Podcast: How Will Southwest Airlines Evolve?

Editors discuss Southwest Airlines' new board and plan after the intervention of an activist investor.

Subscribe Now

Don't miss a single episode. Subscribe to Aviation Week's Window Seat Podcast in Apple Podcasts, Spotify or wherever you get podcasts.

Discover all of our podcasts on our at aviationweek.com/podcasts.

Rush Transcript

Karen Walker:

Hello everyone, and welcome to Window Seat, our Aviation Week Air Transport podcast. I'm ATW and Aviation Week Network Air Transport editor-in-chief Karen Walker. Welcome on board.

Now, before we kick off, I actually just would like to start on a bit of a sad note, regarding one of our past Window Seat guests and someone who I greatly admired, and who was an air transport industry game changer. Ben Baldanza worked for many airlines before joining low-cost carrier Spirit, where he fundamentally changed how the American public viewed air travel by introducing very low fares, he called them “bare fares,” and combined those with ancillaries for almost anything beyond the flight itself. Ben died last week after a long and courageous fight with ALS. He was the 2023 recipient of the ATW Joseph S. Murphy Award for service to industry, and earlier this year it was announced he will be the recipient of the Wright Brothers Memorial Trophy. Both are highly deserved recognitions of Ben's incredible career. Our condolences to his wife Marcia, his college student son, and all those many family, friends, and colleagues who knew and loved Ben.

He also ran a podcast, himself. And one thing I know is that Ben would have loved this discussion that we're about to have this week, and he would have brought many interesting thoughts to it. So, I'm delighted to be joined by ATW and Routes Americas editor, Aaron Karp, and Aviation Week Air Transport senior editor, Americas, Christine Boynton. And we are going to have a discussion today about all the happenings this year at US carrier Southwest Airlines.

Southwest, of course, is something of an icon in US air transportation. It started operations from its Dallas Love Field base in the summer of 1971, and quickly established itself as the airline that would be different from the pack. There were their low fares and low unit costs, the easy booking system, point-to-point operations, rapid turnaround—gate turnarounds—with an all Boeing 737 fleet, that was, therefore, heavily utilized. The stripped-down service on a single class cabin, in which you were given a plastic reusable boarding card, and then picked your seat once you were on board—that was something different, too. And that's before we even get to co-founder and CEO Herb Kelleher, who epitomized Southwest culture.

That all contributed to the building of a large and passionate following of Southwest passenger devotees. But there was something else that really set Southwest apart from the other US carriers. Year after year after year, this airline made a profit, and it never laid off an employee. Those attributes, more than any other, gained Southwest respect and admiration from competitors, lawmakers and shareholders. They also prompted many attempts by startups that wanted to be the next Southwest. Few succeeded. In my belief, it's because they never truly understood the discipline and hard work that it takes to be Southwest.

This year, Southwest's management strategy has been challenged like never before. A US activist fund, Elliott Investment Management, took a $1.9 billion stake in Southwest in June, and then sought to oust CEO Bob Jordan and other Southwest senior management, claiming the company had failed to evolve. The friction and headbutting has become quite apparent in the following months, accumulating in the latest development, which is a new board. I've written, in an ATW Analysis [this] week, that this is the latest chapter in an intriguing story. But how will it end?

Christine, you've been tracking this very closely, and have written a feature that's about to come out in Aviation Week, so give me the top line. Who's in this new board, and who's out?

Christine Boynton:

Sure. Thanks, Karen. So, I think one of the most significant changes is that CEO Bob Jordan is still in place. As you've mentioned, the fund had actually previously conditioned any serious talks on immediate CEO change; they seemed really gung-ho on getting Jordan out. But what happened instead kind of came in two phases. First, in mid-September, executive chairman Gary Kelly announced he would retire, and that six directors would also step down from the board. That was a plan they actually brought directly to Elliott at their offices in New York, after having had what they described as limited engagement with the fund up to that point. So that move perhaps bought them time to then present a three-year action plan at an investor's day later that month. But Elliott would still request a special meeting of shareholders, in the end, for a vote on its proposed director candidates to fill those slots.

The fund even launched what was its first ever podcast to feature conversations with each of those candidates. So, seven days and two podcast episodes later, Southwest and Elliott did reach an agreement to add five of Elliott's proposed list of 10. So those five are David Cush, former CEO of Virgin America, Sarah Feinberg, former administrator of the Federal Railroad Administration, Dave Grissen, former group president of Marriott International, Gregg Saretsky, former CEO of WestJet, and Patricia Wilson, chief information and technology officer at NCR Atleos.

Now, the sixth new director is not part of Elliott's slate, it's Pierre Breber, former CFO of Chevron. And these six directors replaced those who have now, at this point, stepped down.

Karen Walker:

So yes, the big question that comes to my mind then, to be answered, Christine, is how did Bob Jordan, in the end, survive all of this? He's still the CEO. How did that happen?

Christine Boynton:

Sure. Well, it sounds like he was able to have a lot of discussions with Elliott in those days leading up to that final agreement, after having had very little contact with the fund at first. So, to a certain degree, he must have gotten through to them on his focus, and accountability is another word he's used a lot, for returning to sustained profitability.

But even before there was a new chair of the board named, who was Rakesh Gangwal, of course, former co-founder of IndiGo and former CEO of US Airways Group, before he was named chair of the board, he was named a director, and he bought $100 million in company stock. And at the time said he believed that any further leadership change beyond what had already been announced would be counterproductive, and not in the best interests of shareholders, just too much shakeup at the top. So that may have also played a role.

Karen Walker:

And also we should point out that former Southwest CEO, Gary Kelly, who was the chairman of the board, he brought forward his retirement from that position. And again, I'm just speaking personally, but my interpretation of that is he probably did that in return, for ensuring that Bob stayed on board. I know he was very, very supportive of Bob staying on board.

Aaron, if I could just turn to you, Christine's just mentioned that Rakesh Gangwal, a former IndiGo CEO, is now chairman of the board, and another person who's joined the board is Gregg Saretzky, and he was at WestJet, the Canadian low-cost carrier. One of those that really was a sort of Southwest would-be for Canada. What are your thoughts there? I know you're particularly familiar with Gregg. What do you think those two bring to Southwest?

Aaron Karp:

Well, I think Gangwal, IndiGo, there's a similarity in that, it's just the sheer size of it. And it is the biggest airline in the Indian market, particularly dominating in the domestic market. And so I think he's very familiar with an airline of this size. Southwest controls about a fifth of the US market, and just really has such a presence domestically, especially. So, I think there's just someone very familiar with an airline of the same size, that has similar ideas of trying to be lower cost, do a lot of point-to-point flying. And so, I think it's a similar type of airline—obviously, the markets are different, but I think he's very used to dealing with a very large scale airline that has a lot of presence in a domestic market.

Saretzky was the CEO of WestJet from 2010 to 2018, and he really was the CEO when the airline transformed, from being sort of a low-cost carrier that was based, really focused in Western Canada, to a much more substantial airline that he wanted to compete directly with Air Canada. So, he set the stage, for example, for [Boeing] 787-9s to come on board and do long haul international flights. He founded Swoop, which no longer is existing, but was an ultra-low-cost subsidiary of WestJet. And I think he just was head of an airline when it went through a real transformation. It went from being a low-cost carrier, really focused on the domestic market, to one that really wanted to compete, as Canada's second-largest airline, with Air Canada on international flights, domestically.

And I think, so he has some experience of how do you take a carrier that's identity is a real low-cost carrier, and then transform it into an airline that is competing with a mainline airline. And that makes a lot of changes along the way. WestJet, I think, had to jettison a lot of their core identity that they had had from the early '90s, and he was able, I think, to do that pretty smoothly.

So, I think they both come in from airlines that [have] similar things: IndiGo the large size and the growth, and Saretzky overseeing an airline that had to transform from one type of airline to another type of airline.

Karen Walker:

So, Christine, what are your thoughts there, on what Aaron has just said?

Christine Boynton:

Well, I agree with what Aaron has said. It's a lot of good experience. And I'd also imagine, with a lot of airline CEOs, some very strong opinions as well. Jordan was on a panel at the Skift Forum yesterday, and it was brought up that the new slate had a lot of airline CEOs. And he kind of just took a moment to say, "Yeah," long pause, "Yes." But he did say, "I think this will be a good thing." And it's not just airline expertise, but also hospitality expertise, governmental affairs, and technology expertise. So certainly, areas that could help during this period of transformation.

Karen Walker:

Right, but then I think that that also raises the fundamental question here. So, Aaron, what are some of the key changes that they've sort of said, "Yes, these are the sorts of things we're looking at, what we're planning." And how much of that can Southwest do without, what I would say, selling its soul? Selling the most important thing, which Bob Jordan talks about this, its people and its culture are the most important things. So, what are some of the key changes that they're talking about introducing, and how far does that turn Southwest into just another US major?

Aaron Karp:

Well, I think it will be a challenge, because the changes they're talking about—red-eye flights, I think particularly the assigned seating, which is going to generate more revenue for them—and I think the key here is on the cost issue, because Southwest's advantage was always on cost. If you look at their third quarter results, their cost per available seat mile was 15.11, and that was up 4.1%, year over year. As a comparison, American Airlines was 17.92, but that was down 4.2%, year over year.

And one thing that's notable is Southwest's quarterly labor costs are now over $3 billion, and in the third quarter that was up 12.5%. So, I think the issue for them is, their costs are rising, and it may be hard for them to get that under control, and they may be looking more towards generating more revenue to overcome that cost increase. And in order to generate more revenue, like you said, they're going to have to look much more like the other carriers. And the assigned seating is part of that, the red-eye flights are part of that.

And I think that you can already see changes in how they operate. The flight attendants operate much more like the other airlines now, in terms of their dress, and their manner. And so, I think a lot of it will have to change. There'll have to be a new Southwest. Their culture is so important to them, but I think with the labor costs so high, and their cost edging closer to the majors, especially when you see their costs going up and American's going down. And the labor costs, I don't see any way they can lower that. It's just a matter of adjusting to be a much higher cost airline, and then generating the revenue to be able to overcome those rising costs. And I think, inevitably, they're just going to look much more like another airline. They still have the single fleet type. They don't have the long-haul international. But I think when you travel on Southwest, more and more, it will feel like traveling on a major. And I don't think there's any way they can really get around that.

Karen Walker:

Right. And just to your point about the third quarter, it was actually a record third quarter in terms of revenue for them, for Southwest, almost $7 billion. So that seems to be good, the money is coming in, but as you say, the amount that they're making from it is on the wrong path. But they still made a net income of $67 million.

So, what I'm thinking here is, [do] the Greggs of the new board start to talk in terms of transition, of more long haul, more international, et cetera? Then you're really getting to a different place for Southwest. But is that also about growing revenue? More people will say, "I love flying Southwest, but they don't go to the UK, and all these other carriers now do." Including some carriers that were traditionally more low cost and domestic, like JetBlue. So, will this be a turnaround for Southwest, if they just go for more money?

Aaron Karp:

Well, yeah. I mean, you mentioned the record revenue and despite that record revenue you noted there had a $67 million net profit, which was down 65.3%, year over year. And so, I think when you see all that revenue coming in, and yet the profit is still pretty small, they feel like they have to generate more revenue. And I think one thing you noted about the longer haul flying, their fleet is a lot of 737 MAXs now, and they're not flying those planes at the distance that those planes could be flown. So, you could make an argument that they're not fully utilizing those planes, which are expensive planes.

But yeah, I think that there will, of course, be efforts to reduce costs and go through. But I think with the fuel, I mean, with the labor now so high, and it's actually double the next closest cost, which is fuel, they really, despite the record revenue, probably have to generate even more revenue. And that's where the assigned seating comes in, and perhaps more longer haul flying. So, we'll see what they can do. But I think the problem is that their costs are now just very close to what the majors are. And with the labor being such a big part of that, it's just very difficult for them to cut cost, so it's about generating more revenue. Even as they're generating more revenue than they ever have before.

Karen Walker:

Christine, you've been talking to a lot of analysts, and following some of the financial meetings and stuff. What's your feel for their sense of optimism, or something else, in terms of Southwest's future? Do they believe in the changes that are necessary, or do they feel that they've come too late?

Christine Boynton:

I think they very much believe in the changes. Southwest, that it is. I think they very much believe in the changes that they have announced. And I guess you never know what the next industry constraint will be, that maybe emerges overnight. But Southwest is a brand that has weathered a lot of storms. They seem to have a solid plan, which they have said, is already beginning to generate some improvements. They have a re-energized leadership at the helm. I think there's a lot of elements working in its favor.

And one thing that I think is interesting, when we're talking about this need for additional revenue to offset these larger costs, is Southwest's own research as they were working towards implementing these changes, found that 80% of current customers and 86% of potential customers would prefer an assigned seat. And that open seating was cited as kind of the number one reason for leaving Southwest for a competitor. So, I mean, if that's the case, and once they implement these changes, they could see a significant pickup in attracting customers they've lost and attracting new customers for the first time.

As you noted, I did get to speak with some analysts recently. As part of that, I got to pick Mo Garfinkle's brain about this, of course, a longtime industry expert, and he called them the Blackberry or Blockbuster of the aviation industry. A remarkably successful brand, well-known brand, that didn't change when the times did. So, the change may have come slowly, maybe it was slower than it needed to be, in getting to this point and making the changes that other carriers have already done. But they're confident in the direction that they're heading now, is the sense I've gotten.

Aaron Karp:

And I think it's hard to underestimate how remarkable the 47-year profit streak was. And if you look at 2015 to 2020, that streak was continuing. And I think that blinded them to the need to make changes, because it was so much a part of their culture that they'd never—all these years, they had made a net profit every single year. And until they started actually losing money, I think that's when it hit, that things have got to change. And they're now going through a long stretch where the financials have not been very good. But I think, because they kept seeing that profit, and because they had that amazing streak, I think it sort of didn't allow them to quite see clearly that they were going to have to make changes.

Karen Walker:

Yeah, fair point, I think. What I would just add is that it remains a very, very smart company. It always has, and it's a very passionate company, among its leadership and the entire staff. They really believe in the love airline, and I think that will count for a lot. I think that energy will count for a lot, and that they will find new ways to adapt while keeping that Southwest culture intact. Let's hope, hey?

Aaron, Christine, thank you so much for your time today. And thank you also to our producers, Cory Hitt and Guy Ferneyhough, and of course, a huge thank you to our listeners for following Window Seat. Make sure you don't miss us each week by subscribing to the Window Seat podcast on Apple Podcasts, or wherever you choose to listen. Thank you.