Southwest Airlines Sends Goliaths Back to Flying School

Goliath faces life. Robert Crandall, the intensely competitive chairman of AMR Corp., owner of American Airlines, told shareholders last week that the nation's largest airline would have to pull back from some markets because it has trouble competing with a much smaller low-cost rival, Southwest Airlines.

Southwest last year took in $1.3 billion in revenues, one-tenth of American's $13-billion total. But as the song says, "Little David was small, but oh my . . . ."

Southwest has beaten American in the race for market share in California, taking 22.8% of the intrastate traffic to the larger airline's 17.3%.

Founded in Texas 21 years ago, Southwest has expanded around the country and is about to begin service to its 34th destination, Columbus, Ohio.

Most significant, at a time when most airlines are showing red ink and singing the blues, Southwest is making a profit. It earned $27 million, or 63 cents a share, last year, when war and recession cut into travel. And this year, it may earn $93 million, or $2.10 a share, predicts analyst Kevin Murphy of Morgan Stanley.

Something important is going on. Southwest's success flouts the conventional wisdom--still heard 14 years after deregulation--that competition would lead only to monopoly, with American, United and Delta leaving no room for the little guy or for good deals for travelers.

None of it is true. Instead, there are twice as many airline seats available today from almost double the number of carriers as 14 years ago, while much lower fares--adjusted for inflation--attract twice as many passengers.

There are opportunities for operators like Southwest, and opportunities here and overseas for the big airlines, too--although some changes in the U.S. business are just around the corner.

But first, if you understand how a small but smart airline runs, you'll learn a lot about all business in the '90s, when the emphasis is on keeping costs low.

Southwest serves no meals and gives no advance seat assignments. It pays good wages but uses fewer people: Two employees assign seats at a Southwest gate, where another airline may have four--and the Southwest employees may then work as flight attendants.

It doesn't fight big competitors toe-to-toe, but uses flanking tactics. In large cities, Southwest flies in and out of secondary airports--Love in Dallas, Hobby in Houston, Midway in Chicago. In California, it flies from Los Angeles to Oakland, or San Francisco to Burbank or Ontario.

Most of all, where big airlines connect passengers through hubs, Southwest specializes in flying them point to point--no immediate connecting flights. This allows Southwest to land, discharge and take on passengers and depart again in 20 minutes--keeping planes in the air where they make money. It helps to economize on servicing that Southwest uses only one kind of plane, Boeing 737s.

Add it all up and Southwest's costs are 6.7 cents per available seat mile, compared to American's 9 cents.

It's a jolly airline, noted for in-flight humor, peanuts and frequently free drinks. Chairman Herbert Kelleher, 60, a lawyer by training, is known for joking with employees and helping out on the baggage conveyor. As on all airlines, the cuteness has a purpose: easing tensions. Southwest employees encounter millions of passengers annually at times when they are most hurried, irritable, perhaps frightened.

"Situations will arise that we can't anticipate," Kelleher tells employees. "You handle them the best way possible."

The big attraction for passengers: Southwest's average fare is a low $56.

To be sure, it is a regional airline. Its longest trip is 500 miles and its average is 375 miles. American, United and Delta fly across the country and around the world and so offer a different level of service--connecting flights, meals, comforts--at a higher price. Needless to say, if passengers have to make connections, you can't land and take off in 20 minutes and helpful ground personnel are a must. So in a sense, the airline industry is developing two tiers of efficient service--local and long distance.

But there is trouble. American, United and Delta all lost money last year. Crandall claims that losses in the last two years "have wiped out all the accumulated profits airlines have ever made."

His complaint is directed not at Southwest but at bankrupt competitors, such as TWA-- weakened in the '80s by deal-maker Carl Icahn--which continue to operate without regard to profit and spoil the business. American struck back on April 9 with permanently reduced fares designed to drive weak competitors to the wall. Still, fares fell further, until last week when all the airlines began to raise fares again.

But consumers need not fear that fares will rise much in today's competitive environment. Rather, airlines will profit as they always have from productivity gains. The great increases in airline productivity came in the 1950s and '60s, when the 707 and 747 jetliners quadrupled the efficiency of propeller planes.

No new engines are in the offing today, but watch for economies in ground operations, says analyst Harold Shenton of AvMark, an airline consulting firm. Check-in and ticketing will become more electronic, seat selection and boarding will involve fewer personnel. Such automation can boost profits but keep fares low to attract passengers--which means more jobs.

Southwest has increased its employee rolls more than fourfold in the last decade, from 2,129 to 9,778, as fares have risen $18 on average and passenger totals have grown from 6.7 million to 20 million.

The lesson of Southwest's success: Competition is unstoppable and low prices attract customers.

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