The Southwest Perspective

DALLAS — He’s 51 and has been working for Southwest Airlines since he started on the ramp at Lubbock, at a time when the carrier operated five airplanes. Today Bob Montgomery heads up properties out of Southwest’s headquarters, located just outside the fence at Love Field. He’s a popular speaker on the conference circuit, as much for his candor as his good ol’ boy demeanor. He’s genuine — a la the Herb Kelleher mold. And he’s got definite opinions on the airline and airport industry of 2008, about capital development, finances, privatization, and rates and charges.

Montgomery relates that he got into properties almost by happenstance in 1984 — he was the first person to hold the job. Since that time, much in the industry has changed, notably the relationship between airlines and airports and the roles each plays.

“It’s been a heckuva ride,” he says with a chuckle.

As we sit for an interview, he’s talking of how proud he is of the redevelopment efforts at Chicago’s Midway Airport, in which he played a central role. And, oh, by the way, Southwest is holding a press conference in Denver as we speak to announce a major route expansion at DIA, an airport to which the carrier only recently returned.

The vice president of properties shared his insights into just about everything airports and airlines. Here’s an edited excerpt ...

AIRPORT BUSINESS: How was the industry different in 1984 when you first got into properties?

Montgomery: The old network carriers were still very strong and still had very active property staffs, because prior to deregulation it was very common for the airlines to own and develop and do projects.

We were still pretty much around Texas. The first two cities I opened up were St. Louis and Chicago, in 1984. We had just expanded into Los Angeles and San Francisco; we had Phoenix.

AB: In terms of leases and your expectations, what’s the mood of the market versus 1984?

Montgomery: I would say there are two big differences. One is the level of independence that airports have today. The mindset in 1984 was, we have to get agreement with the carriers or nothing can be done. Historically that had been true. The major financial markets really required airline leases and airline agreements, and typically longer term, before they would agree to fund major capital developments.

Whereas today, because of a lot of the compensatory rate methodologies, airports have their own war chest, if you will. They have substantial retained earnings, and the financial markets really respond to the strength of the local market, as opposed to the strength of the individual airlines that are serving it.

History has played a part in that too, just because of the major bankruptcies starting with Braniff in the late ‘70s. The markets saw that there was a backfill of sorts into many of those marketplaces, and that they could issue bonds just based on the strength of the individual marketplace. That’s one of the big differences, their ability to finance things.

AB: And the second difference?

Montgomery: The second is the amount of joint planning that goes on. In 1984, the Air Transport Association had regional offices around the country that were staffed with really good engineers and good flight ops people. And the carriers had in their facilities departments people capable of designing and implementing major airport improvement programs. They could design airfields on a napkin.

Those people would meet on a regular basis with airports to develop their ongoing capital plans, to look at what they’re submitting into the NPIAS, to try and troubleshoot with them the terminal development master plans. In the late ‘80s in a big cost-cutting move, ATA closed those offices.

Now, most cities rarely involve the carriers in any significant way in master planning until they’ve already established the political consensus. That’s led to conflict and disagreement over what projects need doing.

In the meantime, the carriers were in cost-cutting modes as airports got more independent; deregulation diversified the marketplace. Those carriers purged themselves of all those people who had the capability of designing. That left a huge void, and the void’s been filled by airports and their consultants ­— primarily the consultants. There are very capable consultants out there; but let’s face it, their motivation is a fee. It’s not necessarily what’s best for all parties involved.

AB: It’s almost as though the airlines brought this on themselves.

Montgomery: The airlines have always been their own worst enemies.

AB: Of course, air service development is a high priority for airports, and for many Southwest is the number one target. What’s your perspective on what you see when cities approach you for service?

Montgomery: When I walk into offices, it’s never our first meeting. We’ve got a schedule planning department that I think is most capable. We start dialog with communities years in advance of any actual service. We study them for years trying to find out what’s going on in that marketplace, and how does that relate to the strategies that we’re employing. We start getting some people actually on the ground in those cities, driving around, looking at things, talking to people. So, when I walk in, usually we’re ready to start negotiating.

What I typically need to learn is what are their future plans and how is that going to impact Southwest Airlines in our ongoing cost structure? At San Francisco, which we most recently opened up, it’s not a new airport and it’s a very popular destination. You can’t just go gather up gates; you have to work to try to establish what physical plant can be available, and there’s always tension there. So in San Francisco, which could probably command substantial service, we were limited at the start to two gates. And we really had to partner with the city to make those two gates available.

We were able to subsequently free up two more. Now, I’d love to find a way to get ten, and we are working with them.

AB: You say you partnered with the city — was that because they needed to be the negotiator for gates?

Montgomery: One of the huge changes since 1984 is that back then most leases were exclusive-use leases. Now that’s almost unheard of; most leases are preferential. San Francisco still has some holdovers. In our terminal most leases are preferential, which gives the city some flexibility in terms of moving folks around.

AB: My impression was that the reasons Southwest was not in San Francisco were because of your large presence at Oakland, and because of rates and charges.

Montgomery: It wasn’t just a rates and charges issue; that was part of it. Air traffic delays was one of the real strong issues. Another piece was our ability at that time to get the space we needed to operate. Then there were some social programs that the city began pushing that dealt with benefits that the company had to offer across the board that we weren’t prepared to do. They came up with their own minimum wage scale, which presents a problem to a company that has labor agreements across the country. How do you pay somebody in San Francisco more than somebody in Little Rock, when you have existing union contracts which preclude that?

About a year after we pulled out we had a meeting with the airport director and some of the marketing folks in San Francisco who had seen a dramatic dropoff in air traffic. Their traffic hadn’t rebounded after 9/11. Essentially, they came back and said, you were right and we have fixed these things.

AB: And you’ve returned to Denver recently ...

Montgomery: Of the things that got us out of Denver, number one was costs and availability of facilities. Now, that was when DIA was just being planned; we were operating at Stapleton. We were never able to get our own facilities; we were being ground handled by Ozark and TWA, who saw fit to charge us about $500 a flight to lose our bags and keep our flights off schedule.

In the meantime, the city was planning DIA and they were pushing a lease and use agreement and demanding that we sign up long-term, 20 years or more. And the cost per passenger was projected to be $18-20 per passenger. For a carrier that had an average cost per passenger at that time of probably $2.50, that was pretty stark. In the meantime, Southwest Airlines had an immature route structure; we weren’t very big in the West and didn’t have the connections that we do now.

Now DIA’s been built, and the city has come out and differentiated their product offering so that we weren’t looking at $20 a passenger, but $10 a passenger.

One of the other big things that was a big concern at Denver was that all of the costs in the original lease were geared toward user type fees. What that does to a carrier like Southwest that has high productivity is, we put more activity through less facilities and therefore we end up subsidizing people’s inefficiency in their facilities. That’s just offensive to us. I really dislike subsidizing my competitors.

Denver changed where they went to a more traditional type of lease and that dramatically dropped the rate impact to us.

Scroll forward a few years and we have a much more diverse, more mature route network. Denver has substantially reduced their costs. Since it is a new airport we’re really not looking at major capital programs. So, we’re looking at rate stability over time. And you no longer have three hub carriers.

AB: You mentioned joint planning today, and during a recent tour of Dulles International the point was made how all parties had been integrated into the capital development there. Is this becoming a standard?

Montgomery: It’s a real desire; it’s not always accomplished.

Where we’re kind of seeing a real need is with municipalities, which have layered themselves with so many processes to protect the public that they have difficulty doing a project at the same price that the private sector can do it. When I say that the public sector is less efficient than the private sector, I haven’t found anybody that disagrees with that. If I say 25 percent less efficient, nobody disagrees.

Now there are some — Louis Miller down at Tampa; Louis delivers good projects at a good price. The Terminal C there was a fantastic project; they did a design/build.

Some different model needs to be rolled out. Like some of the Philadelphia things that we’re doing, and like we suggested for Boeing Field in Seattle, and like we’ve done with the Islip terminal at Long Island MacArthur Airport, we’ve been able to deliver projects at a controlled cost. We just think history has come back and airline control of projects should be in vogue again.

At Philadelphia, as a way to control costs, they’re actually allowing Southwest to implement and control a significant amount of the construction and that has significantly helped. We’re finding ourselves in more and more situations providing construction services for airport operators.

AB: When you suggest a new model, is privatization in there somewhere?

Montgomery: As you’re aware we’ve signed a non-binding set of terms with Midway. With privatization, there has not been a domestic model that’s been shown to work yet. The international model of privatization, we believe, is seriously flawed. You have trouble finding low-cost privatized airports that offer any kind of service. Ryanair may go into one or two, but they’re going out on the ramp and they’re busing. I don’t count those.

I’ve said for many years what we need is an effective privatization model, not piratization. The whole motive behind privatizing airports is usually to go in and steal the value out of the airport and put it into private hands. I don’t think we need that model, but we do need models that are efficient, that deliver construction at controllable costs, that really live up to what is in the federal statutes — an airport should break even.

There are many airports that are carrying close to $1 billion in unrestricted cash in their organization. Now, why are we doing that when airports, according to federal law, are supposed to be as break-even as possible?

AB: The answer from airports is that they need that money for future reinvestment.

Montgomery: That’s a real easy, quip answer. What we’re finding is that there are much more effective funding alternatives. You don’t pay cash to build a house; you come up with a financing vehicle and one that you can afford that matches your salary and your earnings. Airports are not much different.

They should be coming up with financial plans that meet the needs of the tenants and the people who are underwriting it. You can’t forget that cities don’t pay for a dime; it is the users who pay 100 percent.

There are many airports that like to say, ‘our airline fees are only 15-25 percent of the total revenue of the airport.’ But they conveniently take parking revenues and concession revenues and others that are driven by the airline passenger and put them into their bucket — as if they created those revenue streams.

An airline looks at it much differently; we look at total rates, fees, and charges, concessions, parking revenues, rental cars as being driven by the commercial aviation function.

I’m not saying airports should be stripped bare of all resources. There is a need for reserve funds and reasonable capital accounts.

AB: In Chicago, a primary motivation for privatizing Midway is for the mayor who wants to get a chunk of money and divert the revenue.

Montgomery: Absolutely.

AB: Yet, you signed off on it.

Montgomery: One reason. What happens with privatization, in essence, is present value savings are offered in exchange for long-term costs. In any kind of privatized models, most of those investors are willing to take an operating loss for a time period, as long as they’re assured that at some point you cross the line of where you would have been and they make money on the back end of the deal. Because they’re very patient investors — pension funds and those sorts of investors — they don’t have to have the short-term profit.

So, part of the question gets to be, what’s that present value savings and are you willing to accept it in exchange for that long-term cost? The other part is, how do you control it going forward? These guys are signing their privatization deals over a 50 to 100-year timeframe; yet the airline agreements are much shorter term in nature. In Chicago, you’re talking about a 20-year deal versus a 100-year deal that would be cut with the privatizer.

So, what happens at the end of the term? In Europe, what you see in many places is the privatized party wants to dramatically escalate the rates at the end of the term. In order to put some control into that, some arbitrating body is created. We think it’s a bad model.

In the Midway model, what we were able to do is to limit the amount of increases that could be generated per year and also put some control mechanisms on the end of term question.

AB: What would those be?

Montgomery: I’ll hold on that for now. Number one, it’s on a non-binding term sheet. This whole discussion is going to have to involve the privatizing parties as well, so the City of Chicago right now is trying to get other airline support; then they’ll put out the RFP.

AB: With the upcoming open skies agreement with Europe, it’s expected by many that we’ll see Ryanair in the U.S. Will we see Southwest moving internationally?

Montgomery: What we have stated is we will have international capability by the end of this year via the agreement with ATA. We have stated that in 2009 and afterwards that we’re evaluating the prospect of international code share partners, and we’re also evaluating whether it makes sense for Southwest Airlines to fly internationally. We would focus on near-international — Canada, Mexico, the Caribbean.

But we’re at a point that we don’t know what we don’t know; so we have a lot of effort going on trying to understand the international marketplace.

AB: When I began writing about airports, two of the first words I had to understand were residual and compensatory. Are both these words passe today?

Montgomery: I don’t use ‘em because nobody understands them. I’ve said for years that what I care about is the business deal with a city, and I care about the ongoing costs and how we proceed with improvements. And, whether it’s a residual or compensatory deal, or what I like to call it is a cracker barrel deal, which is I’m going to pay you so much and I don’t have a formula. What I care about is the end result.

For example, Tampa had a long-term residual cost structure until George Bean died and they brought in Louis Miller to run the airport. One of the first things he did was to step in and to adopt a compensatory set of rates, fees, and charges. And he found a way to do it and reduce the airline costs in the meantime. Now we have a really good world in Tampa, where we have a low cost per passenger; he has a high amount of retained earnings, and is able to do all the improvements — and does do the improvements — in a very admirable way. So, there’s nothing magic about the residual or the compensatory.

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