Southwest CEO's Cost Crusade: Haggling With Unions While Profits Soar

Southwest CEO Gary Kelly Photograph by Andrew Harrer/Bloomberg

Southwest Airlines has a tricky message for its employees: At a time of record profits, the airline wants workers to accept labor contracts that lock in cost advantages it enjoys over rivals. That dynamic is likely to play out at other U.S. airlines as industry consolidation boosts profits and tames the vicious business cycles that have lashed carriers for decades. But if times are consistently good, why must workers accept sacrifice?

The wrinkle at Southwest, however, is that the airline’s low-cost workforce is a key part of its business model. Expenses heavily influence fares, and Southwest wants to keep its reputation as a low-fare airline at a time when Spirit and Frontier are expanding aggressively and touting rock-bottom fares.

And there’s another claimant ahead of the workers for Southwest’s new outsize profits. “Arguably our shareholders have suffered for a long time when it comes to getting a return,” Southwest Chief Executive Gary Kelly said in an interview, in which he disagreed with a recent Bloomberg Businessweek story on the airline’s costs. “And our employees have been very well taken care of.”

Kelly insisted his airline will continue to pay employees “industry-leading” wages and benefits to maintain its customer-friendly culture, but he wants to win greater flexibility on work rules and other terms in Southwest’s collective-bargaining agreements. The company has set a target for consistent annual return on capital of at least 15 percent.

Southwest executives argue that—save for Allegiant and Spirit—their costs are lowest in the industry when adjusted for flight distance. On that basis, Kelly said, the airline’s “unit costs,” a measure of the cost to fly a single seat one mile—are about one-third lower than at American, Delta, and United, and also better than at JetBlue Airways and Virgin America. The cost disparity arises partly from Southwest flying just one kind of airplane and selling its tickets online directly from its website, saving the distribution costs other airlines pay to have their fares appear on sites such as Expedia and Priceline.

Yet it’s also true that no carrier save for JetBlue saw unit costs rise as much as Southwest in the decade ending last year—a period when the Big Three U.S. airlines used the blunt force of bankruptcy to shed structural costs. “The legacy airlines have used bankruptcy as a strategy to get their costs down,” Kelly said. “The competition has changed and the competitive environment has changed.” The new landscape, he concluded, “needs to be contemplated in our labor agreements.”

Over the next year, as Wall Street monitors Southwest’s rising costs, its bigger rivals won’t be signing major new contracts. “Delta and American are talking about their unit costs being flat this year, and I don’t think Southwest will be able to do that,” says Joseph DeNardi, an analyst with Stifel Nicolaus. More than 80 percent of Southwest’s employees are unionized, and the airline is negotiating new deals with several groups simultaneously.

One of those unions, the International Association of Machinists and Aerospace Workers, asked a federal mediator last month to intervene in its talks on behalf of 6,000 customer service and reservation agents. The union’s argument is predictable—and hard to argue against: “Southwest earned nearly $1 billion last year, is on pace to report a larger profit for this year, has the most productive workforce in the airline industry and yet refuses to offer any real improvements,” IAM District 142 President Tom Higginbotham argued in a typical news release (PDF).

Kelly said the airline isn’t aiming to have a huge fight about wages or benefits. Executives just want to address “the antiquated work rules in some of our contracts,” which limit how many part-time workers Southwest can employ and how it schedules aircraft capacity against expected demand. The CEO also wants to tie some payments to performance metrics, a controversial change, and devise new ways to address employee attendance, which has been a problem at times. “The nice thing is we have opportunities in our contract negotiations to address waste, to address inefficiencies, to improve productivity,” Kelly said. “In all of those categories, we have fallen behind some of our competitors.”

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