How Southwest Has Been Able To Offer Lower Fares

Historically Southwest‘s (NYSE:LUV) lower fares have been its biggest competitive advantage, driving passenger traffic and increasing market share for the airline. Lower fares have been critical in allowing Southwest to post its 39th consecutive year of profits in 2011 and have helped the carrier in the past decade when the events of 9/11 and the financial crisis caused $50 billion in losses to the U.S. airline industry. ^[1] But what enables Southwest to offer lower fares?

The low-cost operating structure of the airline allows it to offer lower fares while maintaining profits. This specifically designed low-cost structure is facilitated by the operation of a single-aircraft type, flights to and from secondary airports in several cities, a greater reliance on point-to-point network operations over hub-and-spoke network operations and higher employee productivity. However, in recent years, the cost-reduction strategies undertaken by several other U.S. airlines have partially offset the competitive advantage enjoyed by Southwest and other low-cost carriers like JetBlue (NYSE:JBLU).

We currently have a stock price estimate of $9.54 for the company – slightly above its current market price.

See our complete analysis of Southwest here

Operation of a single aircraft type

Southwest operates a single aircraft type – the Boeing 737. This lowers personnel training and maintenance expenses for the airline. Costs related to spare part inventory management are also lower for one aircraft type compared to multiple aircraft types. Additionally, the use of a single aircraft type simplifies scheduling, flight operations and training activities.

In the case of Southwest, the airline could employ an all Boeing 737 fleet as its operations are primarily focused on the domestic U.S. market with no long haul international flights. Thus, the Boeing 737 which is a short-to-medium range airplane is sufficient to serve its current flight operations. In comparison, Delta (NYSE:DAL) and United (NYSE:UAL) that operate on domestic as well as Atlantic and Pacific international routes require both long range aircraft like Boeing 787 Dreamliner/Airbus A330 and short-to-medium range aircraft like Boeing 737/Airbus A320.

Flights to and from secondary airports

Southwest also flies to and from many secondary or downtown airports such as Dallas Love Field, Houston Hobby, Chicago Midway, Baltimore-Washington International, Burbank, Manchester, Oakland, San Jose, Providence, Ft. Lauderdale/Hollywood, and Long Island Islip. These airports in addition to having lower airport and landing fees are typically less congested compared to hub airports of other airlines. Lower congestion allows for higher aircraft utilization as the aircraft spends comparatively less time on ground. This in turn reduces the number of aircraft and gate facilities required and allows for higher employee productivity (headcount per aircraft).

In addition, Southwest’s flight routes are largely point-to-point in nature. Direct flights burn less fuel compared to connecting flights through a hub airport. This further lowers operating expenses for the airline. In 2011, nearly 71% of all Southwest passengers flew direct non-stop flights. ^[1]

Modest on board services with add-ons at an extra charge

The modest on-board services also lower operating costs. Any add-ons such as drinks and access to in-flight WiFi come at an additional charge for Southwest. For example, access to satellite WiFi connection on board a Southwest flight is charged $5 for the complete duration of the flight.

The airline employs several other cost containment strategies. The one-class seating arrangement on all its aircraft increases the number of on-board seats compared to a two or multiple-class seating arrangement. The latter is employed by several U.S. airlines including Alaska (NYSE:ALK), US Airways (NYSE:LCC), Delta (NYSE:DAL) and United (NYSE:UAL). A greater number of seats allows Southwest to carry more passengers per flight and thereby charge a lower fee per passenger.

Other technology and parts addition to Southwest’s fleet have contributed to lower fuel burn and thereby lowering expenses, for example, the installation of blended winglets on more than three-fourth of its fleet. This addition reduces draft and thereby increases fuel efficiency.

However, cost reduction measures by other airlines and AirTran integration challenge this competitive advantage

However, over the past few years, other U.S. airlines have taken several steps to lower their cost structures and thus reduce the advantage held by low-cost carriers like Southwest. For example, Alaska Air Group outsourced a variety of its maintenance and IT requirements to third-party vendors to lower its cost structure while Delta, United and US Airways reorganized under bankruptcy protection to come out with lower cost structures.

In addition, the AirTran integration has posed several challenges for Southwest in maintaining these factors that support its low-cost structure. A few of these challenges are being resolved like the conversion of AirTran’s multiple-class seating arrangement to one-class seating arrangement and flight network optimization between Southwest and AirTran. Nevertheless, we expect Southwest to be able to maintain its low-cost model even post its integration with AirTran.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Southwest 2011 10-K, www.southwest.com [↩] [↩]