Why Southwest Is Rethinking Its Boeing 737 Strategy

Southwest is the airline that brought
low cost travel to the masses with a simple strategy: Operate one
kind of plane, offer only coach class, no meals and fly
to underused secondary airports. Since its first flight in 1971, the
airline has grown to carry more passengers in the U.S. than any other. But now, the maker
of the plane that Southwest has relied on since its start – the
Boeing 737 – is in crisis. The search is on for the
black box recorders that investigators hope will solve the mystery of what caused
a Lion Air flight to crash into the sea shortly after takeoff
in Indonesia on Monday. Tonight, the FAA is under intense
pressure as passengers, pilots and airlines ask whether the Boeing 737 Max
8 is safe, after two brand new planes crashed in
just five months. Boeing 737 Max planes have
been grounded since March 2019. Days after the second crash regulators worldwide ordered airlines to
stop flying the Max planes. The airline ordered more than 200
of the troubled 737 Max planes. Because of the grounding, Southwest had
to cancel 20,000 flights in the second quarter of 2019 alone,
slashed its growth plans for the year and removed the planes from
its schedules until January 2020, a move that means they’ll be leaving
money on the table during the lucrative holiday season. The crisis is testing the airline’s
lighthearted culture as it seeks to assure customers of
the plane’s safety. We’re going to have to
have a communications campaign. We’re good at that. Southwest’s stock is
up about 10 percent in the six months since the planes
were grounded worldwide in mid-March, thanks to strong travel demand, which
is also extending the airline’s streak of profitability. So is the Boeing crisis just
a temporary setback for Southwest, or could it be the start of
bigger trouble for the carrier? Southwest Airlines was
born in 1967. Herb Kelleher, a tough talking New
Jersey born lawyer, and his client, Rollin King, sketched out their
idea on a cocktail napkin. Provide cheap, non-stop flights to
major cities in Texas. The airline had a
personality, upbeat marketing campaigns. And what are now cringeworthy
ads featuring scantily clad flight attendants in hot pants
and go-go boots. The business strategy was simple:
peanuts but no meals. Only coach class. And perhaps most important, basically one
type of plane: the Boeing 737, the single aisle jet that
debuted the year Southwest was founded, 1967. The culture of the 1970s is very
much in our past but Southwest still has a very playful culture. You know, there are videos on
social media of the singing flight attendants and rapping flight attendants,
employees are empowered to be themselves. Southwest is famous for hiring people
based on their personality and then training them for
the skills they need. Using one type of plane
almost exclusively throughout its history helped keep maintenance costs low and
made it easier to swap one plane for another. The airline has
also been known for not having seat assignments and most of the
other add-ons like baggage fees that have brought in billions
for other airlines. On a Southwest flight, passengers can
check two bags for free. They can also cancel or change
their flights free of charge. They only have to pay
the difference in fare. The airline’s first flight was in
1971, and it has since expanded exponentially. In 2018, Southwest carried
more than 163 million passengers, more than
any other U.S. airline. Southwest has posted an annual
profit every year since 1973. That’s a record that’s basically unheard
of in the airline business, which has suffered numerous
bankruptcies and financial turmoil. The airline went public in 1971
at about $11 a share. Its shares are now
trading around $50. The carrier’s fiscal prudence has
won an investment grade credit ratings, a bragging right it
shares with Delta and Alaska. Southwest became the largest U.S. airline by passengers
carried in 2003. In the 12 months that ended in
April, Southwest had a more than 17 percent market share, nearly
tied with American Airlines. It’s smaller and younger, low
cost competitors in the U.S. – JetBlue, Spirit and Frontier – each
have less than 6 percent share. Southwest suffered its first onboard
passenger fatality due to an accident and its nearly 50 year history,
in April 2018, when a fan blade of an engine snapped off,
briefly sucking a passenger out of the window. There was
blood on the windows that was because of her body and
her arms were actually out of the airplane and her head was
out of the airplane. After that Southwest discounted fares to
get more travelers on board. It will have to do it once
more if regulators deem the plane airworthy again. Surveys conducted after
the Ethiopian 737 Max crash in 2019 have shown travelers would prefer
to wait until the 737 Max is flying safely for several months
before they book a flight. In response, the airline says it
won’t hold travelers responsible for paying fare differences if they want to
book off the Max for a different plane once it’s approved. I think Southwest’s biggest challenge
with the 737, aside from regaining the trust with its pilots,
is once the aircraft goes back into service, regaining the trust
of the traveling public. Now, that’s not
just Southwest’s problem. That’s really Boeing and the FAA who
also must play roles in helping to regain passenger trust, help make
sure people realize that once it’s flying again, the 737 Max is
safe, but people are going to avoid that plane for several months, if not
at least a year, just to be sure it is safe. Summer 2019 was a frustrating one
for the airlines that bought the 737 Max. Travel demand is growing to record
levels, but they had to cancel thousands of flights because their
new aircraft were grounded. That has impacted perhaps no
other airline more than Southwest. Southwest only flies Boeing 737’s. As a 2019, its fleet has
grown to more than 750 planes. The Southwest Boeing relationship has been like
peanut butter and jelly. Since 1971, Southwest has bought only
Boeing aircraft and only the Boeing 737, though, in the past
they did at different times operate the Boeing 727 trijet. However, I think this has been
a wakeup call for Southwest. In 2017, the airline took its first
deliveries of a new version of the Boeing 737, called the Max. The planes are a souped up version
of the type of planes Southwest has relied on
throughout its history. The airline now has more Max
planes than any other carrier worldwide. But after two fatal crashes, that
Max plane has been grounded. That means the 34 Max planes
already in Southwest’s fleet cannot be flown. Nor can the more than 40
Max 8’s Southwest had expected to receive this year. Regulators haven’t said
when they plan to allow the planes to fly again. But they’re preparing to evaluate whether
they’re safe enough to do so. All 189 people on board a
Lion Air flight from Jakarta were killed in a crash in October 2018. Another 157 lives were lost, when
an Ethiopian Airlines jet went down in a similar stage in
the flight in March 2019. The global grounding of the
Max is especially problematic for Southwest because the plane has been
key to its growth strategy. The Max planes can fit high
numbers of passengers on board and feature more fuel efficient engines
helping the airlines save money on fuel. That has Southwest pondering
the business model its had since its start in the early 1970s. With the Max planes grounded, Southwest
is planning to reduce its flying this year. CEO Gary
Kelly recently said that capacity constraints are just helping
out its rivals. We look at all of our route
performance, in just market after market after market, it is obvious that
we’re short capacity, that we’re spilling traffic and leaving money on
the table and helping our competitors. Southwest halted hiring of
new pilots and postponed promotions of some first
officers to captain. In July 2019, Southwest announced it
was pulling out of Newark and consolidating its operations in
New York at LaGuardia. Instead, it would use some planes
to build up service in other markets like California and Hawaii, which
it launched in March 2019. I think that there is a serious
issue of trust, not just between Southwest pilots and the airlines, but
between the pilots and Boeing and Southwest and Boeing. That doesn’t mean it’s a rancorous
relationship and it doesn’t mean that the relationship
can’t be repaired. Looking forward, Southwest is going to
be much more pragmatic and I think much more intentionally
disloyal to Boeing. It’s also keeping its fuel
guzzling older 737 longer. It’s pulled the Max planes from
its schedules until January 2020. The first airline to do so, it has
taken a profit hit and its costs are rising as the
Max planes remain grounded. Southwest’s profits peaks in
2017 at $3.5 billion, but fell slightly in 2018 as
a surge in fuel costs ate into the bottom line. While fuel costs
have eased this year, the grounding of the 737 Max is
hurting the airline’s profits. Southwest lost $175 million in operating
income in the second quarter of 2019, the first full
quarter since the Max grounding. But Southwest still posted a
profit of $741 million. The issues with the Max
have Southwest pondering its lifelong commitment to the 737. CEO Gary Kelly says it’s too early
and complicated to suddenly add a new kind of plane to its fleet. Such a change in fleet type
would take years, he said. And both Boeing and its main competitor,
Airbus, are sold out of the single aisle planes through
the early 2020’s. It is something that
we’ll want to explore. In the current scenario some of
our competitors who do have a diversified fleet aren’t having their
growth plans impacted as drastically as we are. If we wanted to diversify the
fleet, it would take us years. Southwest isn’t the only airline that
operates just one type of plane. There are a slew
of budget airline copycats worldwide. Spirit Airlines and easyJet
only fly Airbus 320’s. Budget airline Ryanair in Europe
only flies Boeing 737’s. Ryanair hasn’t even received its Max
planes yet and had some harsh words for Boeing in July 2019 after
it was forced to cut its growth plans because of the grounding
of the MAX plane. We were originally expecting 58 aircraft
for the summer of 2020 that’s now 30 at best. It may well move to 20, it could
move to 10, and it could well move to zero if Boeing don’t get
there “S***” together, pretty quickly with the regulators. Boeing posted its
biggest loss ever in the second quarter of 2019 after
it took a $5.6 billion pre-tax charge, a sum intends
to use to compensate airlines affected by the grounding
of the Max. For now Southwest is standing by
the plane and by Boeing. But further delays in aviation
authorities willingness to unground the 737 Max could
change its opinion. We’ve had a long,
strong relationship with Boeing. It was not their best days handling
the Max crisis, but we have full confidence in them now. Our cost outlook is really unchanged
for the third and fourth quarter for the year, except for
the effect of the Max. Of course we’re incurring a huge
penalty from the Max being grounded. Safety is not negotiable. We’re unhappy that it’s taken so long
and we’re in the dark on a number of technical matters. In a statement to CNBC, Boeing
said that Southwest Airlines has been and continues to be a valued
customer and we’re sorry for the disruption this situation
has caused them. We’ve been in constant contact with
our customers to support them during this difficult time and our
decades long relationship is very important to us. Southwest CEO Kelly
says it expects to negotiate compensation from Boeing, but the
amount isn’t clear yet because there’s no end in
sight to the grounding. For now, the airline is waiting for
its planes and not switching up its fleet. But the grounding has
certainly made the airline rethink its commitment.

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