small communities and legacy carrier labor ask what good Southwest has done them? In fact, it is the network legacy carriers that deserve awards for keeping many small communities alive by continuing air service, even when some of these routes can’t be flown profitably. It is also true that ticket prices have been contained or even reduced by the hub competition that exists in the US domestic market today.

In the future, look to the horizon for the new competitive battleground. It will be more about Auckland than Amarillo. It really will.

More to come.