Flying Against Prevailing Winds
Southwest Airlines Sticks To Strategy of Growth Despite Tough Climate

By Del Quentin Wilber
Washington Post Staff Writer
Saturday, May 26, 2007

DALLAS -- Never afraid to spurn conventional wisdom, Southwest Airlines is doing it again.

While other airlines are reducing domestic seats in response to softening demand, the quirky low-cost carrier is doing the opposite, expanding routes and flights in pursuit of a decades-long growth plan.

But that approach comes with risks and may require executives to begin tweaking a business strategy that has helped revolutionize commercial aviation.

Already, there are signs of trouble, some analysts say. Southwest's stock price has been stagnant. Its operating income dipped in the first quarter. Its planes have gotten less crowded. And it has begun losing the benefit of aggressive fuel hedges, which have saved the airline billions of dollars and kept it profitable while other carriers foundered in recent years.

"The current environment is a little tough," chief executive Gary C. Kelly conceded in an interview at Southwest's headquarters, a few hundred yards from the runway at Love Field here. He quickly added, however, that Southwest is "stronger than at any other point in our history."

The carrier's problems may stem from the same strategy that has rewarded the airline with 34 straight years of profit and a balance sheet that other airline executives envy. Last year, Southwest became the largest airline in terms of domestic traffic for the first time in its history. That success has drawn increased focus on Southwest's tactics and complaints from its competitors that so much growth could harm the industry because they can't charge higher fares to combat rising fuel costs.

Since its inception, Southwest has pursued apolicy of adding flights, seats and planes to gain market share, even in tough times. While other carriers were reeling from a major economic downturn and slashing their fleets, Southwest has added 120 planes since 2002, bringing the total to 494. It also increased the number of flights by 15 percent and its available seat miles, an industry measure of capacity, by 35 percent from 2002 through the end of last year, company data show.

During the first four months of this year, the carrier added 21,000 flights and 2.3 million seat miles, an 8 percent increase over the corresponding period in 2006. It plans to add 56 jets to its fleet by the end of 2008.

For the most part, Southwest used its growing fleet to serve less-expensive secondary airports near major markets, like Baltimore Washington International Thurgood Marshall Airport. That allowed Southwest to keep down costs and boost efficiency while reaching large numbers of customers. Southwest also served some larger airports where executives felt it could quickly gobble up market share .

But its growth, analysts say, has forced it to find airports that it had long avoided or abandoned: congested hubs dominated by major carriers and served by other low-cost airlines.

Last year, for example, Southwest moved into Denver and Washington Dulles International Airport, both served heavily by United Airlines. In 2004, it launched service in Philadelphia, a hub for US Airways.

It also plans to return to San Francisco International Airport in August, six years after abandoning the outpost because, executives said, it was too expensive. United has a major base of operations there.

Operations at those airports are more difficult for new entrants because the dominant carriers offer more destinations and have the muscle to weather fare decreases on their home turf, analysts said. Congestion at the hubs also can crimp Southwest's plan, which relies heavily on tight schedules and quick turnaround times.

Because Southwest has only one type of aircraft, the 137-seat Boeing 737, it cannot expand into smaller markets, which the larger legacy carriers serve with smaller airplanes. "They have been forced to spread their airplanes all over the place and enter markets they once avoided," said Mike Boyd, an aviation consultant who has closely studied Southwest. "Their model is running out of places to go."

Boyd said expansion into those hubs and the continued growth of the airline will lead to less-full planes over time. That could hamper Southwest 's efficiency and put pressure on its profits, he said.

Already, the number of passengers on each Southwest aircraft has fallen. The jets are about 69 percent full on average this year, compared with 71 percent during the corresponding period in 2006.

Flights out of Dulles, where the carrier started service in October, were barely half full during the first two months of the year, according to the most recent data available from the Bureau of Transportation Statistics. Other carriers at Dulles were far more successful: Their planes were 73 percent full.

In Philadelphia, planes were also just more than half full, the statistics showed.

Southwest performed better in Denver -- its planes were 66 percent full -- but still fell far short of other carriers that operate there.

Southwest executives blamed bad weather and the slowing economy for the drops nationwide. They said they were pleased with the results at the new airports.

The airline faces other pressure. Analysts said they expect Southwest to begin losing some of its industry-wide advantage in fuel hedging in the coming months and years. Southwest executives estimate that their hedges -- essentially, the purchase of fuel long before it is delivered -- have saved the carrier more than $3 billion since 1999.

Analysts said those hedges allowed the company to avoid the contract disputes and pay cuts endured by employees at other carriers, which did not hedge as aggressively. But those carriers have been able to reduce their costs by billions of dollars, preparing them for rises in fuel prices. They also can compete more safely and aggressively with Southwest under their new cost structures, the analysts said.

But analysts also said Southwest can overcome its challenges with some simple tweaking: slow its growth, modestly raise fares, offer in-flight entertainment to compete with hipper low-cost carriers and find other revenue sources. They said Southwest's leadership will not allow the company to slip too far off stride.

"This is a bump in the road, not a sinkhole," said Michael Miller, an analyst with the Velocity Group, who said he believes that Southwest will remain a dominant carrier.

Miller and other analysts are particularly interested in Southwest finding new sources of revenue.

Among the ideas: charging a fee for customers who want an assigned seat to avoid the carrier's cattle-call boarding process, said Ray Neidl, an analyst with Calyon Securities.

It is not known whether Southwest would ever consider such fees or fare hikes. Kelly said he was unlikely to raise fares with his planes growing less crowded. He also said the carrier is reluctant to charge fees for pillows or blankets.

"We don't want to nickel and dime our customers," he said, adding that he was looking for other sources of cash because "we need to generate more revenue per trip."

Southwest is considering expanding travel packages on its Web site to include things such as cruises, he said. And Southwest is investigating whether it can get passengers to pay a fee for wireless Internet connections on its planes.

The biggest change could come in the next two years. Southwest is considering getting into a code-sharing agreement with an international carrier or offering its own overseas flights, Kelly said.

Such a move could help soften a domestic slowdown and boost revenue because international flights are generally more profitable than domestic ones. As for his company's expansion plans and performance in Philadelphia, Denver and Dulles, Kelly said he was optimistic.

"We are famous for being patient in developing our markets," he said.

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