MIAMI — Southwest Airlines is now more than two months into its Transfarency campaign, aimed at highlighting the carrier’s simple pricing and bundled fare structure, and the customer response has been immediate and swift.
The initiative pits Southwest against cheaper rivals such as ultra-low cost carrier (ULCCs) Spirit Airlines as well as legacy carriers like Delta and United, all of whom have embraced an unbundled pricing model laden with extra surcharges and fees for services ranging from checking baggage to altering flights.
“Southwest is different,” said the carrier’s Chief Marketing Officer Kevin Krone. “You get what we think is a reasonable travel experience. Two bags, no change fees, there’s no extra for that.”
Krone added that the response to the marketing campaign over the past two months has been overwhelmingly positive. “We’re getting other people that have their horror stories saying: ‘yes, I’ve learned my lesson. I learned what I thought was a low fare wasn’t, that I had to pay all these extra fees.’ People were very supportive of Southwest and the message because again, people are fed up with this kind of bad behavior and we are too.”
Even today, simplicity drives Southwest’s customer relationships
The Transfarency campaign is meant to highlight the relative simplicity of Southwest’s product and customer experience. Despite economic pressure to the contrary, Southwest has held firm with many of the tenets of its product. Checked bags and (some) itinerary changes are still included in the product, as are the free-for-all seating and free peanuts (at least until allergies kill this element). Southwest still offers just one class of service for tickets sold at one place only (its website), and it doesn’t offer code shares or seats through global distribution systems (GDS).
This simplicity is at the core of Southwest’s offering, and even as Southwest has introduced some alterations to its base product in the new millennium, its relative simplicity versus legacies and ULCCs alike is a competitive advantage. And the nice thing for Southwest is that both types of competitors continue to drive up complexity in an effort to optimize their price discrimination. For the Deltas and Americans of the world, that takes the form of stripping out elements of their core product from bottom of the barrel fares like Basic Economy at Delta, while for the ULCCs and peer carriers like JetBlue, it takes the form of bundled and customized fares. Both of these increase the margin for Southwest to make alterations to the core product that their customers do like while still offering more simplicity than the market at large.
Straddling the line between LCC and Legacy
Many of those alterations, such as Southwest’s Business Select fare class, are an acknowledgement that Southwest Airlines is a carrier with a confused identity, with a business model that mixes its low cost carrier (LCC) roots with the practices of its legacy, full-service rivals. Indeed, despite its 44 year history, Southwest is still something of a startup, a moniker that encapsulates more than Southwest’s entrepreneurial verve.
The underlying principle is that every startup, whether driven by technology or by a product, goes through a cycle. At the start, the startup is little more than a product and a core team, and there’s an initial process of offering the market the minimum viable product (MVP) that they’ll pay for. As the startup grows and starts to capture a tangible share of the market, the first step is to scale operations to handle a larger proportion of customers, which is followed by making small optimizations to the product and then growing market share as much as possible on the back of that product. For most startups, as long as the product is good and they have a strong, scalable corporate culture, this can be the ticket to become a viable and even large company.
This is what Southwest was for the first 35 years of its existence. After 5-10 years of experimentation, it found a product that people really liked in Texas and then copied that model in the rest of the US. And thanks to their excellent corporate culture, they were able to ride that to 80 million annual passengers and a fleet of more than 600 aircraft.
But there comes a point when that product can no longer go any further, when there are not that many customers in the broader market left who want that specific product. The normal response here is to add product lines or modify the core product so that it appeals to additional segments of the market. Southwest has blended both of these, adding product lines like service to major airports (Boston, Washington Reagan, et. al) and international destinations as well as modifying its core product (Business Select, streaming media, et. al).
This is an important transition that many companies go through, and usually it results in a more complex company that has to leave some of its initial customers behind. Southwest is currently in this position, as it shifts from an airline that competes on price with everyone to an airline that competes on value with ULCCs and on price with legacies.
Southwest is competing on value for price
Krone agreed with this characterization, noting that Southwest does focus on offering superior value for its fare. “The other [airlines] have stripped [their product] down so bare that I don’t think they are offering value [for the initial price],” he said, “Just a seat that goes A to B and you’ve got to buy back everything else to complete the experience. [Offering customers value for price] is extremely important, it’s one of the main objectives of the company. Our CEO made this a focus for the company and it’s one of those we’re working every day to build on and get better at it.”
The key factor in Southwest’s value proposition today is that Southwest will offer a simple, complete product at an affordable price for whatever type of traveler you are. This might be a different product and price point for the family of four visiting Disney World for a week in July and for the high-powered consultant touching down in Providence for just one night in March. But for many different segments of the market, Southwest’s promise is that they will provide exactly that.
The key intuition here is that the US air travel is not a monolithic mass of customers who care exclusively about price. Even the normal differentiation between Instead, there are 10-15 customer archetypes for domestic air travelers in the US, each of which differs in its price elasticity, budget, willingness to pay, desire for flexibility, control over the purchasing process (low level business travelers have less than high level business travelers who have less than individuals) and a whole host of other characteristics. Southwest’s business model is to offer an affordable, high-quality product to seven or eight of them.
Southwest and the Southwest Effect are victims of Simpson’s Paradox
One common criticism that is levied at Southwest is that they are no longer a low fare carrier, and this was the immediate response to the Transparency campaign. The DOT data largely backs up that claim – since 2005, Southwest’s stage length adjusted unit revenues are up 64% since 2005, from 6.7 cents to roughly 11 cents. And based on that claim, I myself have made this assertion several times that Southwest isn’t an LCC any more – look no further than my proclamation two years ago that the Southwest Effect was dead; replaced by the Spirit Effect.
And I stand by that assertion – the Southwest Effect as we traditionally understood it is in fact dead. Southwest is no longer a carrier that can waltz into a community and drive down average fares by 75% while stimulating traffic by 150% or more – its cost structure and the nature of the market doesn’t allow for that.
But there is another angle by which the Southwest Effect is alive and kicking. And that’s where you shift the focus to look at customer segments instead of the overall market. There’s a well known effect in statistics known as Simpson’s Paradox, which refers to a situation where there is one trend for every subcategory of data that is reversed when those subcategories are combined into one aggregate data set.
Simpson’s paradox is common in commercial aviation, especially in the realm of on time performance. For example, Delta might have a better on-time performance rate than Alaska Airlines at every airport where both carriers operate, but because Delta has hubs in the congested Northeast while Alaska’s operation is centered on the Pacific Northwest, Delta’s overall on time performance might be coded as lower than Alaska’s, even if for any flight where Delta and Alaska go head to head, you have a better chance of getting to your destination on time by flying Delta.
In the case of the Southwest Effect, this comes down to customer segments. Southwest could drive down fares by 75% for last-minute business travelers and by 75% for bargain basement customers as well, but because it is serving so many more business travelers who pay much higher fares, these individual effects might be hidden by the overall data on how Southwest’s fares have changed.
After spending a long time reviewing the DOT data and playing around with various hypothetical itineraries and customer archetypes, I have reached the conclusion that this is exactly what’s happening with Southwest, something that I will explore with more detail in an upcoming analysis that revisits both the Spirit Effect and what I’ll call the “New” Southwest Effect.
I now believe that Southwest is driving down fares a bunch within each segment of passengers, but because the mix of passengers that they have is shifting to include so many business travelers, that effect is being masked in the overall data. For example, following Southwest’s entry into Washington Reagan, Krone noted that fares dropped by 17% in markets where Southwest added service. But if you isolate to the various segments of the market, their fares likely declined by at least 30-40%, if not much more.
Southwest isn’t necessarily a low fare option for every segment of the market. For some, such as business and leisure passengers in premium cabins, it doesn’t even choose to compete. And for a few others such as single backpackers looking for the absolute cheapest ticket possible, it can no longer compete. But for a wide swath of the market, Southwest is still a low fare carrier for the actual product that those customers want to buy.
Playing games with “base fares”
My analysis of the rise in Southwest’s fares is based on stage length adjusted unit revenues, but the usual figure used to attack Southwest for its rising fares is the simplistic metric of average fare paid per customer. When explaining the rise in this statistic, Krone countered by stating: “[Y]ou really have to really think about the drivers… [I]n the last fifteen years, there’s been a huge shift from short haul travel to long haul which is much lower fare. That is a profound impact that you can’t sort of casually gloss over.”
Krone added that as Southwest carries more business travelers, whether on short haul or long haul flights, this creates a compounding effect that drives up the average fare. The rise in average fares is ultimately a meaningless statistic without context.
Even more important is the fact that the rise in Southwest’s base fares only tells part of the story.
“You can say Southwest no longer has the lowest fare, and I grant you that, except for the trick that other people are playing,” said Krone. “So there’s a very thin line one can walk and get that quote “lower base fare”. If you look, not many people can walk that line. It’s designed frankly, so you can’t walk that line. If you go look at the data that’s out there, as you pointed out, the data you do find, there’s other carriers out there who offer a low ‘base fare,’ but when you look at what the airline is making in terms of passengers, you can tell that basically, and in the case I’m thinking about here, their extremely low base fare really gets at the end of the day, puffed up basically though the Southwest Airlines fare.”
“[For example], Carrier A has a $90 base fare and Southwest has a $140 base fare, Southwest loses, but you can’t stop there. At the end of the day, people are really paying $140 on Carrier A. It’s just a lot more pleasant on Southwest, you’re not tricked into it or having all these surprises at the last minute and so Carrier A basically counts on the fact they’re going to get you for another $50 bucks and that’s why they just have split their average fare into two pieces. One is the average base fare and the other is all the other stuff you’re going to have to pay and not want to.”
The metric of out-of-pocket travel costs is simply a better way to measure the true cost of flying a particular carrier. And it is important for airline passengers to start to understand this fact – that the price that is quoted or advertised to them is not the price that they will actually pay.
Transfarency is a valuable customer education play
Marketing value aside, this is where the Transfarency initiative really shines: as a customer education play. Southwest’s existing customer base understands that Southwest is offering a fundamentally different product than every other airline on the market. Just as it’s a mistake to assume that airline passengers are a monolithic entity, so too is it a mistake to assume that airlines themselves are interchangeable.
For too long, passengers have assumed that every airline offers them the same experience and same product, and have accordingly made purchase decisions largely on the basis of price. But this is absolutely not the case, and it is critical for the airline industry to articulate the differences between the various products offered. Spirit Airlines has taken the lead on some of this with its customer messaging, and Southwest has just added another dimension with the Transfarency campaign. Good customer education can double as good marketing – the initial signs are that Transfarency is both.
“The other part of the mission [for Transfarency],” said Krone, “is those people that think Southwest is just like everybody else or that the industry is what it is and everybody does the same thing. We wanted to make sure that we stand for something different and we want you to try Southwest.”