Southwest Airlines Is Becoming Disruptive Again

For much of its 40-plus-year history, Southwest Airlines has been a disruptive force in the airline industry.

While legacy carriers flew hodgepodge fleets, Southwest operated a single fleet type to reduce complexity and cut down on training and maintenance costs. While rivals piled in to crowded hubs, Southwest Airlines mainly operated from cheaper alternate airports.

These are just two of the things that have set Southwest apart over the years. These two key focuses have formed the linchpin of a strategy that enabled Southwest to experience steady growth. But more recently, Southwest seems to have lost much of its uniqueness in the eyes of some industry observers.

Problems included slow growth, rising costs, and deteriorating labor relations.

It's true that the Southwest Airlines of 2015 is not the Southwest of 2000. The carrier now flies to virtually every big city in the country and tries desperately to court business travelers. But Southwest is starting to show the industry that it can be as disruptive as ever -- and competitors like American Airlines are already feeling the pinch.

Years of slow growth

In 2011, the year Southwest merged with smaller rival AirTran, the two carriers' combined capacity totaled 128.5 billion available seat miles, or ASMs. In 2014, Southwest offered 131.0 billion ASMs -- indicating that it increased capacity less than 2% in a three-year period.

The combination of this slow growth, pay raises, and Southwest's expansion to more expensive airports led to significant unit cost inflation. In 2011, Southwest's unit costs excluding fuel and special items totaled $0.0759. This metric rose 10% over the next three years, reaching $0.0836 in 2014.

Legacy carriers like American Airlines have capitalized on this cost creep to improve their competitiveness relative to Southwest.

Becoming aggressive again

The tide is turning, though. Having completed most aspects of the AirTran integration process, Southwest is looking to grow more aggressively while focusing on cost containment.

For 2015, Southwest currently plans to increase capacity by 6%. In other words, it will grow three times as much this year as it did in the last three years combined! This return to growth, along with changes in Southwest's fleet mix, will allow the company to reduce its non-fuel unit costs (excluding special items and profitsharing) by 1%-2% in 2015.

Breaking down Southwest's growth further, 3 percentage points of growth will come at Dallas Love Field. Changes in federal regulations that went into effect last fall now allow Southwest to fly anywhere in the U.S. from Love Field, rather than just within Texas and a few nearby states.

Another 2 percentage points of growth will come at New York's LaGuardia Airport and Washington's Reagan Airport, where Southwest acquired slots that American Airlines had to sell to gain approval for its merger with US Airways. Lastly, 1 percentage point of growth will come from new international routes to Latin America and the Caribbean.

A thorn in American Airlines' side

Unfortunately for American Airlines, it has a big presence in all four of the markets Southwest is targeting for growth this year. In Q4 2014, American Airlines missed its original unit revenue forecast as the impact of new competition (mainly from Southwest) turned out to be more severe than expected.

American Airlines executives have warned investors that unit revenue will remain under pressure because of competitive capacity growth. American currently expects to report a 1%-3% unit revenue decline for Q1, though that's actually slightly better than what it had projected just a month ago.

Air travel demand in the U.S. appears to be quite strong, but Southwest's growth could continue to put pressure on American Airlines' results going forward. In Dallas, Southwest originally planned to grow its route network to 31 cities while offering about 150 daily departures. It has continually increased its ambitions, though, and is now scheduled to offer 180 daily departures to 50 cities by August.

Last fall, Southwest achieved extremely high load factors of 90% or more on most of its new Love Field routes. Southwest is clearly pulling passengers off of competitors' flights. In Dallas, this mainly means American Airlines, which operates its biggest hub at Dallas-Fort Worth International Airport.

As Southwest's growth in Dallas continues this year, it will continue to disrupt American Airlines' once-secure dominance of that market. As it turns its growth plans to other markets in the future, other legacy carriers will face the unwelcome truth that Southwest Airlines can be as disruptive as ever to their business models.

(Investopedia)