Another Interesting take on Southwest Airlines Purchase of AirTran Airways

Here's the most important thing you need to know about Southwest Airlines, which Monday announced a $1.4 billion deal to buy AirTran Airways: Southwest has made money for 37 years in a row in an industry that has burned through perhaps $200 billion since the dawn of aviation deregulation in 1978.

While its competitors have screwed up mergers, infuriated customers, bankrupted stakeholders, battered labor forces, collapsed unceremoniously, and abandoned municipalities that spent millions of tax dollars on airports, Southwest is serenely independent and has been content to do what it does: carry more passengers—most of whom actually like flying the airline—than anyone else; make more money than anyone else; pay a dividend for 136 consecutive quarters; and keep its rank-and-file employees dedicated and relatively happy.

Despite the mainstream media blather this week about a combination of two "low-fare airlines," however, Southwest and AirTran are completely different animals. It's certainly the riskiest move that risk-averse Southwest management has ever made. And business travelers like us have more than a small stake in what happens next. We'll have to live with (and fly on) what comes to pass.

Will it work? There are lots of questions and concerns, some of them outlined below. But one thing I do know: When an airline makes money for coming on four decades and pays consistent quarterly dividends for all but two of those years, it gets the benefit of the doubt. For better or worse, Southwest's acquisition of AirTran will be the stuff of textbooks a decade from now.

The Big Gulp

Southwest built its business and its brand on internal, organic growth. Its few previous acquisitions have been small:

In the 1980s, tiny Muse Air, created by one of Southwest's own founders.
In the 1990s, Morris Air, a Southwest-style boutique operation based in Salt Lake City.
Its biggest deal to date, with now-defunct ATA Airlines earlier this decade, gave Southwest its presence at Chicago's Midway Airport. But Southwest was careful to buy ATA's best assets without taking on any of its problems.

The $1.4 billion deal for AirTran is unique. AirTran actually flies to more airports (70) than Southwest (69). It flies 20 million passengers annually, generates $2.3 billion in revenue, employs 8,000 people, and has almost as many daily flights (202) at its primary airport (Atlanta) as Southwest operates (224) at its largest base (Las Vegas). And there's the corporate culture: AirTran has been around in one form or another since 1993.

Southwest has a fanatical dedication to its own way of doing things. And it doesn't brook dissent from its newly acquired people lightly. One example: Morris Air's best thinker, David Neeleman, didn't last long at Southwest. A few years later he created JetBlue Airways, the most successful startup since Southwest.

Buying, Not Creating, Customers

Even before Monday's announcement, Southwest had admitted its days of organic growth were over. Co-founder Herb Kelleher once claimed Southwest competed more with Toyota than other airlines because its potential new customers were driving rather than flying. But after decades of creating customers at secondary airports, Southwest ran out of car trips to cannibalize. In recent years, Southwest has gone where existing passengers lived, which meant high-cost, delay-prone markets such as Boston, Philadelphia, Minneapolis-St. Paul, Chicago, Denver, and even New York. Those cities came with existing competitors and Southwest's next frontier (Newark) was only doable because United and Continental airlines needed to offload some gates and slots at Newark to get Justice Department approval for their imminent merger.

Besides picking up more capacity in the crowded markets along the Eastern Seaboard, Southwest's acquisition of AirTran gives the Dallas-based carrier its first entry into Atlanta, the nation's busiest airport. "The story here is about Atlanta," Southwest chief executive Gary Kelly admitted on Monday.

But Atlanta also comes with fevered competition from Delta Air Lines, Atlanta's hometown carrier and the world's largest airline. Southwest didn't become the nation's largest carrier by passengers flown (86 million last year) by shying away from the competition. But AirTran's Atlanta customers, many of them frequent flyers attracted by lower fares for and easy upgrades to AirTran's unique business-class service, won't be instant converts to Southwest's one-class-fits-all model.

The Fleet Fetish

Southwest has remained a singular financial and aviation sensation, thanks to a fetish about doing business its way. And one of its core beliefs has been that one plane fits all of its needs. The economics of scale and the consistency of service permitted by using just one fleet type has been a hallmark of the airline since its founding as an intra-Texas carrier in 1971. No other airline operates this way, which is one of the reasons that no other airline consistently makes money.

Southwest now has a fleet of 547 planes, and every one of them is in the Boeing 737 family of jets. AirTran's fleet of 138 planes includes 86 Boeing 717s. Southwest made all of the right noises on Monday about its willingness to adopt a second fleet type—the 100-seat 717 allows AirTran to profitably operate in many marginal markets that Southwest itself doesn't serve—but history says otherwise. Most of the 717s are leased, which would give Southwest the chance to dump them. How and if Southwest manages the 717s and the markets they serve will be a key to the merger's success.

Hubs, as in a Rub

Traditional hub-and-spoke operations—airlines collect passengers from smaller "spoke" cities at a hub airport and then redistribute them to other spokes—has been anathema to Southwest's way of doing business. It has specialized in point-to-point operations, which carry passengers from their point of origin to their destination without a change of planes. Southwest's logical argument: The more times you force passengers to change planes, the more chances you have for delays, missed connections and lost luggage. A hub-and-spoke carrier is also more expensive to operate than a point-to-point airline.

Here's the rub: Atlanta, the aforementioned prize of the AirTran acquisition, is a hub-and-spoke operation. So is the carrier's focus city of Milwaukee. To some degree, Southwest's operations at Phoenix, Chicago/Midway, and Dallas' Love Field resemble hubs, but Southwest has never run anything like AirTran's Atlanta flight nexus. Will Southwest change Atlanta? Or will Atlanta change Southwest?

Service by Any Other Name

Southwest's service model is famous: open seating, one class of service (a three-by-three alignment of coach chairs with about 32 inches of legroom), and minimal in-flight frills. It has also gobbled up market share in the last two years by continuing to allow passengers to check two bags free of charge.

AirTran has prospered with a different model. It assigns seats. It has a business class with two-by-two seating and a coach class with seats that often fall below the industry standard of 31 inches of legroom. Its entire fleet is wired with free satellite radio and pay-to-play WiFi. It charges for its checked bags.

Southwest reaffirmed its commitment to its brand and its service style on Monday, but it didn't definitively rule out changes. Will anything from AirTran survive? And will business travelers who've come to view AirTran's business class as a cherished (and reasonably priced) small amenity of a hard life on the road accept Southwest's our-way-or-the-highway approach?

Seizing the Seas

As growth opportunities for Southwest has dwindled, the airline's executives have talked vaguely about expanding beyond the continental 48 states. But when it dismembered ATA a few years ago, it passed on all of ATA's flights to Hawaii. It has refused to fly to either Canada or Mexico, preferring instead to forge as-yet-unimplemented code-share deals with local carriers. And unlike AirTran or JetBlue, which have both profitably exploited opportunities to fly to Caribbean and Mexican vacation destinations, Southwest has ignored this growth path.

So what does Southwest do now that it will inherit AirTran's flights to places such as Nassau, Bahamas; San Juan, Puerto Rico; Cancun, Mexico; Montego Bay, Jamaica; and Punta Cana, Dominican Republic? The airline's executive said Monday that it expected to fly to those places and more. But international, overseas flying adds complexity and cost—two things that Southwest has consistently found reason to banish from its operations.

The Fine Print…

There are two more major questions about Southwest's future, with or without the AirTran acquisition. When and how will it implement a new reservations system to replace the antiquated, limited service that served it well in the past but is now limiting revenue growth? And what shape will Southwest's revised Rapid Rewards frequent-flyer program take when it is finally unveiled next year?

(Joe Brancatelli - Portfolio.com)