Herb Kelleher, founder of Southwest Airlines once said, “A company is stronger if it is bound by love, not fear.”
But is love enough to save Southwest?
“No change fees. No cancel fees. No bag fees,” Southwest Airlines CEO Bob Jordan said recently in an email to The Dallas Morning News. “Rapid rewards points don’t expire. Flight credits don’t expire. We have the friendliest, most flexible policies in the industry with a terrific network. But the biggest thing that makes us ‘us’ is our people and the unique and unrivaled hospitality they deliver.”
Jordan’s comments about the airline, which famously grew from an idea etched on the back of a cocktail napkin at a Texas bar in 1967, follow a series of significant changes that he recently announced to some of Southwest’s most popular perks.
Airline officials publicly disclosed their intentions last month to end open seating and to add premium seating to customers, alongside offering overnight flights for the first time. The changes follow the airline’s decision earlier this year to finally allow customers to book flights and compare prices on search engines such as Google Flights and Kayak.
The operational adjustments are occurring years too late, some employees and analysts told The News recently. They surface as the airline faces substantial financial pressures, one of which includes an aggressive effort by an activist investor that says it wants to shake up the airline’s business and oust its executives and board members.
For nearly five decades, Southwest racked up profitability, enjoying 47 consecutive years of profit and usually outpacing the industry in revenue for a company its size.
However, since 2017, the airline — which employs nearly 75,000 people — hasn’t produced a year-over-year improvement in its pre-tax margin. That’s among other financial troubles, such as costs outpacing the growth of unit revenues, resulting in declining profits.
Additionally, the airline is being audited by the The Federal Aviation Administration after several safety incidents on some of its flights this year.
The headwinds are why activist investor Elliott Investment Management has said it has been buying company stock in an effort, the hedge fund wrote in a letter to Southwest’s board last month, to “strengthen oversight, upgrade management and improve company performance.” Elliott is demanding Southwest leadership step aside. Other major airlines, such as United, have experienced similar efforts from activist investors, and sometimes, they have resulted in new leadership and other changes.
To analyze and understand why and how the recent steps Southwest leaders have announced might affect the airline’s future, The News spoke to a handful of aviation analysts, historians and authors, to more than half a dozen of its frequent passengers and two of Southwest’s major union leaders. The News also called and emailed all of Southwest’s 15 board members. None responded. Elliott Investment Management declined interview requests beyond its public letters to the board.
The News also requested an interview with Gary Kelly, executive chairman of Southwest’s board, and Jordan. Jordan agreed to answer questions only by email.
“We’ve shared that we have work to do to restore our financial returns to the levels our employees expect, I expect, and our shareholders expect,” Jordan wrote to The News. ” … Our board of directors, our leadership team, and I agree this is the right direction for Southwest.”
Several analysts, employees and loyal customers say they aren’t sure if the same leadership and now, changing hospitality, will be enough to hold back Elliott Investment Management.
William Swelbar, chief industry analyst of Swelbar-ZhongAir, said each of Southwest’s new additions is a “step towards profitability,” but not a “silver bullet.”
“One of the attributes that made Southwest a vaunted competitor was its balance sheet,” Swelbar said in an email. “They would stand and fight longer than anyone else and the balance sheet is still an envy of the industry. But they no longer have the cost advantage and productivity that worked in parallel with the balance sheet. In my mind that is why the next moves are so important.”
Brett Snyder, president of Cranky Flier who writes a weekly aviation blog and has worked at America West and United Airlines, said Southwest leaders need to spend time answering a few key questions: “‘How do we think about our product to appeal to more people? Do we need to make changes to things?’ I think the Southwest of the last 20 years just didn’t do that.”
Southwest has a true homegrown story, according to Bruce Bleakley, an aviation historian who has penned books on Dallas Love Field, the North Texas airport where the airline is headquartered. Southwest was Dallas’ airline, he said.
“There was this really kind of a neat relationship feeling between the airline, airport and the community,” Bleakley said.
Southwest was incorporated in the 1960s in San Antonio and initially only flew Boeing 737 airplanes to three cities — Houston, San Antonio and Dallas, a plan famously concocted at a San Antonio bar by Kelleher and Kelleher’s business partner, Rollin King. Back then, it was known as “Air Southwest.”
The early days were colorful, and included flight attendants in go-go boots and free alcohol on flights. Today, some of those same friendly sentiments still exist, according to loyal passengers.
But Southwest is no longer “that little Texas airline,” Swelbar said.
“The same old low-fare airline (not the case today) or a culture over and above that of other airlines has long been the mantra and continues to be repeated … It is a much easier task to nurture culture when you are a 300-airplane airline than one with 800,” he said in an email.
Texas mother of three Jenai Bacon, 40, said she has made many memories with the airline, like the time a Southwest gate agent allowed her daughter to sing “Happy Birthday” to her over the PA system at Midland International Airport and when pilots allowed her children in the cockpit.
With those personal touches, Southwest grew its airline business and bottom line by keeping things simple, using the same practices founder Kelleher started. For example, Southwest’s only and preferred aircraft is the Boeing 737.
In recent years, the company’s loyalty to Boeing has been challenged.
In 2019, Boeing grounded its 737 Max aircraft after two deadly crashes killed 346 people in less than five months, both outside the U.S. As a result, dozens of Southwest’s Max airplanes sat idle for nearly two years.
The executive chairman of the airline’s board, Gary Kelly, was Southwest’s CEO then. He is also one of the leaders Elliott Investment Management has directly called on to leave.
Author and longtime friend of Kelleher’s, Kevin Freiberg, told The News the airline’s allegiance to Boeing aircraft is a direct reflection of Kelleher’s intent to keep things the same. Kelly took the helm of Southwest in 2004.
Kelleher felt simplicity made the airline easier to manage, Freiberg said. Crews only had to order parts and learn one type of plane, Freiberg said. It was also a cheaper way to operate. Freiberg co-authored Nuts!: Southwest Airlines’ Crazy Recipe for Business and Personal Success, and once spent one day a month for a year with Kelleher and his business partner, Colleen Barrett, in 1995.
That devotion to Boeing has been costly.
According to Southwest, Boeing’s safety issues cost the company hundreds of millions of dollars as the airline’s fleet was hobbled for nearly two years. Boeing settled with Southwest over the grounding with cash payments and discounts on future aircraft and Southwest granted $125 million of it to its employees through annual profit sharing distribution. Fort Worth-based American Airlines expected a $540 million operating loss in 2019 from the groundings.
George Ferguson is a senior aerospace, defense and airline analyst and research team leader at Bloomberg Intelligence who has followed Southwest for nearly 15 years. Southwest isn’t more vulnerable than any other airline with an all-Boeing fleet, but it could present another opportunity for investor Elliott Investment Management to criticize, he said.
Some of Southwest’s financial struggles have coincided with the airline’s need to invest in new and more advanced technology — especially its rescheduling software system.
Headlines across the country during the Christmas holiday season almost two years ago publicly brought attention to the airline’s rescheduling software system that stranded thousands of passengers for more than a week, their belongings strewn all over the country after a winter storm. The storm, coincidentally named Winter Storm Elliott, hit two critical hubs for Southwest — Denver and Chicago. Other airlines were able to bounce back sooner, but Southwest ended up canceling more than 16,000 flights and lost more than $1.1 billion.
Kelly took more criticism, this time along with Jordan, for failing to invest in the infrastructure upgrades that other companies adopted years before. Ironically, just before the meltdown, Jordan boasted about how the company was eliminating the physical paperwork needed before each flight — moving to computers.
After the meltdown, Southwest pledged to spend more than $1.3 billion on technology upgrades. Its crew optimization software and the airline’s customer phone systems have been upgraded for better surge protection and efficiency during high call-volume times.
This year, the company reported at its full-year results in January, that it expected to spend $1.7 billion in technology, upgrades and system maintenance.
There’s no question Southwest has suffered financially since the meltdown. In its latest quarterly earnings call July 25, Jordan told investors the results “are not where we need them to be, and they are not reflective of what (Southwest is) capable of delivering.”
The airline’s financial struggles are why an activist investor, like Elliott Investment Management, might see Southwest as an opportunity to make money.
In June, Elliott disclosed a $1.9 billion stake, or 11% in economic interest. Activist investors put money into underperforming companies to improve their performance for profit. In doing so, Elliott has made three major demands: Elliott wants to oust leaders like Jordan and Kelly, reevaluate Southwest’s board of directors and conduct a business review.
Elliott investors declined multiple requests for interviews with The News, in response inquiries about the public letters they have issued. Other major investors, such as The Vanguard Group with a 10% stake in the company as of March, disclosed by Southwest in its latest proxy statement, did not respond to requests for comment.
Jordan told reporters two days after Elliott disclosed its stake that he won’t resign. He said he and Kelly remain focused on implementing the changes they have recently promised.
Elliott’s stake in Southwest has also triggered Southwest Airlines leaders to adopt a “poison pill” plan. The “poison pill” is often used to thwart activist investors.
Under Southwest’s plan, if Elliott purchases 12.5% or more of the airline’s shares, current shareholders gain the option to buy additional shares at a lower price. This action would dilute Elliott’s holdings, decreasing the value and making it more costly for Elliott to gain control of the company. In other words, it prevents Elliott from taking over Southwest, although it has said it has no plans to do so.
“Contrary to the company’s statements, Elliott is not seeking control of Southwest,” the hedge fund wrote in a July letter.
A few weeks after that letter to board members, Southwest ended its 53-year tradition of open seating. While it’s a push away from Southwest business practices, the company had been evaluating the plan for months, even before Elliott disclosed its stake, Jordan told investors.
According to Southwest, 80% of customers prefer an assigned seat and 86% of potential customers prefer an assigned seat.
So far, the open seating changes, scheduled to begin next year, are receiving mixed reviews.
Kim Samuels of Dallas said she has a strategy of setting her alarm for 24 hours and two minutes prior to her flight and then staring at her phone until it is time to check in to claim the best boarding position. The ending of open seating isn’t a deal breaker for her, she said.
“I think if they started charging for bags, I would consider American more,” Samuels said. “I live closer to Love, but DFW is not too bad.”