Southwest Is Holding Steady

As rivals sputter, can the lowfare airline stay on top?

In the hours immediately after the terrorist attacks on September 11, 2001, the newly promoted executives at Southwest Airlines Co. (LUV ) made a bold decision. Without even consulting the legendary co-founder and current chairman, Herbert D. Kelleher, Chief Executive James F. Parker and President Colleen C. Barrett swiftly agreed to grant refunds to all customers who asked for them, regardless of any ticket restrictions. Only later did Parker learn that the airline could have had to shell out several hundred million dollars, an unsettling prospect, given the uncertainty of the times and a $187 million profit-sharing payment that was coming due. "Fortunately, the potential flood of refund claims never came," says Parker, in his typically understated style. Quite the opposite: One devoted customer even sent $1,000 to support Southwest after the attacks.

Now, the low-fare leader is watching its biggest competitors struggle mightily, in and out of bankruptcy court. So Southwest's gutsy leaders must be reveling in their rivals' misery, ready to press their advantage in the industry's worst-ever downturn, right?

Not exactly. Steeped in Kelleher's disciplined operating philosophy, longtime lieutenants Parker, 56, and Barrett, 58, are throttling back on growth at the world's most admired and most profitable airline. While poised to swoop down if, say, United Airlines Inc. (UAL ) or US Airways Group (U ) has to drop a certain market, they won't try to push weakened rivals out. After all, this is a management team that, despite its fun-loving image, got where it is today by tempering opportunism with fiscal conservatism. Indeed, in choosing Parker and Barrett to succeed Kelleher in June, 2001, the board intended to signal "business as usual.... If it ain't broke, don't fix it," says director June M. Morris.

And it sure ain't broke. Southwest is the only major carrier to remain profitable in every quarter since September 11. While its six biggest rivals have grounded 240 aircraft and laid off more than 70,000 workers, Southwest--which has never laid off a soul in its 31 years--has kept all of its 375 planes and 35,000 people flying. While others battled with unions to cut wages, Southwest quietly wrapped up five crucial agreements, ensuring labor peace with those groups until 2005. It is now in talks with flight attendants. Although its stock has dropped 25% since the attacks, Southwest is still worth more than all the other biggies combined. Its balance sheet is the best in the business, with a 43% debt-to-capital ratio. And luckily for Parker, it has $1.8 billion in cash, with an additional $575 million in untapped credit lines.

Faced with such a strong competitor and with such a stormy economic climate, the big airlines are trying desperately to emulate Southwest's efficiencies. For some, including American Airlines (AMR ) and United, comparable costs are as much as 170% of Southwest's. US Airways and United are both in bankruptcy, struggling to emerge as lower-cost contenders. Likewise, American and Delta Air Lines (DAL ) are looking for ways to slash billions in costs without destroying the route networks and service that command prices higher than Southwest's. Meanwhile, younger low-cost carriers that offer more amenities, such as JetBlue Airways (JBLU ) and AirTran Holdings (AAIR ), are trying to grab a bigger chunk of the market.

Not since the downturn of the early '90s has Southwest presented so clear a target for its rivals. "At some point, Southwest is going to be faced with much more aggressive and more cost-competitive rivals," predicts Robert L. Crandall, retired CEO at American.

But Parker is determined that Southwest will continue to be, well, Southwest: a primarily short-haul airline that flies directly from city to city, with just one type of plane--the Boeing 737--and the lowest costs. For all of its enviable numbers, the nation's fourth-largest airline still accounts for only 10% of domestic traffic. That's a dominant slice of the overall 16% share held by discount airlines, but it means Southwest still has plenty of opportunities to gain on its so-called hub-and-spoke rivals. Southwest aims to hike its capacity by at least 8% annually in the years ahead. "Obviously, we will not ignore any threat arising from our competitors' lowering their costs," says Parker. Nevertheless, he adds, "I don't see how they compete with the kind of point-to-point system we have at Southwest Airlines."

In some ways, the aftershocks of September 11 are making Southwest an even fiercer contender. Here's one way Parker and his crew have boosted loyalty and morale, long a key to Southwest's high productivity: When the federal government offered cash grants to prop up the industry, Parker included this money in the company's profit-sharing formula for employees, even though he wasn't required to. And although Southwest has never offered the industry's highest base salaries, Parker is now able to offer raises and stock options at a time when other airlines talk of sacrifice. "A whole new generation of Southwest employees hired in the last five or six years are now fundamentally understanding the advantages of the Southwest business model," says Brad Bartholomew, a Southwest pilot for 15 years. The pilots' new contract provides raises of at least 30% through 2006.

All things considered, the transition of power is proceeding smoothly, if slowly. Parker and Barrett admit they regularly seek Kelleher's counsel. And why not? The three go way back: Parker, a former Texas assistant attorney general, joined Kelleher's San Antonio law firm in 1979; Barrett was Kelleher's legal secretary. After fighting fierce battles to get Southwest aloft in 1971, Kelleher became permanent CEO in 1982. Parker joined him as general counsel four years later.

On the surface at least, the San Antonio-born Parker appears to be the polar opposite of Kelleher. His drawl and quiet diplomacy is a sharp contrast to Kelleher's manic energy and raucous laugh. "Because he looks like this pudgy, easygoing good ol' boy, he's very often underestimated," says a former exec. Parker's reserve belies a dry wit: At a graduation ceremony for new flight attendants last fall, Parker cracked that "when CEOs started going to jail, that's when Herb gave up the title." Style aside, the two have much in common: keen intelligence, a deep devotion to Southwest and its employees, and a taste for a good party. Colleagues even presented Parker with a beer keg for his new office; it is regularly replenished for after-hours parties.

The pony-tailed, chain-smoking Barrett, who was promoted to executive vice-president for customers in 1990, oversees most of the day-to-day operations. Although more officers report directly to her than before, her focus on service and the company culture hasn't changed. Besides keeping tabs on such basics as on-time performance (Southwest now ranks a lowly No. 6), she's the "sentimental slob" who collects letters from passengers praising the airline's often extraordinary service. A reluctant public speaker who doesn't know how to use e-mail, she lets Parker take the lead with Wall Street and the media.

And her former boss? Well, by all accounts, the flamboyant, irreverent Kelleher--once the star of the company's TV commercials--is staying out of day-to-day affairs. He no longer leads the executive planning committee, the airline's major policy-setting body, which meets every three weeks. In fact, he's so invisible that some employees send cards wishing him well in retirement, unaware that "he's working his ass off," says Barrett. In fact, the 71-year-old chairman is leading the airline's lobbying efforts in Washington, where airport security, terrorism insurance, and other matters have suddenly become vital to the industry's survival. At the same time, he maintains control of schedule planning and aircraft acquisitions, the backbone of Southwest's strategy.

The trio running Southwest may be cautious about the future, but they're not complacent. Southwest is poised to accelerate its modest growth plans if the right opportunities come along. "A large, single-market opportunity has not fallen in their laps yet, but wait. They're certainly ready to exploit it," says analyst Samuel Buttrick of UBS Warburg. For instance, the company vastly expanded its presence at Chicago Midway Airport in 1991 when Midway Airlines Corp. ceased operations there, and it moved into Baltimore in 1993 and Raleigh-Durham in 1999 when US Airways and American scaled back in those cities. Now, it's the top operator at Chicago's Midway and in Baltimore.

Parker has his own worries. Despite Southwest's relatively good health, it is still suffering from a weak economy, fears of war and terrorism, and penny-pinching by business travelers. The company's net profit last year fell 52%, to $198 million, excluding special items, on flat revenues of $5.5 billion. Of course, that looks fabulous next to the combined losses of the major carriers--more than $13 billion in the past two years. Southwest's capacity grew by only 5.5% last year, its lowest rate since 1973. Traffic grew a weak 2%, hurt in part by airport security hassles. That compares with a 6.2% drop for United, and 4.2% at American. Parker predicts a "very gradual" recovery for his airline and the industry. As a result, the company says it will add only 4% to its capacity this year and no new cities to the 58 it already serves.

As for the competition, Parker and Kelleher, like many airline observers, believe the big carriers won't be able to reinvent themselves radically. There may be fewer of them, and they may operate with fewer hubs. Their costs will be lower, but not as low as Southwest's. And they'll continue to cater to higher-paying business passengers with broad networks, first-class service, and airport clubs. "They'll narrow the [cost] gap substantially, but not enough to keep Southwest from continuing to eat market share," agrees Michael Roach of Unisys R2A Transportation Management Consultants.

Of course, Parker also has to keep an eye on the low-cost upstarts. They are growing fast and are likely to target many of the same dense markets that Southwest would like for itself. JetBlue, in particular, is attracting loyal customers in droves, with such amenities as televisions in the seatbacks of its 37 airplanes and assigned seating, which Southwest's flights do not offer. But, so far, Parker isn't worried: "None of those `Southwest-with-improvements' have shown they can produce an economically viable business model over a long time," he says. Only three years old, nonunion JetBlue enjoys unusually low maintenance, wage, and benefit costs, which are bound to rise in years ahead.

When pressed to describe his hopes for Southwest, Parker tells a story. Shortly after his promotion, he sat next to a lawyer from Amarillo on a Southwest flight. When the man found out who Parker was, he admonished him: "You've got a damn good airline here. Just don't f--- it up." So, says Parker, "that's kind of my goal."

By Wendy Zellner in Dallas, with Michael Arndt in Chicago

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