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Southwest losing consumer lustre as pilots vote on integration

20th October, 2011

Two things are happening at Southwest that threaten both its consumer-friendly image and its plans to integrate AirTran into a single carrier and maximize the synergies between the two airlines.

Having built its 40-year reputation on working on behalf of the beleaguered airline passenger suffering from fees and high fares, numerous stories are appearing announcing the legacy carriers are successfully beating Southwest at its own low-fare game by consistently being cheaper than the Dallas-based airline.

Avondale Partners analyst Bob McAdoo received widespread coverage when he looked for a reason business demand at Southwest softened in the second quarter and he didn’t have to go far to find out why. He suggested it might be Southwest’s fare aggression.

Examining his own experience as a Southwest passenger out of Kansas City, Mr McAdoo then studied 70 routes out of eight cities, selecting both busier and less busy routes. McAdoo reported fare activity on 20 routes were not clear while in 40 of the 50 remaining routes Southwest was higher and only on 10 routes was it less expensive.

Its most aggressive low fares were against Alaska, which has restructured itself in the past five years to compete with low-cost carriers on their own terms. Mr McAdoo further found Southwest averages USD134 more for the ticket, a 26.5% premium.

CFO Laura Wright reported 19% of tickets sold in the second quarter were full fare tickets, compared to 22% in the 2010 second quarter.

While this may tarnish its low-fare consumer perception, Bob McAdoo pointed to the company’s significant curtailment in capacity growth as allowing higher fares not only for Southwest, but for the rest of the industry as well.

One thing is perfectly clear. Despite numerous fare increases – CEO Gary Kelly pointed to seven this year alone – that have tested passenger elasticity and won, the booking window to capture a low Southwest fare is now well beyond the 14-day advance purchase.

What Southwest had going for it was its refusal to charge bag fees, putting it at a competitive advantage to its legacy rivals. Now, however, more often than not, legacies have lower fares even when counting in their exorbitant bag fees.

The question is whether its aggression will tarnish its lustre as America’s so-called favorite airline and as the largest domestic carrier in the US.

Indeed, it will be interesting to watch whether the coveted business traveller, who has considered Southwest the go-to airline in terms of service and fares, will abandon the carrier as economic necessity dictates the use of other carriers.

For consumers, the problem is that there are low Southwest fares out there but they are in highly competitive markets, not off-line points such as Albany, NY, Providence, RI and Manchester, NH. Of course this makes Boston a much more competitive airport, especially as legacies depart and jetBlue builds its presence by catering to the very travellers that are now realising the extent of Southwest’s fare aggression.

Interestingly, the same is true of Milwaukee where AirTran and Southwest, albeit with a much smaller presence, are competing against Frontier, which is pulling back dramatically this autumn.

There is an increasing number of stories commenting on how Southwest’s fares are higher. Fares at legacies are often USD100 cheaper than Southwest including the fees, and Continental and US Airways can be credited with their own kind of aggression of fares: beating Southwest.

The changes at Southwest have also included the restructuring of its Rapid Rewards programme last March, following jetBlue and the rest of industry in favouring the higher-fare-paying business traveller. Instead of its consumer friendly and very simple rewards programme that awarded free tickets for every eight flights, it has imposed a more complex structure awarding more points to those who pay higher fares.

While this is now industry standard, it caused a heated backlash when it was first rolled out and continues to compromise its egalitarian image. Southwest, however, is not like, say, Apple that can get charge a premium for its product. In fact, the assumption that low cost means low fare is well and truly gone, except with the likes of Allegiant and Spirit.

Southwest is not even the lowest cost carrier in the industry. It is now in the lower third of the pack with legacies having trimmed their costs. jetBlue beat its USD 7.91 cent CASM excluding fuel costs in the first quarter at USD 7.22 cents. In the second quarter, jetBlue’s CASM excluding fuel was USD 6.62, compared to Southwest’s USD 7.63. Frontier beat it in the second quarter at USD 7.56. Alaska’s CASM excluding fuel in the second quarter was USD 8.46, down 3.1% while Southwest’s rose 3.8%.

See related article: Comparative statistics of 2Q2011 US financial results

The problem is, Mr McAdoo also noted, that Southwest’s revenue performance is lagging its peers. Unit revenue growth, according to CEO Gary Kelly slowed to only 4.1% in the second quarter from 8.7% in the first quarter. This compares to 14.1% at jetBlue in the first quarter and 10.2% at United. For the second quarter, JetBlue’s unit revenues were up 13.2% and Frontier was 10.4%. United and Delta were up 9.1% and 9.9%, respectively.

The growing complexity with AirTran and problems with pilot integration will further test its costs, especially if it is unable to maximize the synergies from the merger.

Passengers are increasingly checking online search sites after checking Southwest and opting for other airlines when they see the difference. What Southwest has done is to give legacies the opportunity to tout they are even cheaper than the airline.

Perhaps Southwest is transitioning from being an airline passengers fly on not for how cheap it is, but because of who and what it is – its brand. As CAPA's boardroom magazine Airline Leader wrote in an introduction to monetising airline brands through frequent flyer programmes, "If you're running an airline, you're probably in the wrong business. Not just for the obvious reasons. You should be marketing your brand, not selling tickets. One is unique and valuable, the other is a commodity. One can be monetised, the other mostly creates jobs for others."

Read more: For love and money - the airline frequent flyer programme

Southwest still earns kudos for its bags-fly-free policy, but that is diminishing in importance as legacies go after the brand. Similarly, its no-change-fee policy remains popular but it is clear from the diminishing levels of such fees, passengers are becoming more disciplined, which makes the proposition less valuable.

But at the end of the day to airline shareholders, it is yield that matters. In 2Q2011, Southwest's yield of 14.67 US cents was beaten only by US Airways (16.30 cents) and Delta (15.67 cents).

Pilots ride a confusing roller coaster

The impact of its fare increases on business travellers is now being compounded by the confusing roller coaster that represented its effort to merge the seniority lists between the 6000 affiliated with the Southwest Airlines Pilots Association (SWAPA) and 1700 AirTran pilots represented by the Air Line Pilots Association (ALPA).

In Aug-2011, Southwest seemed to have achieved a merger milestone when it reached agreement to merge the lists with both pilot groups. This later fell apart and now it is saying that if it cannot reach accord, it will operate AirTran as a stand-alone airline and slowly dismantle it similar to its actions after acquiring Muse Air.

In Jul-2011, the two groups reached agreement on integration but AirTran’s pilot leadership opted not to send that agreement out for a rank-and-file vote. This has some AirTran pilots calling for a recall of that leadership.

In Sep-2011, a second agreement was reached and the two groups are now in the midst of a ratification vote that ends 07-Nov-2011.

Following the refusal to put the first agreement out of vote, however, Southwest pulled its sweetheart deal for AirTran pilots, which is the reason for a recall move. It also completed its alternative plan for the two carriers on 20-Sept, calling for AirTran and Southwest to be operated separately if the integration vote fails. Essentially, the agreement reached in September protects SWAPA seniority rights, leaving AirTran pilots with only pay raises.

Southwest briefed pilots that the Plan B arrangement still earns the Dallas-based carrier savings and revenues because it will retain the baggage fees AirTran charges, approximately USD200 million annually. It would also retain the Boeing 717s that Southwest had previously planned to retire in favour of its own 737s.

If this happens, it would make Southwest/AirTran the second airline in which maximising merger synergies failed due to pilot problems. It follows US Airways/America West where pilot groups continue to fight over integration as long as six years after US Airways and America West merged. Former US Airways pilots refuse to accept court rulings favouring America West pilots and, in fact, were recently enjoined from a job action against the airline by another court.

Even so, Southwest comes out the winner because it still gets what it went after in acquiring AirTran – access to Atlanta.

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