Southwest's New Direction

It's adding longer flights to its bag of tricks

Southwest Airlines Co. executives swear that their first nonstop transcontinental flight last Thanksgiving Day--between Baltimore and Oakland, Calif.--was a one-time experiment. The $99 one-way tickets filled the plane, and almost half of the passengers had never flown Southwest before. The only glitch: So much trash accumulated during the flight that some of it was inconveniently stowed outside the rest rooms. Chief Executive Herbert D. Kelleher insists there's no immediate plan for more such flights, though he admits "the potentiality is there."

That potential isn't lost on anyone tracking Southwest these days--including the American Airlines Inc. spy who flew along on the Baltimore-Oakland trip. Long the most successful purveyor of cut-rate, short-haul flights, Southwest in the past year has sharply stepped up its expansion into longer, nonstop trips on routes such as Baltimore to Las Vegas (2,099 miles) and Austin, Tex., to Los Angeles (1,234 miles). And it's adding one-stop trips through places like Nashville and Kansas City for travel coast-to-coast. The prospect of Southwest going long-haul on a grand scale is "the genie [rivals] always hoped would not come out of the bottle," says analyst Kevin C. Murphy of Morgan Stanley Dean Witter. He believes an even bigger push is likely in the year ahead. "It will really rewrite the economics of the airline industry."

EASTWARD HO. Southwest won't say just how profitable its long-haul routes are. "All I can say is they haven't seemed to drag us down much," says Kelleher. Thanks in part to lower fuel costs, Southwest posted record earnings last year of $433 million, a 36% gain, on 9% higher revenues of $4.2 billion. Its operating margin hit 16.4%, the best since 1981. This year should be even better. The growth in longer flights should help fuel earnings growth of 14%, to $496 million, this year, while profits fall for most of the industry, Murphy estimates. Adds James R. McGlynn, a vice-president at Tom Johnson Investment Management in Oklahoma City: "As they go into more long haul, they should be able to still maintain their margins." His money management firm holds more than 2 million Southwest shares.

Certainly, there's still plenty of room for Southwest to expand its traditional short-haul flights. It now flies to 52 cities but has barely scratched the densely populated East Coast, where it first started serving Baltimore in 1993 before moving into Florida, Providence, R.I., and Manchester, N.H. Following its strategy of favoring uncongested secondary airports, Southwest in March will move into New York with service to Islip, Long Island, about 40 miles east of Manhattan. Two other new cities, probably on the East Coast, may come this year. Southwest has done at least as well in building eastern markets as elsewhere: In its first year flying between Baltimore and Providence, traffic soared nearly tenfold.

Moreover, because Southwest avoids attacking the bigger carriers head-on, the risks of a sharp price war are low. With nearly 3 million people on Long Island, for instance, Southwest should be successful even if it doesn't lure many Manhattanites. Elsewhere, counterattacks by US Airways' MetroJet, Shuttle by United, and Delta Express could dent Southwest's profitability, but analysts say that with its lower costs and bulletproof balance sheet, Southwest should prevail. The biggest risk Southwest faces as it moves into longer routes, says one rival airline exec, is outgrowing its roots: "It's very much of a culture issue, how well they can stick to doing what they do well."

Southwest downplays any suggestion that it's shifting focus. About 80% of its capacity is still on flights shorter than 750 miles. "We're built for the short-haul markets, and we know that," says Chief Financial Officer Gary C. Kelly. Indeed, the airline's very identity is wrapped up in its underdog tradition--and in the flamboyance of Kelleher, the chain-smoking, Wild Turkey-swilling funnyman who fuels Southwest's legendary esprit de corps. Past stunts include the time Kelleher arm-wrestled another CEO for the rights to an advertising slogan. He lost but still got to keep using the slogan.

"HUGE THREAT." Kelleher claims that Southwest never would have jumped aggressively into routes of 1,000-plus miles if not for changes in the federal ticket tax in 1997 that were pushed by bigger carriers. The new system replaces a percentage tax with one that includes a flat, per-segment fee that hits low-fare carriers harder. But some competitors believe that Southwest would have moved strongly into long hauls anyway. "They've dug all the shallow holes," says Rono J. Dutta, senior vice-president for planning at United Airlines Inc. And he notes that in Southwest's core markets, "they've now got competition" from the majors' low-fare units.

On the other hand, Southwest's success on longer routes will put growing pressure on the profits of its bigger competitors. Southwest's cost advantage is built on rapid 20-minute gate turnarounds; an efficient all-Boeing 737 fleet, including new 737-700s that can fly cross-country nonstop; and a more productive workforce. That edge shrinks on longer flights, but it's still significant. Roberts, Roach & Associates Inc., an airline consultant in Hayward, Calif., says Southwest has at least a 59% cost advantage over bigger rivals at flights of 500 miles, and a still husky 35% lead at 1,500 miles. "It's a huge threat," says a rival airline exec.

With long-haul flights as a growing part of its arsenal, Southwest has opened a second front in its war on higher-cost rivals. Already, nonstop flights longer than 1,000 miles account for more than 16% of Southwest's capacity, up from 9.5% five years ago, estimates Samuel C. Buttrick, an analyst for PaineWebber Inc. "In the final analysis, Southwest's growth opportunities are bounded by consumer demand for lower fares," he says. As more travelers look for ways to pinch pennies, that demand, long or short, seems almost limitless.

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