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Southwest: Dressed To Kill... Competitors


Gary C. Kelly is a steady, mild-mannered former accountant. But don't let that fool you. The new 49-year-old chief executive of Southwest Airlines Co. (LUV) is also spearheading some of the most aggressive moves that the low-fare king has made in years.

Since taking over at Southwest last July, after the sudden retirement of James F. Parker, the Porsche-driving former chief financial officer has accelerated the company's attacks on struggling high-cost competitors and undermined long-held beliefs about how Southwest will compete. Kelly's boldest move: the acquisition of six gates at Chicago's Midway Airport from bankrupt ATA Holdings Corp. (ATAHQ), and the signing of Southwest's first alliance with another airline. That followed Kelly's vigorous attack on the federal law that limits Southwest's flights from its home base at Dallas Love Field. In doing so, Kelly ditched a decades-old policy of "passionate neutrality" toward the restrictions and created a direct challenge to American Airlines Inc.'s (AMR) nearby hub at Dallas-Fort Worth International Airport. Analysts and competitors marvel at the newfound moxie. "This is a different Southwest. They've always jumped on opportunities. We've just never seen them this jumpy," says Darryl Jenkins, a visiting professor at Embry-Riddle Aeronautical University.

The youthful and energetic Kelly is a good fit for the Southwest image. "Gary brings a lot more of a 'change agent' element here" than his predecessor, says one insider. That was abundantly clear at last year's Halloween party, when Kelly shocked co-workers by showing up as Gene Simmons, front man for the rock group Kiss.

Perhaps Kelly, who joined Southwest as its controller in 1986, has simply figured out that no one was buying the airline's old "Aw, shucks, we're just an underdog" act anymore. Says America West Airlines Inc. (AWA) CEO W. Douglas Parker: "They really were at one point the scrawny kid who was lifting weights in his basement. Now they come out and they're bigger than anybody else and stronger than anybody else." In fact, Southwest now carries more domestic passengers than any other U.S. airline. For his part, Kelly insists there's nothing different about Southwest's behavior: "We've always been a growth airline, and have always been a maverick, and have always been very competitive."

The difference now is that Southwest, with the lowest costs and the strongest balance sheet, appears to be permanently shifting the balance of power to low-cost carriers. So it should come as no surprise that Southwest is on the offensive again. It plans to increase capacity at least 10% this year, adding 29 planes to its fleet of 417. Like other airlines, it hunkered down after September 11 and the crippling recession that brought four years of industry losses. Southwest grew by just 4% in 2003. But with travel improving, it's seizing opportunities as big competitors struggle to return to profitability in the face of costly fuel and shrinking fares.

"GROWTH OPPORTUNITIES"

Yet Southwest's game plan is defensive, as well. Its 2004 earnings of $313 million were just half what it earned in 2000. Without financial hedges that helped it manage fuel costs, Southwest would have lost money in three of the last eight quarters. The best way to improve future returns, says analyst Gary Chase of Lehman Brothers Inc. (LEH) in a research report, is for Southwest "to take advantage of the growth opportunities created by industry duress." That's now important because formidable low-cost rivals, especially AirTran Airways (AAI) and JetBlue Airways (JBLU), are eager to grow in the same lucrative markets Southwest is targeting. And they can promote arguably better products, including assigned seats, business class, and seat-back televisions.

Thus Southwest is rushing to stake its claim in places like Philadelphia and Pittsburgh, now dominated by bankrupt US Airways Group Inc. (UAIRQ) US Airways and other hub-and-spoke giants are working furiously to survive by slashing labor and other costs. They're still a long way from matching Southwest, but some are likely to emerge much nimbler. Southwest needs healthy expansion to help keep its own unit costs under control. It boasts the richest wages for pilots of narrow-body jets -- 38% above those at United Airlines Inc. (UALAQ), after that carrier's deep pay cuts. By growing, Southwest averages in new, lower-paid employees and spreads its costs over more seats. At the same time, it is pushing for higher productivity from its already highly efficient workers. Southwest's pilots say they're being asked to fly 70 hours a month, up from about 65. Pilots at the traditional carriers average less than 60.

Perhaps no Southwest move stunned the industry more than its December deal to link up with rival discounter ATA. For $117 million, Southwest got six more gates, bringing its total to 25 of Midway's 43. It also will get a 27.5% ownership stake, which it says it will unload over time. And in a move previously unheard of for Southwest -- except for an experiment with Icelandair in 1996 -- it is code sharing with ATA, which means it will market tickets for some of its flights. Southwest's customers can easily connect with ATA to such cities as Boston, Denver, Minneapolis, and Honolulu. Southwest also gains precious access to New York's LaGuardia Airport and Ronald Reagan Washington National Airport.

SHAKING THINGS UP

Not incidentally, Southwest's deal locks up Midway, some rivals contend. AirTran and America West each wanted all 14 of ATA's Midway gates to create a viable hub there. Now, even if ATA dies, they might find that impossible to do. Indeed, ATA has pulled out of most routes where it was competing with Southwest from Chicago. "They've kind of carved up the market," says Robert L. Fornaro, president of AirTran Airways Inc.

Southwest seems equally determined to remain the dominant low-fare carrier in Dallas-Fort Worth. With Delta Air Lines Inc.'s (DAL) recent dismantling of its hub at DFW International Airport, Southwest considered starting operations there that would be unfettered by the so-called Wright Amendment. That 1979 federal law, amended in 1997, limits Southwest's flights at Dallas Love Field to Texas and seven other nearby states. But rather than split its operations in Dallas or abandon its longtime home, Kelly is calling for repeal of the law, which was meant to protect a fledgling DFW airport. "Every member of Congress that I've talked to agrees that it's a bad law," says Kelly. Repeal could free up more than $500 million in potential revenue for Southwest, figures analyst Chase.

How much of the recent aggressiveness -- or "assertiveness," as they prefer at friendly Southwest -- reflects new opportunities or a new boss is the subject of much debate. After all, company co-founder and Chairman Herbert D. Kelleher, 73, is still firmly in charge of strategy and route plans, as he was when Parker, a reserved lawyer, was CEO. "We just didn't have these kinds of opportunities in 2002 and 2003," says Kelly.

But Kelly has been shaking things up inside the company, too. One of his first moves was to realign his management group to improve accountability and cooperation between departments. And while Southwest has long been known for its warm labor relations, those relationships were frayed during Parker's bitter contract negotiations with flight attendants. Feeling demonized by union leaders, Parker turned the job over to Kelleher, who reached a richer-than-expected settlement. Parker retired soon afterward, citing "personal reasons," but many believe the contract dispute was a key factor. Kelly created a new department focused on labor relations and now meets quarterly with union leaders to discuss finances and strategy. He's also insisting that all employees get regular scorecards on productivity and profitability measures.

For all of the changes, Kelly hasn't yet introduced such complications as international flights or the use of smaller regional jets, a move planned by JetBlue. He's even cautious about assigning seats, a service that new technology would easily allow but that many passengers, believe it or not, have said they would detest. But if Kelly's early months in office are any indication, Southwest is sure to keep rocking the industry.

By Wendy Zellner in Dallas


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