Southwest Airlines, once a rebel, shows its age

The carrier is coping with labor strife and high costs. Some employees pine for the days of co-founder Herb Kelleher.

By MSN Money Partner Apr 2, 2014 12:27PM
Credit: Karen Bleier/AFP/Getty Image

Caption: Southwest Airlines passenger planes are seen at Chicago's Midway Airport
By Jack Nicas and Susan Carey, The Wall Street Journal

At Chicago's Midway Airport on Jan. 2, Southwest Airlines (LUV) canceled a third of its flights, lost 7,500 bags and, at one point, had 66 aircraft on the ground -- about twice as many as the carrier has gates. Passengers were stuck on the tarmac late into the night.

A severe snowstorm was the main culprit, but Southwest managers also blamed ramp workers, suggesting that nearly a third of them called in sick to protest slow contract talks. The spat boiled into a legal battle, with the workers suing Southwest for requiring they provide doctor's notes. They say they are chronically understaffed and are being blamed for executives' mismanagement of the storm.

Labor strife has long roiled the airline industry, but not Southwest. The carrier never has laid off workers or cut their pay, and has had only one strike in its history, a six-day mechanics' walkout in 1980.

But now Southwest is asking for some of the biggest contract changes ever from employees in a bid to contain costs -- and some union leaders are furious. "We built this airline," says Randy Barnes, a union representative for Midway's ramp workers. Now, he says, management is "tearing it down."

The recent acrimony is one way that Southwest is showing its age. Once the industry's brassy upstart, the airline, which took wing 43 years ago, has begun to resemble the mainstream rivals it rebelled against in its youth: carriers that were slow-growing, complex and costly to run.

First sketched out on the back of a cocktail napkin in 1967, Southwest was built on simplicity, thrift, labor harmony and rapid expansion. For decades, it was the fastest-growing and lowest-cost airline in the U.S., undercutting competitors' fares in new markets and sending traffic skyward -- a phenomenon known in government and industry circles as the "Southwest Effect." 

To help keep things simple and cost-effective, the airline flew one model of plane -- Boeing's 737 -- and stayed close to customers with wisecracking flight attendants and funny ads. For decades, that original formula helped the company soar.

Over the past year, Southwest's stock has risen 77.6 percent to $23.94, and the carrier remains the only U.S. airline with an investment-grade credit rating.

Still, the airline has failed to hit its long-standing goal of a 15 percent return on invested capital since 2000; it recently said it doesn't intend to grow overall until it does. Even with record profit last year, its return was 13 percent, up from 7 percent in 2012.

There are other big challenges. Southwest is flying fuller planes, connecting more passengers and serving bigger airports that are prone to delays. Partly as a result, some of its operational ratings have plummeted. Last year, it lost more bags per passenger than any other carrier. And after years as one of the most punctual airlines, just 72 percent of Southwest's flights were on time in the fourth quarter -- dead last in the industry.

Southwest was "blessed for so many years with a product nobody else had and financial results that nobody else was able to touch that they kept doing things their old way," says Bob McAdoo, an airline analyst for Imperial Capital LLC. But now, industry changes and Southwest's maturation mean "there are so many areas they're under pressure to change, things the company never had to deal with," he says.

Gary Kelly, the chief executive who has run the Dallas-based company since 2004, says the Southwest model still works. He points to record profits of $754 million for 2013 -- up from $421 million in 2012 -- and a surging stock price. He argues that the launch of international flights this year will open new avenues for growth.

"Southwest is in a better position today than it has ever been in its history," Mr. Kelly says.

But the CEO also emphasized the need for Southwest to adapt. High fuel prices, for example, have forced it to "pivot" from its longtime blueprint of offering short-haul flights between midsize cities toward longer flights between bigger cities, which use fuel more efficiently. Fuel last year accounted for 35 percent of Southwest's costs, more than double the share a decade ago. That shift has required it to add larger planes, drop service to many small cities and enter bigger markets while meddling with key traits like its first-come-first-served boarding process.

Other U.S. carriers, meanwhile, have bulked up and trimmed spending through mergers and bankruptcy restructurings. The three U.S. airlines larger than Southwest -- American Airlines Group (AAL), United Continental Holdings (UAL), and Delta Air Lines (DAL) -- offer first- and business-class service, elite loyalty programs and global networks that capture lucrative business travelers. Ultra-discounters, including Spirit Airlines Inc., are undercutting Southwest fares while JetBlue Airways Corp. and Virgin America Inc. are competing more aggressively for the middle-class customers whom Southwest long owned.

"Not only has the world changed, but our relative position within the industry on costs has changed," says Kelly, a 59-year-old Texan and former accountant who joined the company 28 years ago. "Now we just need to make sure our labor contracts are updated to reflect the current reality."

With its growth stalled, Southwest can't hire as many new employees at the bottom of the pay scale. From 2007 through 2012, Southwest's cost to fly a seat one mile rose 42 percent -- more than any other major U.S. airline, according to Massachusetts Institute of Technology data that adjust for flight distance.

Its low fares, long the core pitch to customers, aren't so low anymore. Its average one-way fare was $144 in the year ended in September, a 21 percent increase over the same period five years earlier, when adjusted for inflation. That compared with single-digit increases at larger rivals and big price cuts at new ultra-discounters like Spirit, according to the MIT data.

Many longtime customers remain loyal fans. "If there's a Southwest flight going to where I'm going, I'll fly Southwest" even if it's more expensive, says Dr. Joseph Coyle, a psychiatry professor at Harvard Medical School. "They treat everybody equally."

Kelly says Southwest's research shows that at any given time, it is the least expensive option in as few as 40 percent of its markets, compared with more than 50 percent of its markets in 2000. He notes that Southwest is almost always the best deal for fliers with checked bags, since each passenger can stash two pieces of luggage free.

While nearly all competitors impose a bag fee, Southwest has stuck by its "bags fly free" mantra -- although Kelly has said he is open to charging for bags in the future.

This year holds some pivotal tests. Southwest hopes to complete its integration of AirTran Airways, which it bought for $1.5 billion in 2011, by finishing up the work of training workers, overhauling airplanes and linking the carriers' networks. It plans to begin international flights under its own brand after inheriting several Caribbean and Mexico destinations from AirTran. That will require it to master marketing in foreign countries, hire overseas workers and even make sure its flight attendants have passports.

Southwest also faces costly upgrades to its outdated computer systems -- a holdover from its simpler days -- to bring them in line with industry standards.

After snowstorms forced airlines to cancel thousands of flights this winter, other carriers' computers automatically rebooked many customers. But at Southwest, employees had to manually reschedule each disrupted passenger, says Teresa Laraba, Southwest's senior vice president of customers.

Another problem: Southwest's antiquated phone system limits the number of incoming calls, so some passengers were met with busy signals. Southwest says it plans to soon replace those systems. "I've been waiting a long time" for the upgrades, Laraba says.

Perhaps Southwest's biggest challenge involves its 45,000 workers, who long have enjoyed unparalleled job stability and compensation. About 83 percent of its workers are unionized, and Southwest is currently in negotiations with nearly all of them over new contracts -- some of which seek to freeze pay scales.

The average Southwest worker earned nearly $100,000 in 2012, including pension and benefits, compared with about $89,000 at a traditional hub-and-spoke airline, according to MIT. Southwest also shares profits with employees, paying them $228 million last year, or more than 6 percent of their pay.

"It is harder today for us to claim that we are the low-fare leader than it was before because our cost advantage has been narrowed," Kelly says. "And that is exactly what we want to make our employees understand."

He says Southwest is seeking savings from increased productivity and more flexibility in workers' contracts -- not from pay cuts.

For its nearly 17,000 ground workers and customer-service agents, Southwest wants to tighten rules on sick time and largely hold compensation flat. In prior contracts, workers generally received raises. It also ultimately wants 40 percent to be part-time, meaning their families would have to pay more for health benefits.

The company says it aims to do this by filling new openings with part-timers, rather than forcing current employees into part-time status. Still, unions blanch at the idea, saying they want to protect careers, not just jobs.

The ground-workers' union recently won a victory when the carrier backed off a proposal to outsource a sizable number of jobs to outside vendors.

Randy Babbitt, Southwest's senior vice president of labor relations, says Southwest's existing contracts were designed for a smaller, short-haul airline that didn't fly late at night or adjust service levels according to demand. For example, Southwest now flies to Fort Myers, Fla., 20 times a day in the winter and 10 times a day in the summer.

"You've got to have something flexible or part-time," Babbitt says. "It's what everybody else has. We just never needed to address it until now."

Union officials argue that Southwest employees have a more demanding workload compared with others in the industry. The airline carries about 3,000 passengers per full-time employee, compared with 1,350 passengers per employee at its bigger rivals, according to MIT's data.

The flight attendants' union says it has made clear to the company that it won't agree to a rule that would require its members to fly a minimum number of hours -- standard practice in the industry.

Capt. Mark Richardson, president of the pilots union, said the slow pace of negotiations is "frustrating" but acknowledged that Southwest is distracted by talks with other work groups.

Some Southwest employees still pine for Herb Kelleher, the raucous co-founder who stepped down as executive chairman in 2008 after 30 years in the post. He was beloved by employees and known to spend hours in employee break rooms, smoking cigarettes and chatting with workers. Kelleher, 83, is famous for his love of Wild Turkey bourbon, Harley-Davidson motorcycles and outlandish costumes. He declined to be interviewed.

"Ever since Herb . . . left, this has been more of a corporation and less of a family," says Barnes.

The winter's brutal weather aggravated the labor rancor. Over the first week of 2014, Southwest canceled 40 percent of its flights at Midway and delayed another 40 percent, largely due to weather. The carrier said that ramp workers at Midway called in sick more than 450 times over that week, for about 22 percent of their scheduled shifts.

After Southwest began requiring ramp workers to provide doctor's notes, the union sued the carrier for breach of contract in U.S. district court in Dallas.

In court documents, Southwest alleged the sick calls were "widely perceived to be a coordinated job action to protest the slow progress" of contract negotiations.

The union said there was no work action, but rather a spike in illnesses fueled by mandatory overtime that exhausted workers. The union also produced work logs that it said contradicted the company's sick-call figures.

A judge dismissed the case in February and instructed the union to file a grievance, which it has.

Kelly acknowledges that "mistakes were made" during the operational meltdown but he disputes the union's claims that the company understaffed Midway or mismanaged the operation.

While he says he has no desire to replicate Kelleher's flamboyant tenure, he was recently content to call upon the former CEO to deliver one of his signature no-holds-barred insights.

On March 12, the birthday of both Kelleher and Kelly, the two addressed employees in a video posted online. Kelly asked his predecessor, "How do you respond to employees concerned about change?"

Kelleher responded: "What I tell them is . . . 'What we're talking about here is your future. If we don't change, you won't have one.'"

More from The Wall Street Journal

Apr 2, 2014 3:41PM
Just flew round trip CA to MI on Southwest. Still the lowest prices, bags fly free, the staff on the planes were great and even flew on one of their brand new planes which is their largest. If management is screwing this company up they better fix it fast.
Apr 2, 2014 2:59PM
The article fails to mention that spirit airlines has cheaper fares because they charge you to take a carry-on.  I will never fly them no matter how cheap the fare...
Apr 2, 2014 4:20PM
If Southwest gets rid of their "bags fly free" deal, then there will no longer be incentive to fly with them.....period.  They'll make the biggest mistake that will doom their dominance and customer loyalty. 
Apr 2, 2014 2:02PM

I will never understand greed. Telling people that make  $30,000.00  to $70,000.00 a year that they need to do more with less, so people that make $3,000,000.00 to $70,000,000.00 a year can have more  is insane.

Apr 2, 2014 2:39PM
I fly Southwest whenever I can --- I work in Phoenix, but live in Denver -- so I go home almost every weekend. I routinely buy tickets one way for under 50 bucks -- you have to plan ahead and watch the fairs -- they go up and down it seems at random. USAir, United, Frontier and Spirit along with Southwest have on average 39 flights each day between PHX and DEN -- I fly all the airlines --- where every I get the cheapest ticket. Southwest is by far the best --- almost always on time or even early.
Apr 2, 2014 4:48PM
People in America just do not get it. They want lots of  high paying jobs, with all kinds of benefits, but they want the cheapest price on everything. They want everything free or really cheap and heaven forbid companies make money! So where is that money suppose to come from to accomplish the high wages and benefits! Or they want other companies and their employees to take pay cuts, or not get raises so they won't have to pay more. Then say about OTHER companies and employees they should be happy they have a job, do not ask for a raise, take pay cuts. But not at your company!
Apr 2, 2014 4:35PM

Unions were good 60 plus years ago now the employees have gotten lazy because of them.  They are slitting there own throats they're just to lazy to know it.


Southwest employees should get ready to enjoy unemployment all courtesy of their union.

Apr 2, 2014 5:22PM
Funny how Southwest have been union from day 1 and has made a profit every quarter, but now for some reason unions are killing it.

Apr 2, 2014 5:34PM
The Chicago crooks got them. Corrupt union bosses and corrupt politicians are a deadly combination against business.  I think they would be best served by pulling out of Midway completely.
Apr 2, 2014 5:30PM
If I owned Southwest I would pull out of  Chicago Midway, one place I have always tried to avoid flying to  and from if at all possible.
Apr 2, 2014 5:35PM
Still the only airline that offers airplanes with some damn room!  Detour Chicago.
Apr 2, 2014 3:57PM
The problem with building your business model on efficiency is that eventually others copy the things that made you efficient, reducing your price advantage.  For example, I recently flew an Alaska Airlines flight from Oregon to Maui on a 737.  Granted, it was a 737-800, an expanded version of the 737 (in the past, I had flown to Hawaii on a 757.)  Southwest was the first major airline to use the 737s for all of their flights, as they found they were fuel efficient and cut down on training costs for pilots if they only had to be trained to fly one type of aircraft. While Alaska Airlines still flys more than one type of aircraft, they have seen the advantage to flying fewer types of aircraft than they did in the past.
"We built this airline," says Randy Barnes, a union representative for Midway's ramp workers. Now, he says, management is "tearing it down.""

Ah, the worst president in milky way galaxy history begs to differ, "you did not build that, government did"!
Apr 2, 2014 4:15PM

Yah when you join that union you lose that family feeling in a business isn't that a frickin shock. You define the us VS them and then you wonder why things change?


The union didn't build anything but penis envy so they could get their foot in the door.

Apr 2, 2014 2:04PM
Airlines are like the government now, both run by incompetent jerks without the know how to run a peanut company. Making rules no-one can live with....only reason they are in business is there are no choices.
Apr 2, 2014 9:26PM
Just look at what the unions are doing to GM........again.  I'm not saying there is no place for unions, but they need to learn how to partner, and not demand like spoiled children. And please union members, quit whining!
Apr 2, 2014 6:21PM
Southwest didn't choose to use only one type of plane for pilot training programs. They did it for mechanics and parts issues. They have the fastest and most eficient maintenance programs in the business. Take it from an A&P (Airframe and Powerplant technician) of over 20 years.
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