September 23, 2008

Can Southwest’s Success Continue?

By Chris Walsh

Maybe it's the sand volleyball court in the parking lot or the snow cone machine that several employees set up near the lobby on a recent afternoon.

Perhaps it's the summer deck parties - with $1.50 beers, snacks and sometimes live music - or the casual dress code, where even top executives opt for short-sleeve shirts instead of suits.

Whatever it is, Southwest Airlines' headquarters feels more like a college campus than the corporate offices of a Fortune 500 company.

The party atmosphere is understandable. Southwest ranks as one of the nation's most successful airlines over the past few decades, cobbling together an impressive string of yearly and quarterly profits, developing a cultlike following among fliers and employees and, more recently, expanding into cities while its competitors cut back.

It's been a remarkable run, but some experts question how much longer it can last.

Southwest faces its biggest challenges yet amid high oil prices, a slumping economy and a potentially severe slowdown in leisure and business travel. Several experts warn that the airline could even post a quarterly loss later this year, which hasn't happened since 1991.

With that as the backdrop, the company known for its predictable, streamlined business model is undergoing significant change - and risk - to raise revenues and blunt the cost of fuel. Its strategic decisions will ultimately set the stage for whether the party rages on or starts to fizzle out.

"In terms of economic cycles, this is certainly the toughest we've ever been through," Gary Kelly, Southwest's chief executive officer, said recently. "At the same time, we've also never been stronger than we are today."

If you're searching for a case study on how to run a successful airline, look no further than Southwest. In an industry continuously plagued by challenges related to fuel, the economy and geopolitical events, Southwest has been a model of stability and growth. The carrier hasn't lost money on an annual basis in 35 years, and in the past two decades it has recorded more than $5 billion in profits..

That's no small feat.

Commercial and cargo carriers in the United States lost a collective $14.9 billion during the past 20 years, according to the Air Transport Association, a Washington-based industry trade group. Most of Southwest's competitors have filed for bankruptcy protection along the way or gone out of business entirely.

And while other airlines are bleeding cash and wobbling on the edge of bankruptcy, Southwest has ample reserves and a solid balance sheet.

"Through all the ups and downs they've been through, from the early 1980s oil-price shocks to 9-11, to the current fuel crisis, they've always managed to make a profit," said Peter Cohan, who runs a management consulting and venture capital firm in Massachusetts and wrote about Southwest in a book on leadership. "Considering the billions of dollars the industry loses on average, to make a profit is amazing and to do it consistently is even more impressive."

Southwest has thrived for more than three decades by sticking to a no-frills, streamlined business model focused on low fares, low costs and operational efficiency.

The carrier, for instance, flies a single type of aircraft, which keeps maintenance and training costs down. It primarily targets smaller airports with lower fees and charges. It can quickly load, unload and clean aircraft, allowing it to fly each plane as much as possible each day. And it has largely shied away from code-share agreements and regional partnerships with other carriers, which can dampen profits.

The carrier, however, owes its profit streak over the past decade to one thing above all others: fuel hedges. Southwest has had an uncanny ability over the past decade to essentially lock in its future fuel prices at low levels. Using financial tools such as options and futures contracts, Southwest cements contracts in which it agrees to buy fuel for a certain price at a later date.

The airline saves money if fuel prices rise, which is exactly what happened in recent years.

Southwest might not have that luxury much longer, and the storm clouds are gathering quickly.

The fuel-hedging contracts Southwest cemented when oil was much cheaper will run out in coming years. In 2011, for example, Southwest currently has about 20 percent of its fuel needs hedged at $77 a barrel.

Another serious challenge revolves around industry demand, which is tapering off after several years of growth. Southwest recently reported that miles flown by paying passengers in August dipped 5.2 percent compared with the same period a year earlier - the biggest decline among major U.S. carriers.

Originally published by Chris Walsh Scripps Howard.

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