Fees in the Future for Southwest?

Southwest Airlines is one of the few great current success stories in the airline business. It’s the largest low-fare airline in the U.S. It’s the largest to sixth-largest among all U.S. airlines, depending on how you measure. It’s the model for such other giants as EasyJet and Ryanair as well as a bunch of smaller lines and most current wannabes. Although Southwest has been regularly profitable while most other lines spilled red ink, however, recent developments have caused some industry mavens and individual travelers to ask if the airline is ready for the next 20 years or so. A reader put it this way:

“Is Southwest’s pricing model sustainable, given its betting on peak oil prices? Will Southwest eventually be forced to raise ticket prices or add a la carte fees like their competitors?”

My short answer is that, as I understand it, Southwest’s troubles with oil price hedging are almost over. And its current pricing strategy seems to be working. Given its track record, I believe it is in good shape for the long haul.

The Hedging Fiasco

“Hedging” fuel is a practice that many airlines—not just Southwest—use. Before about 2000, the main purpose was to maintain consistent fuel prices, allowing an airline to make financial and operating plans that were not subject to market fluctuations.

Southwest’s managers were hailed as geniuses when, in 2000, they adopted a more aggressive hedging strategy—not just to stabilize fuel prices but also to profit from the price increases it expected in the future. This process worked well until the last half of 2008, when oil prices suddenly tanked. Instead of paying less than the market price for fuel, Southwest suddenly had to pay more than its competitors were paying. Southwest did, in fact, take a financial bath.

The good news is that Southwest is apparently out from under all—or almost all—of its earlier high-priced fuel commitments. The company has announced that it plans to hedge no more than about 10 percent of its fuel needs over the next few years, and that at much lower prices than the earlier hedges.

Overall, I haven’t seen a complete analysis of whether Southwest netted out better or worse over the full eight-year period than it would have absent the hedging. But the problem of high-price hedges apparently will not be repeated.

The Pricing Model

Southwest has always marched to its own drummer on pricing. After experimenting with a mix of round-trip and one-way fares, Southwest now prices all of its tickets on a one-way basis. It uses advance-purchase restrictions and capacity control for yield management.

Although at one time Southwest almost always posted the lowest fares on any route it flew, that’s no longer always the case. Other lines occasionally undercut it, although usually with stiff restrictions. But Southwest keeps fares at a level low enough to keep its planes reasonably full. As with other lines, it may charge substantially higher fares, per mile, on noncompetitive routes than on routes with stiff competition.

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Southwest is the only U.S. airline still offering a full senior discount program, for travelers age 65 or over. Southwest’s senior fares are almost always higher—sometimes much higher—than the lowest advance-purchase fares available to travelers of any age. But they carry no advance-purchase restrictions, they’re fully refundable for cash, and they’re well below Southwest’s walk-up and fully refundable fares for other travelers.

As another pricing quirk, Southwest has not agreed with the main online agencies—Expedia, Orbitz, or Travelocity—to post its fares. Screen-scraper Kayak displays Southwest’s schedules but not its prices.

Southwest has, so far, resisted the general industry trend to nickel-and-dime coach travelers with separate charges for almost everything, including the first or second checked bag, onboard soft drinks and snacks, making reservations by phone, curbside baggage check, and such. (Check here for a rundown of fees for all major U.S. airlines.) Southwest has been heavily advertising this “no extras” feature, and the ads at least appear to have some traction in the marketplace.

Southwest’s only real “extra” is a premium level of its unrestricted fares that provide priority boarding—and therefore access to the best seats, none of which is pre-assigned—as well as a “free” drink and extra frequent flyer credit. I haven’t seen how well this program is working, but since it’s an extra fee on top of Southwest’s top-dollar fares, it isn’t of interest to most leisure travelers.

Historical Business Model

So far, Southwest has generally followed a fairly consistent growth strategy:

• Operating a point-to-point rather than hub-and-spoke router system, minimizing problems and costs of accommodating connecting passengers.
• Avoiding head-to-head competition with the giant legacy carriers at their “fortress hubs” and on their major bread-and-butter routes.
• Using secondary rather than primary airports where feasible—Midway rather than O’Hare, Love Field rather than Fort Worth, Long Island-MacArthur for New York, Manchester and Providence for Boston, and such.
• Not participating in any industry through ticketing and accounting protocols.
• Flying only a few 737 variants, and sticking to routes with enough traffic to support two or more daily round-trips with 737s.
• Maintaining the industry’s highest productivity.
• Maintaining the industry’s highest ratings for customer service.

Growth Prospects

Southwest’s previous approaches could severely limit its future potential. Southwest has already picked the “low hanging fruit” of possible routes in the U.S. Significant growth will require some departure from traditional strategies.

• Southwest has already announced code-sharing deals for cross-border flights with WestJet (Canada) to start late this year and with Volaris (Mexico) to start in 2010. And it is reported to be considering some international services on its own.
• It has entered some of the high-cost, congested airports it once shunned: Dulles, LaGuardia, and San Francisco to start; others maybe to follow. And it has challenged Northwest at its primary Minneapolis hub.

An intangible is the absence of Herb Kelleher, its charismatic co-founder and long-time chief executive, who retired as chairman in mid-2008. Virtually every step of Southwest’s spectacular growth, from a small intrastate line in Texas (using a business model borrowed from California’s pioneering intrastate line PSA) into the top rank of U.S. airlines, bears Kelleher’s personal imprint. Some industry mavens question whether the current management—or any management—could continue as Kelleher did.

On balance, Southwest seems to be in a good position to stay successful. The airline has indicated its ability to maximize the benefits of its core strategies while departing from individual strategies when circumstances require. As with airlines, generally, it will not grow much, if any, during the current financial crisis. But I believe it’s well positioned for the long haul.

(Editor’s Note: SmarterTravel is a member of the TripAdvisor Media Network, an operating company of Expedia, Inc. Expedia, Inc. also owns Expedia.com.)