Just imagine this. You’re running Southwest Airlines, trying hard to fight off Elliott Investment Management’s desire to fire you and your board chair. It says you’ve missed out on a ton of revenue opportunities, and it’s time to change. What’s the last thing you want to see? Probably a miss on your revenue guidance.
So it was last week — the last week of this very quarter — when Southwest announced that its Q2 revenue guidance was too rosy. Instead of unit revenue being down 1.5 to 3.5 percent year-over-year, it’s going to be down 4.0 to 4.5 percent. Woof.
What exactly is going on here? Is a wave of revenue weakness hitting the industry? After all, American revised its guidance downward just a few weeks ago. If we see Delta and United miss their guidance — something that probably won’t happen — then I’ll believe it’s an industry issue. But for now, this appears to be a Texas flu with two distinct variants.
With American, it’s hard to know what exactly went wrong in the forecasting process, but when the airline fired its Chief Commercial Officer at the same time it lowered guidance, it would certainly point to internal problems as being the main culprit.
At Southwest, the airline explains this as being a very specific problem of internal mismanagement of the revenue management system. Specifically, in the SEC filing, Southwest said this:
The reduction in the Company’s RASM expectations was driven primarily by complexities in adapting its revenue management to current booking patterns in this dynamic environment.
The airline isn’t saying more than that yet, so let’s talk about what that probably means.
Back in April 2023, it was announced that Southwest had fully switched to use Amadeus’s Network Revenue Management (NRM) solution for all of its revenue management. Southwest made the decision to really put all its eggs in the Amadeus basket, already using the Amadeus Altea passenger service system and Sky suite for network planning optimization. This is probably a good thing since I’m assuming this is what the RM department looked like before.
Southwest had actually been using multiple systems for awhile, testing them to see which would be the best option for the airline. In the Amadeus press release, Southwest Chief Commercial Officer Ryan Green was quoted as saying this about the company’s decision:
We directly observed revenue uplift from the Network Revenue Management product through an extensive multi-year production pilot. Following these results, we are excited to announce the selection of Amadeus as our next generation revenue management system provider. We have completed the full cutover to NRM three months earlier than our original plan thanks to the strong partnership between the Southwest and Amadeus Revenue Management teams.
This wasn’t just changing RM providers, but rather it was a change in philosophy. Instead of managing the network using a leg-based system, it switched to an origin and destination (O&D)-based system. That is no small task.
In a traditional leg-based system, it’s all about managing demand on a specific flight. Let’s pretend you’re managing Southwest 355 from Long Beach to Phoenix today. You have 143 seats on the 737-700, and Southwest no longer really overbooks, so assume your goal was to sell 143 seats.
The idea is to sell as many high fares as you can, and then you want to fill in the rest of the seats with lower fares. That’s backwards, of course, since you have to sell the lower fares first. So you have to guess how many of the high fares you can sell closer to departure and hold back seats while selling lower-priced ones in advance. Airlines have more than a dozen different fare buckets which the revenue management system opens and closes. Analysts watch the flights to make sure demand is developing as expected. They will tweak models and adjust numbers if they see a need.
But with an O&D-based system, it gets more sophisticated. There are some people flying from Long Beach to Phoenix, but there are also people going from San Jose to Phoenix or from Long Beach to San Antonio, Omaha, Tampa… you name it. They’re all flying on the same leg from Long Beach to Phoenix, but they are paying wildly different fares depending upon where they are flying.
I don’t want to get into too much detail, but this is far more complex, and it requires a mindset change for analysts to handle this. As one long-time consultant, Tom Bacon, explains in a blog post:
When airlines change from leg-based revenue management to O&D revenue management, they face a huge change management task. The change is not just deployment of a more sophisticated RM system that promises more revenue. The new system represents multiple wholesale changes, including implications for the organizational structure, for recruiting and training, for accountability, for performance metrics, and for executive interaction. Many airlines fail to gain the benefits of O&D RM because they do not properly address some of the critical associated requirements.
Without knowing any more detail from the airline, this is what appears to have happened at Southwest. A system that was supposed to improve revenue performance has not done it. That doesn’t mean it’s the system’s fault. As Ryan said in that quote, the testing phase brought better revenue performance. Further, there were consultants-a-plenty to help with this project along the way. So it’s likely more of an issue about how Southwest has built up and trained its team to do the job.
The good news is it’s fixable. The question now is how quickly Southwest can turn the ship around and get it producing better revenue results. My guess is that we’ll hear more about this on the airline’s earnings call later this month.
12 comments on “Southwest’s Complicated RM Switch Sinks Revenue At the Worst Possible Time”
Guess it depends which point of view you adopt : from a passenger perspective (or from Elliott perspective), it’s probably the best news of the week !!!
Presumably part of the challenge in cutting over to an O&D revenue management system was that the new system did not have any O&D data and was running in parallel to the old leg-based system to try to build that history but it needed to do that for a couple of years in order to build decent history.
Add in that WN’s network is becoming more and more focused on hub-like operations instead of point to point because it is having to use so many more 737-800/MAX8s and it is doubtful that any revenue management system or department can fix the strategic problems that WN is facing because of Boeing delays.
WN will get through this and probably can genuinely show that they are addressing the issues for underperformance and were long before Elliott showed up.
Good news from a Boeing standpoint is that they are making progress on fixing their quality issues including with the purchase of Spirit Aerosystems.
Now, they just need to get the astronauts back home with the Starliner.
WN and Boeing’s worst times might be behind them – and the revival of the two is as linked as they were during their declines.
“Presumably part of the challenge in cutting over to an O&D revenue management system was that the new system did not have any O&D data and was running in parallel to the old leg-based system to try to build that history but it needed to do that for a couple of years in order to build decent history.”
This makes no sense. Of course WN has O&D data. As a competently-run (usually…) airline they doubtless have years of data showing exactly where their customers were going, when they booked, what they booked, and what they paid. The old system wasn’t using all of this data, since it was focused on the leg level data, but the O&D level data was certainly there, being broken down into legs for the system to digest.
yes, WN has had TICKET LEVEL O&D data for years but that does not contain the level of detail that a revenue management system needs to forecast O&D demand which needs date/day of week/season/holiday/time of day etc detail.
Missing revenue forecasts is not uncommon when revenue management systems have changed at airlines; other US and foreign airlines have had the same issue even if they are going from one O&D system to another but esp. when going from a leg-based to an O&D based revenue management system.
“yes, WN has had TICKET LEVEL O&D data for years but that does not contain the level of detail that a revenue management system needs to forecast O&D demand which needs date/day of week/season/holiday/time of day etc detail.”
Again, none of this makes any sense. Of course their ticket level O&D data has all of the features you mentioned. These are all things that any reasonable database ETL process will capture. I work closely with airline RM and data systems. While I’m not as familiar with all aspects of WN’s system, any system run by a major US airline will have been collecting this data for years, even if it wasn’t being used by the RM system.
There have been teething issues with their new system, and such issues are not uncommon, as you correctly point out. But these issues are not arising because the system doesn’t have the correct data. I have no idea where this assertion is coming from.
dfw88 – I hope to find more information about this after the earnings call this month, but I don’t see why data would in any way be a problem. My assumption is this is about how the airline was managing the new system, not about the data inputs.
Please do keep us posted but it is far easier (and strategically safer) to blame a lack of data or than on management incompetence in training on the new system which I doubt WN or any airline would say even if Elliott weren’t breathing down their neck.
Thank you, Cranky. That has been my assumption as well, which is why I’ve been very confused by Tim’s statements. I’d appreciate any clarity you can get on the issue.
By Southwest standards, that picture of the technology used by Revenue Management is incredibly innovative.
Oh and speaking of Elliot, here’s a good analysis from analyst Michael Boyd (https://myemail-api.constantcontact.com/Touch—-Go—Special-Report–The-Bottom-Line-on-Southwest-Elliott—Cutting-To-The-Basics.html?soid=1136461704486&aid=bepdRUi57iA)
Hm. One advantage for consumers in their leg based approach is that nonstops didn’t cost more than connecting itineraries. I really hope that doesn’t change. I’d lose a lot of reason to fly them, if it did!
grichard – This has nothing to do with filed fares which were always O&D-based. This is just how inventory is managed.
I can remember when Southwest would pride itself on legs. Part of legacy was due to the Wright amendment which would required PAX to buy separate tickets when flying beyond the zone while sitting on the same jet. This formula worked just fine because PAX appreciated non-stops to mid-level markets avoiding a connection on the Big Three.
However, things changed when Southwest picked up AirTran and Atlanta (ATL) which is inherently biased to hub & spoke (connections). The ATL terminal is “jammed” with SW PAX making connections; more like a mini-me Delta of ATL. Phoenix (PHX), Denver (DEN), Los Angeles (LAX), and Las Vegas (LAS) also lend themselves to making connections and incremental revenue. However, Southwest failed to capitalize at Houston Intercontinental (IAH) and bailed.
Southwest has changed by default. Yet, those in the C-Suite are in a 80’s mindset with negative long-term implications for the airline.
Lots of catch up ball needed to stay in the game.