CEO: Southwest's strategy shifting

Jun. 28--For 36 years, Southwest Airlines has pursued two basic principles. Rule 1: Keep everything simple. Rule 2: Don't do anything that violates Rule 1. The result has been an anti-corporate flying experience for passengers, with no frills, low...

At the core of Southwest's philosophy has been steady growth, and it rarely reins back that growth. But in an uncharacteristic move, Mr. Kelly announced Wednesday that the carrier will reduce its growth in capacity -- available seats per mile -- to 6 percent in the fourth quarter and for 2008, compared with the 8 percent it had planned.

That means it will need only 19 of the 34 new Boeing 737-700 airplanes it had scheduled to receive in 2008.

Southwest, which usually has had to beat the bushes to find enough airplanes, will have to adjust to getting rid of airplanes -- by selling or leasing surplus jets, possibly its less-efficient Boeing 737-300 airplanes.

"After being surprised coming into the year by slowing demand in the first quarter, we're now more wary and cautious about the rest of this year and next year," Mr. Kelly said.

In the fourth quarter, Southwest plans to drop flights on some routes, ending nonstop service between Philadelphia and Los Angeles, for example. That capacity will be moved to other routes that have a better chance of making money, Mr. Kelly said.

"The resulting schedule we think will be more profitable," Mr. Kelly said.

But even with only 6 percent growth in 2008, Southwest will still be one of the fast-growing major airlines, particularly on domestic routes.

In light of recent complaints from some analysts, investors and competitors that Southwest has been growing too aggressively, Mr. Kelly defended taking the 19 airplanes in 2008.

"And if things improve, we can always pursue options to accelerate our growth," he said. "Our long-term plan remains to grow the fleet every year."

In all, Southwest has set a target of increasing its revenues by $1 billion annually with the new initiatives by 2010, Mr. Kelly said.

Rather than leisure travelers, he said, the airline's market research says "road warriors" -- frequent business travelers -- offer the best chance of bringing in new revenue.

"Any way you look at it, from every segment, we have a tremendous brand ranking," Mr. Kelly said. "Our conclusion, though, was that the greatest upside capability for us lies with the business customer, as long as we continue to offer low fares, a reliable, convenient schedule, with the best customer service."

To target business travelers, Southwest intends to improve its Rapid Rewards frequent flier program, with minor changes now and more drastic ones later. It is also improving its "revenue management," the pricing of fares to get the most money, and launching a new advertising campaign aimed at road warriors.

Southwest, which tested a variety of boarding methods in San Diego last year, including assigned seating, will change its boarding and seating process by the end of the year, Mr. Kelly said. It will announce its decision on assigned seating then, he said.

In airline industry parlance, Southwest has been known as a low-cost carrier, or LCC, while older competitors such as United Airlines and Delta Air Lines were called legacy carriers.

The legacy carriers were launched before the industry was deregulated in the 1980s. They carried built-in costs such as high union salaries and hefty pension plans, which Southwest never had.

But those differences are disappearing. Many of the legacy carriers have jettisoned their pensions in bankruptcy court and extracted salary reductions from employees.

In a recent interview, aviation consultant and journalist Scott Hamilton said Southwest needed to change the way it operated because of mounting problems that made it more like the old-line carriers.

"They are what I call the first legacy LCC," Mr. Hamilton said. "With the term legacy comes all the implications that I intend."

Southwest's labor costs now are "the highest in the industry," Mr. Hamilton said. "Something like 45 percent of their expenses are labor now. They make up for it by being efficient in other ways, but nonetheless, it's still the highest in the industry now."

In addition, other low-cost carriers, such as JetBlue Airways and AirTran Airways, are "nipping at its heels from below, like Southwest used to nip at the heels of the legacies," Mr. Hamilton said.

Southwest has also had the advantage of fuel hedging that kept its net fuel costs far lower than its competitors, but that advantage is disappearing over time as fuel prices remain high and Southwest's older hedges mature, Mr. Hamilton said.

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