Elliot and Southwest – Change is Needed

Southwest Airlines, despite having competitive costs, as shown here, is not performing well, and underperforming its key peers. Change is needed. Several factors contribute to that underperformance, including senior management clinging to obsolete strategies as the industry continues to evolve post-pandemic. Elliot is correct in asserting that Southwest can do better and needs strategic change. The question is whether their business plans are different enough from the existing Southwest plans to implement true changes that can make a difference. Let’s examine a few of the problems at Southwest, specifically their fleet, their product offering, and management team. The Single Aircraft Strategy First, and foremost, they are operating the wrong size aircraft due to the 737-7 being unavailable from Boeing. While we hear promises of certification being close, that hasn’t been the case and the airlines has once again pushed back its expectations to 2025, which could extend further given Boeing’s track record. The 737-8 that Southwest is substituting for forthcoming 737-7 aircraft means operating too many seats in smaller markets. While seat-mile costs are excellent, lower load factors translates to lower yields to generate traffic volumes to remain viable in smaller markets. Southwest began, and grew its reputation by being exceptionally reliable and quickly turning its aircraft with an efficiency and utilization advantage over its major airline competitors. But with the 737-8 and 178 sets, it takes longer to enplane and deplane passengers with this aircraft that is not well suited to smaller routes than an entire turn used to take. The company needed a smaller aircraft to replace the 737-700 fleet three years ago, not two years from now, Boeing’s rolling delays are as bad as being a passenger waiting for maintenance updates that extend and extend and extend again until all of your flight options have disappeared. But there is a good option for Southwest. The Embraer E195-E2 would be an ideal replacement for Southwest’s 737-700s. They are similar in cabin size (132 in all economy versus 143) and can optimize smaller markets by flying “right sized” aircraft. If the market grows beyond that size, Southwest has 737 MAX 8 aircraft to replace them, and could use the E195-E2 elsewhere to open new markets. Embraer can provide earlier availability of “right-sized” aircraft than Airbus or Boeing, which still hasn’t obtained certification for the 737-7. Of course, this would challenge a fundamental tenet of Southwest Airlines strategy, which is that operating only a single aircraft type will optimize costs. That strategy, while helpful in gaining the company critical mass as it grew, has now proven itself to be counterproductive, obsolete, and fraught with single aircraft provider risk. Yes, Southwest has competitive costs, but it is at the mercy of Boeing, who haven't been acting in Southwest's best interests. Many carriers operate mixed fleets and a carrier as large as Southwest has the critical mass to support more than one fleet type while optimizing economics for each, as they are well over the point at which economies of scale flatten out. The additional costs for a second fleet type would be outweighed by additional revenue generation and higher margins that come with “right-sized” aircraft that fit those markets. Having 50 more seats to fill per flight is tough in smaller markets, which typically need two daily frequencies, morning out and evening back, to be attractive to business travelers. Product Offering Southwest needs to step up its game to capture business travelers in comparable proportions to the big 3 legacy carriers, but doesn’t have a premium product to be competitive. Southwest is a one class, board by number airline that is certainly egalitarian, but post-pandemic the industry has shown stronger demand for premium cabins. From wealthier travelers moving to private aviation to an increase in first, business, and premium economy traffic, the industry is evolving to offer a suite of possibilities that better suit customer desires, and provide the associated higher yields. Southwest has clung to an older model, including touting two free checked bags to road-warriors, who typically travel with only a carry-on. Having traveled on business for 50 years and 5 million miles next month, I can count on two hands the number of times I’ve checked luggage, including frequent trans-oceanic trips with just carry-on baggage. Business travelers like premium cabins, extended legroom, and pre-assigned seats. Southwest has none of these, while even new start-ups have more refined business-oriented cabins, including new moves from very low cost carriers like Frontier and start-ups like Breeze. While the Southwest product may have been just fine pre-pandemic, the market has evolved over the last few years, and Southwest’s product simply doesn’t cut it anymore competitively. Southwest’s current management team believes in delivery a fair product at a fair price. But competing with three options against a panoply of ala carte choices for the competition, and Southwest’s two free bags nearly always being a higher nominal fare than the competition, it is often difficult to match a customer’s needs within one of their fare levels. Management Elliot hinted that it wanted management changes, and Southwest’s CEO has stood firmly stating that he isn’t going anywhere. Southwest release a statement regarding the Elliot proposal that stated they were willing to meet. They also reiterated that “We are confident that Southwest Airlines has the right strategy, the right plan and the right team in place to drive long-term value for our Shareholders.” There may be a showdown coming. Southwest is once again looking at its seating process and the potential for assigned seats, but doesn’t appear to be considering major product changes, including premium seating to capture higher yield travelers. The company is also unwilling to budge from its single aircraft strategy. While Southwest is Boeing’s single largest 737 customer, it has repeatedly faced delays and substitutions for its fleet renewal, resulting in a fleet not optimized to Southwest’s routes. The Bottom Line Southwest has underperformed for a reason, and that reason is that Southwest’s management has failed to recognize what others in the industry already know. First, you can’t put all your eggs in one basket, or be taken for granted by the sole OEM, and don’t need to take delivery of aircraft that don’t meet your needs. Second, when a trend occurs that is changing the industry, you need to react, and third, despite a strong family culture at Southwest, that culture can be myopic based on their prior success. Times change, and so must Southwest if it wants to return to the solid profitability it was one known for. It is time to listen to those outsiders who are so certain that Southwest can be turned around that they invested $2 billion.

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