In the years since its founding as an intra-Texas low-cost
carrier (LCC) in 1967, Southwest Airlines has grown into the second largest
U.S. airline as measured by the capacity of its domestic route network.
But though many have long since stopped viewing Southwest as
an LCC, analysts say that the airline’s approach to dealing with weakening
industry demand over the remainder of this year reveals that its business model
is still influenced by its low-cost roots.
“In the broadest sense of all, Southwest is still an LCC,
and LCCs win more with cost advantages than with revenue advantages,” said Seth
Kaplan, managing partner of the newsletter Airline Weekly.
Each of the four major U.S. carriers — United, American and
Delta along with Southwest — reported softening demand during earnings calls
last month. Southwest, for example, projects that its unit revenue, defined as
how much money it makes per seat for every mile it flies, will be down 3% to 4%
this quarter compared with a year earlier.
The carriers attribute the softening market to a more
competitive fare environment for close-in bookings and to weak corporate-travel
For legacy carriers United, American and Delta, difficulties
in the transatlantic market, in large part related to foreign currency weakness
and to the fallout from Brexit, are other causes of concern. Southwest does not
fly to Europe, though it does serve Latin America.
In response to softening demand, each of the Big Three
announced plans to curtail capacity growth for the remainder of this year.
Reducing growth doesn’t make sense to this year’s bottom
line, Southwest CEO Gary Kelly said during the carrier’s second-quarter
earnings call on July 21.
“We’ve not been able to model a scenario where it was profit
positive for us to do that,” he said.
Southwest’s approach sparked a sharp question during the
call from UBS Securities stock analyst Darryl Genovesi, who noted that capacity
cuts from the legacy carriers will likely help Southwest. Why, Genovesi asked,
is Southwest resistive to coordinating with its main competitors on capacity
and pricing, at least to the extent that such things could be done without
violating antitrust laws?
“With Southwest having grown to be as large a player as it
is in the industry today, isn’t it kind of required that, overall, the industry
is healthy in order for Southwest to be healthy?” Genovesi asked.
Kelly, in what was likely a well-advised effort to avoid any
issues related to antitrust laws, declined to answer the question.
Kaplan, though, said that Southwest simply has a different
decision matrix than the legacy carriers when it comes to capacity expansion.
He said that as a general rule, legacy carriers have higher
cost structures than LCCs due to less favorable union contracts and more
expensive offerings such as fancy airport lounges and differentiated products,
including business-class cabins. Because their costs are higher, such airlines
tend to react to weakened demand by reducing capacity in an effort to cut costs
and drive ticket prices higher.
In contrast, LCCs have much lower overhead than their legacy
competitors. So their key to higher profitability is to create additional
efficiencies through route expansion. More routes mean lower gate fees on
average and more efficient use of aircraft, for example. Because overhead is
lower, LCCs can expand longer than legacy airlines in a weakened fare
That difference is evident in the current rate of expansion
of various U.S. airlines. While the Big Three are adding just a point or two of
capacity this year, the ultra-low-cost carriers Spirit and Allegiant increased
their available seat miles by 24.7% and 16.9% respectively through the second
quarter. The LCC JetBlue, meanwhile, said it anticipates growth of 8% to 9.5%
for the full year, though it, like the Big Three, did reduce planned capacity
growth by .75% in June.
Southwest’s growth rate this year of 5% to 6% falls in
between the LCCs and legacies, reflecting what both Kaplan and airline industry
analyst Bob Mann of RW Mann and Co. say is its status, both in pricing and
overhead: somewhere between the LCC it was two decades ago and the legacy
carriers with which it is now on par with regard to the size of their domestic
Because Southwest is now bridging that gap, it still competes
a bit more directly for route space with the upstart airlines than do American,
United and Delta.
“There’s a smaller difference between Southwest and the
irritants who want to grow rapidly,” Mann said.
Kaplan added, “In terms of capacity, it is always a little
more important for Southwest to grow than it is for Delta, American and