Dogfight Over California

Southwest Airlines Co. CEO Herbert D. Kelleher doesn't seem like a man who is bracing for war. Soon after United Airlines Inc. announced detailed plans on July 28 for its low-fare West Coast shuttle--to compete directly with Southwest on at least eight routes--Kelleher is his usual irreverent self. How does he really feel about United's "declaration of war," as he calls it? With gleeful laughter, he responds with an obscene gesture.

Kelleher can afford to laugh--for now. His airline still boasts the lowest costs among the industry's major carriers and commands a 50% share of the lucrative intra-California air-travel market. But even he concedes that the West Coast showdown is no joke. This is United's first attempt at proving that concessions won as part of an employee buyout will make the carrier competitive with any rival. For scrappy Southwest, it's a fight to keep United--and other Southwest wannabes--out of its short-haul niche. United's move, says Kelleher, "falls into the category of a frontal assault."

Strong rhetoric, but what are Kelleher's battle plans? Probably fare cuts, he hints, as well as new Southwest flights on both short- and long-haul routes. The moves are designed to drain revenue from United when it starts its shuttle in October and later expands to Chicago's Midway Airport.

MORE SEATS. To beef up for the fight, Southwest has oral agreements to lease two additional planes this year and is looking for two more. Even without these additions, Southwest will have boosted its fleet by 40 planes, to 197, and pumped up capacity by nearly 30% this year, partly by acquiring Morris Air Corp. in December, 1993 (chart).

Despite their size differences--Southwest's $2.3 billion in revenue last year was just 16% of United's--most observers give Southwest the edge in this battle. After all, the airline has honed its short-haul, high-frequency formula for 23 years. "Taking on Southwest head to head is unwise for anyone," says A. Maurice Myers, president of America West Airlines Inc.

But United insists it can challenge Southwest in the Golden State. After all, its hub in San Francisco and strong brand name in California, where Southwest drove it out of many markets several years ago, make the state a logical starting point. "People want to fly us because they can consolidate their [frequent-flier] miles and get better service," says Rakesh Gangwal, United's senior vice-president for planning. And United aims to lure travellers with amenities not available on no-frills Southwest, including first-class sections and assigned seating.

To succeed, United must narrow the cost gap with Southwest. United is aiming for costs of 7.4 cents per available seat-mile on the shuttle, close to Southwest's 7.2 cents and 30% less than United's short-haul costs before the buyout. Wage concessions from employees, who recently swapped $4.9 billion in cuts for 55% of the carrier, may get the airline close to its target. Argues Gangwal: "Now that we're cost-competitive, we're back in the game." But in the end, many predict, Southwest's more frequent flights and even lower costs will beat United's perks.

Maybe so. But United's shuttle is sure to woo some Southwest passengers. And the struggle for market share could crimp Southwest's earnings if fare wars break out. Samuel C. Buttrick of Kidder, Peabody & Co. notes that intra-California flying accounts for less than 15% of Southwest's total. But he expects Southwest's earnings growth to slow to 15% for the next few years--still healthy, but less than the 39% jump, to $215 million, forecast for 1994.

CLOSE TO HOME. Kelleher vows he won't lose his focus on Southwest's short-haul niche, despite his hints that he might challenge United on some longer routes. Even if the airline steps up flying on routes of 750 miles or more, now 10% to 20% of Southwest's system, such flights would remain "supplemental," says Kelleher, and might grow at most to only 30% of Southwest's flights. And the carrier would likely look for routes that don't involve head-to-head combat at United's hubs in Chicago, San Francisco, and Denver.

After the dust settles, even Kelleher concedes that Southwest and United might be able to coexist in the West. But for that to happen, he says, "you'd probably have to have some other carriers dropping off those routes." Indeed, the slugfest could hurt such less-well-heeled rivals as America West, Reno Air, and USAir--whose pilots proposed on Aug. 3 that employees swap $2.5 billion in concessions for 25% of the carrier. Myers of America West worries about United's ability to undercut competitors as it enters such markets as Los Angeles-Las Vegas. "Excess capacity is always a problem," he says. If Kelleher has his way, that problem won't be his.

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