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Southwest CEO Rallies the Troops with a Sobering Note, Focuses on Costs

Southwest chief Gary Kelly sent out a great email to the airline’s employees (or, “People”) yesterday talking about the situation with American and more broadly, about the airline industry and Southwest’s place in it. He kept calling Southwest a Maverick, but the tone cast an ominous shadow over the perils of failing to control costs. You can read the entire letter below, but first, let’s discuss.

Southwest Needs Cost Control

What’s most interesting about this? It is truly a rallying cry. It’s a somber message – the good old days are over, and it’s a more level playing field now that the big boys have gone through bankruptcy to lower costs. But it’s clearly a call for Southwest employees to come together.

Now, while our costs are still lower, our advantage has been cut in half. We currently do not have a sufficient cost advantage to stimulate the market because our fares are much closer to our New Airline competitors.

Gary is very clear that costs are king, and Southwest is having trouble in that area when compared to other airlines.

The New Airline industry is profitable. In fact, the New Delta and New United had better profit margins than Southwest in the third quarter, despite the magnificent gains we’ve made over the last four years with our Customer Experience enhancements and our revenues. On that front, we have outperformed all competitors. We have a cost challenge, and it is one that looms large.

Then he zeroed in on how labor is a part of that.

Our labor rates are now, far and away, the highest in the industry. Through bankruptcy, very large New Airlines have emerged with lower rates than us and better productivity. Next to fuel, labor is our highest expenditure. We cant have lower overall operating costs if our labor costs aren’t lower. We cant have lower labor costs if we arent more productive. The good news is that we have a lot of opportunities to improve our productivity, eliminate waste, and preserve our pay rates and benefits for the foreseeable future. Its crucial that we take advantage of those opportunities.

He sets the focus for the airline on four big changes, including one (the new reservation system) that I thought was tabled.

And, it is our People who will continue to transform Southwest with four big initiatives: AirTran, All-New Rapid Rewards, B737-800, and a new reservation system.

But ultimately, it’s going to come down to one thing . . .

Finally, please remember, all the great things our People do will be for naught without low costs. Just ask the old “Legacy” airlines.

Like I said, a very somber note, but one that seems right on the money to me. This ain’t your father’s Southwest. Now the question is . . . what can they actually do about those cost problems? That’s the hard part, because Southwest employees have lived the good life. Sure, they were always happy to trade productivity for higher pay, but how much better can you do with productivity? I’m eagerly watching to see. Read the entire letter below.


Gary C. Kelly
Chairman of the Board, President &
Chief Executive Officer
P.O. Box 36611
Dallas, Texas 75235-1611

To: All Southwest and AirTran Warriors
From: Gary Kelly
Date: December 5, 2011

RE: American Airlines More Challenges for Southwest than Opportunities

The past week has been extraordinary with the bankruptcy of American Airlines and the unexpected retirement of their Chief Executive Officer. Not surprisingly, I have had questions from our People about what this means for us. I have heard comments like, “Im sure glad Im not at American. Im glad to be at Southwest.” I can assure you, in this season of giving thanks, it is the correct perspective. In this time of enormous world-wide economic uncertainty, it is the right perspective.

Just as I wrote in an article in LUVLines after 9/11: While an airline needs to be good at many things to be successful; low costs and profitability, ultimately, mean the difference between survival or not. To be clear, American Airlines, as you knew it, will not survive. Bankruptcy, by definition, means that it will be radically reorganized, or it will be completely shut down and liquidated.

American isnt the only airline not to survive without bankruptcy. Lets look back to 1989 the year Southwest became the newest member of the old major airline club, based on annual revenues. All the majors from 1989 have gone bankrupt. Pan Am. Eastern. Braniff. Continental. America West. TWA. US Air. United. Delta. Northwest. And now, American. Every single one failed. Why? Not because of Customer Service, but
because of high costs. Great Customer Service cannot overcome high costs. That is the imperative I wrote about a decade ago: low costs.

Southwest Airlines is the only major airline from 1989 that has survived this tumultuous industry without bankruptcy. Why? Because our low costs have preserved our profits. Period.

If American Airlines emerges from the ashes of bankruptcy, and I believe they will, you can be certain their costs will be substantially lower, especially their labor and aircraft costs. If they cant achieve that, they will cease to exist (like Pan Am, Eastern, Braniff, and TWA). If they do emerge from bankruptcy, as I believe they will, they will join the New United, New Delta, and New US Airways as giant, lower-cost airlines. They are, collectively, much more formidable competition than their predecessors. The term, “Legacy Carrier,” no
longer will apply.

In the good old days, when the Legacy Carriers costs were higher, we brought our low costs and low fares to their markets, stimulated demand, and expanded dramatically. Now, while our costs are still lower, our advantage has been cut in half. We currently do not have a sufficient cost advantage to stimulate the market because our fares are much closer to our New Airline competitors. These New Airlines, reconstituted from their Legacy ashes, join younger, lower-cost airlines like JetBlue and Frontier, as well as an even newer group of ultra low-cost airlines like Allegiant and Spirit. As predicted, the industry has transformed to lower costs.

Of course, one major point of low costs is to drive profits. The old airline industry was famous for not achieving profits, which rendered them very weak competitors. The New Airline industry is profitable. In fact, the New Delta and New United had better profit margins than Southwest in the third quarter, despite the magnificent gains we’ve made over the last four years with our Customer Experience enhancements and our revenues. On that front, we have outperformed all competitors. We have a cost challenge, and it is one that looms large.

American Airlines lost its way. It made promises it could not keep. It tried very hard to avoid bankruptcy. As every other major airline used that tortured strategy, American became higher and higher cost relative to the New Airline industry. Just when we thought 2011 would be safe from the perils of the 2009 recession, American is posting another massive loss. The New Delta and the New United are producing strong profits. Why? You know lower costs. It puts New Delta and New United in a position to grow from here. American has shrunk dramatically this past decade. They will shrink more. That may provide Southwest some opportunities to capture more Customers and grow; however, we will have to compete with a stronger marketplace for Americans customers. You know how much harder that is because of our
diminished cost advantage.

Americans employees will make many sacrifices. It is convenient to lay the blame at the feet of Americans management. Certainly, they deserve their share of the blame. But, just as employees deserve credit when a company does well, so do they deserve some of the blame when it does not. American has outdated and inflexible work rules that render it less productive than the New Airline industry. Thats just one example of how the company lost its way, and just one example of what is imperative to change, lest they be shut down.

For us, the bottom line is simple. There may be some near-term opportunities for Southwest as American shrinks and is distracted with the human struggle of bankruptcy. American will be governed through a bankruptcy court and a creditor committee, and it will be sheer hell for them. Once they get through it though, several years from now, they will join the New Airline industry as a much more formidable competitor. We need to prepare ourselves better right now for this New Airline industry.

So, what if we dont? As stated earlier, Southwest is the only 1989 major airline that has survived without bankruptcy. Why? Because our low costs have preserved our profits.

Our labor rates are now, far and away, the highest in the industry. Through bankruptcy, very large New Airlines have emerged with lower rates than us and better productivity. Next to fuel, labor is our highest expenditure. We cant have lower overall operating costs if our labor costs aren’t lower. We cant have lower labor costs if we arent more productive. The good news is that we have a lot of opportunities to improve our productivity, eliminate waste, and preserve our pay rates and benefits for the foreseeable future. Its crucial that we take advantage of those opportunities.

The imperative I spoke about nearly a decade ago has been fulfilled by our remaining, formerly “Legacy,” competitors. The imperative is now squarely upon Southwest. I know you all understand the evidence hundreds of airlines perished since deregulation. No 1989 major airline has survived without bankruptcy except Southwest. We are the maverick. We are different. Thats how we have prevailed with a Warrior Spirit, a “Never Give In” resolve, and a burning desire to be the very best. The sloth-like industry you remember competing against is now officially dead and buried. We fought them, and we won.

Now, the enemy is our own cost creep, our own legacy-like productivity, and our own inefficiencies. Fighting this cost enemy is an imperative to remain the Maverick. We will fight, and we will remain the Maverick.

It is important to say that low costs, alone, will not win the day. Our People are most important. It is our People who produce this great low-cost airline. It is our People who serve our Customers in an outstanding way. And, it is our People who will continue to transform Southwest with four big initiatives: AirTran, All-New Rapid Rewards, B737-800, and a new reservation system.

Finally, please remember, all the great things our People do will be for naught without low costs. Just ask the old “Legacy” airlines.

I am very grateful and very thankful for all of you.

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