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Southwest Airlines has been under attack by investor group, Elliott Investment Management, and succumbing to that this week just killed the airline. Here’s why.


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Elliott Kills The Golden Calf

Southwest Airlines has announced its latest and most substantial change, eliminating its inclusion of free checked bags with every seat sold. The Southwest checked bag policy has changed from “bags fly free” to on some fares, up to two bags may fly free but for the cheapest fares no checked luggage is included.

The airline not only avoided charging for checked luggage when every other US carrier did, but it made it the sales pitch of the company. Despite my insistence over the last decade that even when including the checked luggage charges, Southwest was still more expensive than other US carriers, its customer base has been steadfast (and perhaps blind) in its loyalty to the carrier. Refutation of any claims that Southwest wasn’t the best value on the market was met with pitchforks.

Consumers were willing to look past fare increases and other deficiencies because they hate fees and love the culture of the airline. But without that advantage, the airline is going to face comparisons it has been able to avoid to this point.

For what it’s worth, I predicted in July that the airline would start charging for bags and some were certain that wouldn’t be the case.

Why You Can’t Treat Southwest Like The Other US Carriers

Putting aside for a moment the traditional cost benefits of Southwest and its service, the carrier has some deficiencies that others don’t – some of them are glaring.

All Boeing 737 Fleet

Its single aircraft type, the Boeing 737, limits the airline in a few ways. It can’t fly to markets that are unable to support its smallest variant, the 737-700 (or MAX-7) even for expensive connecting traffic. It also limits the frequencies it can operate, for example, United might fly four E170/175s from Pittsburgh to Houston but Southwest would have to run that with just two frequencies as its jets hold twice as many passengers.

The single aircraft type also limits the carrier’s range so growth remains solely in North America unless it tries a stretch flight from very far northeast US to the western-most European destination. It will, of course, find competition from JetBlue, Iceland Air, and if trying to expand to South America, Copa and Azul would put up a fight too.

Onboard Experience

Lack of onboard amenities like seat-power and in-flight entertainment screens make long flights less attractive than competitors like Delta who have made this a point of emphasis. On top of that, the carrier doesn’t have ovens that can support food for sale nor food as a value add for higher fares. That’s a limitation that some customers will not be able to overcome. That’s not to say that customers choose an airline because of the food – they don’t – but for longer flights, peanuts and pretzels won’t be enough.

Partners

With just one international partner, Iceland Air, and no domestic partners, Southwest has a very real wall for its customers. American, United, Delta, and Alaska have many international partners, but so does JetBlue. For Southwest, it could point to Frontier, Breeze, Spirit, and Allegiant who don’t have significant partners either but that doesn’t really match the size of Southwest and its ambitions.

Right Intentions, Wrong Approach

Elliott Investment Management has pressured the company to perform and identified areas where it’s falling behind competitors. Opportunities for ancillary revenue like charging for checked bags will do two things: 1) it will generate revenue for those that continue to travel with checked luggage, and 2) will reduce fuel burn for those that might have been overpacking because it was included, but change their approach when it costs more money.

The airline has not been performing to the same level as peers, but perhaps that comes down to its limited footprint, or lack of partner destinations and inventory. Southwest customers still fly to Europe, South America, Canada, and throughout the Caribbean in destinations the carrier doesn’t serve – they just fly someone else.

Adding luggage fees assumes the underlying constant (fares, and passenger volume) will remain the same but it will not. By charging for seat assignments, reducing the value of the loyalty program, and turning heel on its most famous value-add, the carrier will certainly lose business of clients that were willing to accept a less frequent schedule or didn’t put them right in their target airport because they could fly their bags for free. They were willing to absorb higher prices because they factored in the cost of their luggage on other carriers and like the privilege of not doing the math at the airport.

Elliott was right that the stock was not performing to the same degree as some of the other US carriers and that for its size and market scope, it should be more valuable. But that also assumes the airline is more or less a commodity as American, United, and Delta have become. It doesn’t have the entertainment options of Delta, doesn’t have the frequency convenience, it doesn’t have partners that add value where Southwest can’t or won’t. What might have been a superior product for domestic road warriors and infrequent leisure travelers, just became as common as the others. The carrier has given away its competitive moat. That means it will need to compete on price which will drive margins down even further.

Conclusion

Setting aside the Southwest culture, the airline gave up on why its customers choose the airline even when it’s not the best option available for them. And, unfortunately, it will cost the airline, its passengers, its staff, and its shareholders dearly. Southwest had exclusively direct sales in a time when no carrier does. It gave that away over the summer too. The only reason to choose Southwest now is price or schedule, and that assumes that you ignore the limited options onboard. Elliott might have wanted to improve shareholder value, but it’s clear that it didn’t fully grasp the rest of the market and why Southwest can’t compete without its (nor former) core advantages. As the kids say, (paraphrasing) Elliott has messed around, soon they will find out.

What do you think? 

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