Boyd on Southwest's entry to Denver
Southwest & Denver:
More Proof of The Maturing of The LCC Model
Head scratching.
After years of literally telling the world it would not come to Denver, Southwest suddenly announces it's doing it. To a lot of folks, it looks like the airline planets are out of alignment. Colorado Springs was supposed to be the heir apparent for Southwest service in the Rocky Mountain region. Denver International was too expensive. Heck, the president of Southwest actually said so, not too long ago.
This is the same airline that less than a month ago was threatening to bolt away from Sea-Tac because of high airport costs. The same airline that has made clear in the past that airport costs were a critical component in serving a city.
Then they announce Denver, which, regardless of the hype, is an expensive airport.
An Airline Under Attack - From More Than One Side. This has a lot more to do with what's going on at Southwest than it does with Denver International, airport costs notwithstanding.
To be clear, Southwest - its great service, motivated employees, and incredible brand equity notwithstanding - is an airline under siege. Quietly, but still under very serious siege.To be sure, this can be said of any airline, but WN has some real issues of its own.
Labor costs are high. Fuel will edge up for them next year. Meanwhile, legacy carriers are getting their own costs down - to the point that they're on the ragged edge of actually breaking-even or making a profit. Without fuel hedges, which are essentially a situation where the somebody else is getting the short end of the deal, Southwest would be losing money. And, while the carrier is well-hedged going forward, its fuel bill is still going to go up nastily in 2006 and 2007.
But most dangerously for Southwest, the LCC skies are getting more and more crowded. Look for another 250 or so 100+ seat airliners over the next three years, including just those with planned deliveries at AirTran, jetBlue, and Southwest. A lot of those competitors to Southwest have raised the service ante, with seat assignment, inflight entertainment, and wider seats. The number of markets where the low-cost, price-stimulated model can work is not unlimited. And as The Boyd Group was the first to point out, the LCC model is not well suited to take advantage of the new emerging revenue flows between mid-size communities, as well as those developing to international points.
So here's the sea change: Southwest - regardless of the sunshine media stories - is no longer alone, nor is it immune from competition from other LCCs, nor from re-structured legacy carriers. Far from being the invincible airline dreadnought that some lightweight Wall Streeters think it is, Southwest has a lot of vulnerabilities. (Again, after these become too obvious to miss, the same clowns will be "forecasting" the problems at Southwest.)
That's the bad part.
Understand The Problem & It's Already 50% Solved. The good part, at least for Southwest, is that they seem to be fully aware of it. One of the reasons that Southwest has survived and prospered over the last thirty years is that they've never taken their press or PR completely seriously. Sure, they've reveled in all the good news coverage. They've leveraged the stories of their chairman's motorcycle and his free-spirit approach to running an airline. They've put on incredibly wacky public relations stunts that are the stuff of airline lore. But at the bottom line, all the frivolity has never gotten in the way of strong customer focus, level-headed planning, and operating a ruthlessly-efficient airline. That means they have a clear understanding of the future, and it's beyond question they know what they're facing.
First, There's This Fuel Thing. The brilliant and innovative decision to take the chance on long term and massive fuel hedges has paid off handsomely for the airline. In fact, the hedges are the main reason that Southwest is reporting any profits at all. And that's part of the siege - the basic Southwest model as it's structured today doesn't make money at $2+ jet fuel. The revenue flows just are not there.
Second, There's This Labor Thing. Southwest today has among the highest labor rates in the industry. It's been offset by the carrier's ability to fly more hours, lowering average ASM costs. It's worked great so far, to everybody's benefit. (To read some of these alleged analysts, one might think that paying employees above the food stamp level is a crime. It's to Southwest's credit that they do pay higher wages.)
Third, There's This Competition Thing. Southwest must increasingly watch its six for other LCCs. jetBlue offers leather seats, wider seats, and free TV to keep the little brats shut-up on the long flight to see Grand Ma in 'Lauderdale. Frontier has TV, too. Other LCCs, like AirTran & Spirit, have business cabins, which can develop brand loyalty.
And virtually all of them offer seat assignment, while Southwest still does not. The official line is that it's no big deal, and Southwest isn't sure if customers are willing to pay the extra costs of having seat assignment. The reality is that the competition is offering it, even when they match WN fares. The head'em-up-and-move'em-out boarding system might be perfectly acceptable for the Dallas business traveler heading to Lubbock. But it's woefully outclassed in long-haul and transcon markets. That family of four that didn't have a computer to check in early at WN, might find that little Johnny may have to sit in 34E, six rows from mamma, between two Mohammed Atta look-alikes on their way to a jihad convention in 'Vegas. That's a severe disadvantage for Southwest - one that may be a real Achilles heel as they take on Frontier and United at Denver.
Yep. It is an airline under siege. But it's one that's fully aware of what they need to do to survive. The old game plan is getting a facelift. Unlike most the swooning media and academics who rave on about costs, Southwest does understand that it's the revenue stream that will make or break it or any airline. If you can't cut costs, then you'd better add lots and lots more revenue to your system.
The Solution: Show Me The Revenue Streams. Hence, Philadelphia. Hence, Denver. The revenue imperative now trumps, to a large degree, airport costs. If they have an alternative, like Boeing Field, okay. But if not, they're now focused on gaining more revenue to spread their costs even at high cost airports, as long as the traffic base is huge.
And that brings us back to the Denver issue, which illuminates the challenges that Southwest is facing. Three years ago, Colorado Springs was the odds-on option to enter this region. It was cheap. It could draw passengers from Denver as well as from most of the I-25 Colorado Corridor. And that's what the carrier said, too. But the new competitive environment changed all that.
Remember, Southwest can only offset higher labor and other costs by flying more ASMs, spreading the expense over more product. As they grow, too, they add employees - all at the entry level of the pay scale. The combination tends to moderate ASM costs.
The potential fly in the ointment is that getting ASM costs down by flying more is easy. The hard part is making sure that most of those ASMs are matched to an RPM - i.e., Southwest must fill those new seats in the sky. They can't take any chances in that regard. Today, the only safe way of doing it is entering or expanding at markets that are really big. Denver is just such a market, regardless of the airport costs.
These new realities knock Colorado Springs out of the running. At COS Southwest would be dependent there on gaining reverse leakage from the Denver Metroplex, as Western Pacific did in the mid 1990s. Or as WN has been doing at Manchester, drawing passengers from the Boston area.
But to get people to drive an hour for a low fare is predicated by the local airport not having such fares in the first place. Ten years ago, that was the case at Denver. Today, there's not only Frontier, but also a re-structured United, matching F9's fares. That means there'd be less traffic willing to drive to catch a WN flight at COS. It's a risk that Southwest cannot afford to take.
Buttressing this, and only anecdotally, there have been indications that WN's Florida traffic at MHT and PVD has been vulnerable, now that jetBlue is firmly installed at Boston Logan. In short, the peripheral airport gig is not as much of a sure thing as it used to be.
Bottom line: Denver International's cost have not dropped anywhere near as much as Southwest's need for lots of new passengers has increased. It's a new world. Southwest now has to react to competitive market conditions.
Instead of the other way around.
