MIAMI — The corporate culture of Southwest Airlines is cited the world over as a model, and company executives are the outward manifestation of that culture. Earlier this year, Southwest Airlines graciously granted us an interview with its Chief Commercial Officer. During my conversation with Southwest Airlines’ CCO Robert Jordan, I found Mr. Jordan refreshingly candid and more than willing to draw upon his twenty six years of experience at the carrier to give detailed responses to my questions.
I start by pondering Southwest’s general appeal to business travelers, and Mr. Jordan is keen to dispel the perceived myth that Southwest Airlines is an exclusively leisure airline:
“It is kind of funny that folks think automatically of Southwest as a leisure airline [when] we carry more business customers than any other domestic carrier here.”
This slightly sardonic response sets the tone for a large slice of the entire interview, during which my earnest questions about Southwest’s public perception are summarily dispatched. It is clear that Mr. Jordan is keen to dispel many of the rising misconceptions about the Southwest Airlines model, about the underlying rise in costs and fares that has caused whispers in some circles that Southwest Airlines is no longer a low cost carrier.
On the subject of Southwest’s revenue-based Rapid Rewards frequent flyer program, Mr. Jordan clearly takes pride in Southwest’s market leadership in the field. Before I can even complete my (admittedly convoluted) question about Rapid Rewards, he interjects in response to my opening sentence about Southwest switching to revenue-based.
“We did, we did, and Delta, Delta just followed!”
Implicit in that statement is a subtle but important shift in the power dynamics of the US airline industry. For the longest time, Southwest was the industry’s financial darling – the most profitable carrier in the US in both percentage (margins) and absolute terms (it’s been profitable for 41 consecutive quarters). At some point in the early 2000s, Southwest plateaued. The combination of steady growth and its remarkable fuel hedges positioned Southwest as a carrier that was profitable almost without trying. What had once been a plucky underdog that thrived on constant innovation had turned into a lumbering industry behemoth in its own right.
But consolidation has flipped that script – today Delta is the financial darling of the US airline industry – the world’s most profitable airline – a free cash flow generation machine – a titan in returning cash to shareholders – on the cutting edge of revenue generation. Mr. Jordan sounds genuinely proud that one of his airline’s innovations is being copied by the industry’s current king.
Southwest is once again overshadowed by the big three legacy carriers and, once again, Southwest is the plucky underdog, fighting to grow its revenues in a race against Father Time. And despite the challenges implicit in that scenario, I get the sense that Mr. Jordan, and by extension Southwest, are perhaps more comfortable pursuing innovative forward momentum.
Rapid Rewards is one manifestation of that forward momentum, and Mr. Jordan touts the progress being made:
“We’re seeing just a tremendous response to the program. The share of wallet that we get. The annual spend per member. Every single metric is up-double digits. Every year since we introduced the program. Our Chase Rapid Rewards Visa card is one of the largest card- it’s one of the largest Visa card portfolios in the world. And it’s seen just tremendous growth since we’ve changed the program.”
Alongside the revenue momentum provided by Rapid Rewards is a broader pitch to grow revenue by giving Southwest product that can attract revenue from high value business customers.
“We have different fare products; Business Select is a fare product that has attributes like more credit and early boarding and those kinds of things. And then we have add-ons like Early Bird where… you’re earlier in the line, you have better access to … seats and those kind of things. So over time, we have added optionality to what you can buy.”
Mr. Jordan stresses the word optionality, which Southwest views as superior what they term “forced” fees such as charges for checked baggage or flight changes. The last eight years have seen a marked shift in Southwest’s relative position in terms of service quality in the US market. As legacy carriers have cut back on economy class and ULCCs have devolved their core product to a-la-carte pricing, former no frills airlines like JetBlue and Southwest have found themselves, ironically, with a superior base (Economy Class) product. Southwest’s marketing and focus has changed implicitly to highlight its superior product, and a key part of that service quality lies in Southwest’s lack of checked baggage and change fees. Thus Mr. Jordan stresses the distinction between Southwest’s optional charges and unavoidable ones, because the latter are viewed with almost universal negativity.
These business-targeted ancillary products have driven substantial growth in corporate revenue for Southwest, which Mr. Jordan further demarcates into three buckets. The first is unmanaged corporate travel, typically small and medium businesses that are loyal to Southwest and work with Southwest but do not have formal corporate contracts. The second is informal corporate travel, business travel on Southwest that does not fly due to any specific contract or discussion. And the third is managed corporate travel; the kind of corporate contracts that the big boys (Delta, American, and United) live and die by. Mr. Jordan notes that while all three buckets of business travel are growing faster than the base business,
“[Southwest’s] corporate managed business is growing substantially faster than the other corporate business. So we’re seeing double-digit growth in that managed corporate space. Again larger span, larger contracts, larger companies. And we’ve got a real focus there, so we got a team of people that work that like most carriers do.”
Southwest may have been carrying business customers for a very long time, but this encroachment on the domain of legacy carriers is certainly virgin (no pun intended) territory. On a recent earnings conference call, Southwest CEO Gary Kelly stepped for a moment out of his normally muted personality, and dared to dream a little bit.
“We serve 96 cities today with Southwest and AirTran and have a potential to add 50 new destinations over some period of time, and that would be several hundred airplanes — worth of flying.”
Deep down, that’s the dream that Mr. Jordan and Mr. Kelly are chasing, that’s the silver bullet that will solve Southwest’s perpetual race against its labor costs by boosting revenue. And that’s where all of the work that Southwest has put into corporate contracts will pay off; leisure travel may provide the volume internationally (and to Hawaii and Alaska as the quote references), but business travel brings the requisite yields and profitability. That growth ethos has been missing from Southwest’s earning calls since the merger with AirTran closed (and even going back before the global financial crisis), but its resurrection (enabled in part by improvement in technological platforms) is inextricably tied to the renewed focus on business travel.
In the past, that growth ethos has had a very important, and positive impact, on the shape of the US air travel network.
“The legacy carriers consolidated their hub structure, and so we… go [into] places where the fares are too high and the service is too low and attack. And as the legacies pulled out of places like St Louis and Reno and Raleigh and Cleveland…we have worked to backfill some of that service…. [Especially] … mid-tier cities. So not the New Yorks, but places like St Louis, Kansas City, Nashville, Orange County- a very long list- also Austin, TX.”
For those types of cities, and places like Baltimore and Nashville can be added to the list, Mr. Jordan rightly points out that Southwest has played an essential role in maintaining nonstop service. For example, today in St. Louis, despite losing its American Airlines hub by 2007, the airport still has nonstop access to close to 59 destinations thanks to Southwest’s “hub” there. After being de-hubbed by US Airways, Pittsburgh has service to fewer than half as many destinations. The traditional Southwest Effect of fare reduction and market stimulation might be well known, but the hidden Southwest Effect of preserving nonstop air service at secondary airports might be more influential in the years to come. Given how closely tied international business is with airline hubs, Southwest’s “hubs” even as Mr. Jordan refuses to call them that, will play an irreplaceable role in local economies.
Amidst constant discussion of high priced business travel, I cannot resist the opportunity to grill Mr. Jordan on Southwest’s rising fares. By and large, Southwest is still widely perceived as a low fare carrier. Unfortunately, I just don’t know that that’s really the case. Adjusted for stage length, Southwest’s domestic airfares have risen nearly twice as fast as those of its network and legacy counterparts. DOT data is certainly flawed, but it isn’t lying, especially for an effect of this size.
Part of the rise in fares certainly comes from the disappearance of Southwest’s fuel price advantage, and Mr. Jordan leaned heavily on that as a reason for the fare jump.
“We still have excellent fuel hedge protection in terms of insurance, but we had a real strategic advantage for years. But our fuel cost per gallon has risen from 50 cents to over 3 dollars in that period.”
And he is eager to move the discussion away from base fares (which are not kind to Southwest) to total out-of-pocket travel costs:
“If you look at somebody like Spirit, which may publish a very low fare, they’re getting almost 60 dollars per passenger in fees. Bag fees, change fees, passenger convenience fees, booking fee, government security fee, nuisance fee- you know all kinds of things! You know, recently, they’ve gone to charge you to carry on your bag and put it in the overhead bin. So you’ve got to consider the all end price…we are still by far the lowest.”
There is certainly some truth to that. But using out-of-pocket travel costs as a metric has its own challenges centered on which fees need to be used to measure average costs. Even compared to Spirit, while Southwest can be a steal for certain types of passengers, on average, Southwest is more expensive out of pocket than Spirit (adjusted for network differences).
Southwest Airlines is an evolving business, and my conversation with Mr. Jordan only strengthens that perception. He has been at Southwest since the days of Herb Kelleher, and his diction still carries the underlying tone, the underlying values of legacy Southwest Airlines. But as with everyone in the US airline industry, he and his airline have been forced to adapt.