Southwest Airlines plotting new strategic course

Aug. 2--Let's say you're sitting in your assigned seat, surfing the Internet while flying to catch a connecting flight to Europe. Today, you wouldn't be flying Southwest Airlines Co. when you do any of that.

But in a few years -- who knows?

In a major re-examination of what makes it tick, Southwest is considering a lot of steps that would have been unthinkable in years past.

"Southwest has to modify its model because parts of it don't work anymore," aviation consultant Michael Boyd warns.

That means that it may begin assigning seats as soon as this winter. It is putting together the computer capability to handle international operations, either through connections with partners or flying the trips on its own. The Dallas-based carrier, which is looking at what amenities it needs to attract passengers, is readying a test of wireless Internet service on board its airplanes.

The big changes mirror what's happening at the airline internally. Longtime chairman Herbert D. Kelleher, who gave up his chief executive job in 2001, will surrender his chairman's job in May, and president Colleen Barrett leaves her executive job next July.

And Southwest, which prides itself on avoiding the massive furloughs that other airlines have endured, has offered buyout packages to 8,700 of its highest-paid operational employees.

The carrier has set a goal of increasing its annual revenue by $1 billion in the next few years by doing things it isn't doing now.

The impetus for the rethinking is that its costs have grown significantly in recent years as it feels the impact of higher fuel prices and labor costs, even as it's facing new challenges from its trimmed-down older competitors and threats from newer rivals.

In particular, its unit costs -- the expense of flying one airplane seat one mile -- have jumped 16 percent in two years, from 7.81 cents per seat mile in second quarter 2005 to 9.03 cents per seat mile last quarter. So Southwest is trying to raise its revenue to compensate for the higher costs.

"That's the essence of our earnings challenge," chief executive Gary Kelly told analysts on the airline's July 18 conference call to discuss earnings.

"It's not new. It's not surprising. It's not unexpected, and we have been working to transform Southwest's revenue-generating capabilities to address that challenge and to enhance the low-fare Southwest brand."

Which model?

Analysts say Southwest has to decide which elements of its competition it should follow. There are the ultra-low-cost carriers like Spirit Airlines Inc. and newcomer Skybus Airlines Inc. There are the higher-amenity low-cost carriers like JetBlue Airways Corp. and Virgin America.

And the older network carriers like American Airlines Inc. and Delta Air Lines Inc., once paralyzed by their operating expenses, have cut their costs to compete better against Southwest.

"They've been the darling, they've been the role model, they've been the intelligent one," University of Portland business professor Rich Gritta said. "They did it with the brilliant operating strategy and the brilliant financial strategy. ... You've beaten the easy teams. Now things are going to get harder."

To consider the two low-fare futures that Southwest must ponder, look at the differences between Skybus Airlines and Virgin America.

Skybus, based in Columbus, Ohio, takes cheapness to new depths. It charges passengers $5 to check each bag. It charges for everything on board, including soft drinks. It more closely resembles the European airlines Ryanair Ltd. and EasyJet PLC than Southwest.

There is no assigned seating. If you want priority boarding, it'll cost $10. If you want an e-mail notification of your flight status, it'll cost you.

Virgin America, a new carrier set to begin flying Wednesday out of San Francisco, is on the other end of the scale. It will offer state-of-the-art television and music, including the ability to put together music playlists that you can call up on any Virgin America flight.

It has 110-volt power outlets at every seat. Each plane has a first-class section, with massagers built into each seat. Customers will be able to do computer chatting with passengers elsewhere in the airplane. Soft drinks are free.

"I think for Southwest, the most important thing is that it stay true to its 30-plus-year heritage of providing affordable transportation," said travel analyst Henry Harteveldt of Forrester Research.

"Even if it chooses to charge extra for seat assignments, Internet access or anything else, it has to be in tune with the Southwest legacy of providing consistently good value to the customers," he said. "That's going to be a combination of attractive price and consistent delivery of the product."

Seat assignment

One of the first changes is likely to come in the boarding process. Today, Southwest distributes boarding passes on a first-come, first-served basis, brings passengers aboard in groups A, B and C, and lets people sit in the first empty seat that suits their fancy.

Previously, low-cost competitors followed Southwest's example with no assigned seats. But many of today's rivals, including JetBlue and AirTran Airways, are assigning seats, and Southwest feels it is often at a disadvantage, particularly when chasing the higher-paying business traveler.

Southwest has tested a variety of options. By the fourth quarter, the airline is expected to announce some changes to the 36-year-old practice of first-come, first-served.

The airline could assign all seats. It could let passengers pay extra to get priority seating -- the right to get on before any passengers who didn't pay for assigned seating. The priority seating could be for an assigned seat or the first choice in open seating.

Southwest concedes all possibilities and confirms none of them. But it has said it wouldn't be making changes if the result would be higher costs and no increase in passengers or revenue.

Mr. Boyd, president of the Boyd Group Inc. in Evergreen, Colo., said Southwest has to go to assigned seats to remain competitive with other airlines. The lack of assigned seats hurts Southwest when it enters new markets.

"This stuff about people are going to love, love, love this?" Mr. Boyd said of assigned seating. "Horse manure. The markets where they have to expand, people don't like it."

Passengers can get seat assignments, along with in-flight TV and a more comfortable Airbus airplane, when they fly low-cost Frontier Airlines between Denver and Orlando, Fla.

"At Southwest, you get a humorous boarding announcement," he said. "It's hurting them."

Stuart Klaskin, principal at KKC Aviation Consulting in Miami, sees Southwest charging for assigned seating or priority boarding.

"I don't know if it'll be pure assigned seating," Mr. Klaskin said. "But maybe if you pay a fee from any fare or are booked in the highest class of fare, you get some priority of boarding."

Retrofitting TV

Longer term, Southwest must decide how -- and if -- it wants to respond to onboard TV and music offered by JetBlue, Virgin America and others. Those carriers had the advantage of ordering new fleets with TVs from the outset; Southwest has to consider a solution that works with its 500 existing airplanes.

Southwest is readying a test of wireless Internet on some planes. It'll give the carrier an idea about how popular it is and what technical issues it would face to extend the service over its entire fleet. Internet access could also provide the carrier a backdoor way to bring TV onboard.

On the issue of international service, the airline says it doesn't yet have the technological capability in its reservations and operations systems to handle flights that go outside the U.S.

But by 2009, it should have the capability to begin feeding passengers to other airlines, starting with current domestic code-sharing partner ATA Airlines Inc.

Mr. Kelly told analysts July 18 that Southwest sees the potential for "hundreds of millions of dollars a year" from international code-sharing. The domestic code-sharing with ATA now brings Southwest about $40 million in annual revenue, he said.

"So if we can expand that offering into the near-international markets, we are very hopeful that that alone will produce a very sizable increase in incremental revenues," he said.

The near-international markets -- Canada, Mexico and the Caribbean -- are mentioned most often for Southwest's first international service, either through code-sharing or providing the service itself. The carrier hasn't ruled out feeding passengers to carriers on other international routes to Europe or Asia, or, for that matter, someday flying internationally.

Industry consultants said Southwest should also rethink its policy of one airplane type, the Boeing 737. Southwest likes the simplicity of having a single plane for repairs and service, but different planes would give it access to more markets.

Mr. Boyd and Mr. Harteveldt said a smaller narrow-body jet like the Embraer 190 would open up smaller U.S. markets that currently aren't large enough to support Southwest service. Mr. Gritta said if Southwest is serious about getting into international flying, it should consider the wide-body Boeing 787 that is to enter commercial service next year.

Mr. Klaskin applauded Southwest's willingness to deviate from its traditional successful model.

"It'd be a lot easier to just keep doing what they're doing. They could be the great holdout -- the low-cost, low-fare, short-haul, domestic, cattle car, plastic boarding pass airline. They could sail off into the sunset doing that," Mr. Klaskin said.

"You know what? That'll work well for another few years, no question. But they're smart enough to know it's not going to work forever. They're smart enough not to get chained down by the public expectations of them."

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