Herb Kelleher, founder of Southwest Airlines once said, “A company is stronger if it is bound by love, not fear.”
But is love enough to save Southwest?
“No change fees. No cancel fees. No bag fees,” Southwest Airlines CEO Bob Jordan said recently in an email to The Dallas Morning News. “Rapid rewards points don’t expire. Flight credits don’t expire. We have the friendliest, most flexible policies in the industry with a terrific network. But the biggest thing that makes us ‘us’ is our people and the unique and unrivaled hospitality they deliver.”
Jordan’s comments about the airline, which famously grew from an idea etched on the back of a cocktail napkin at a Texas bar in 1967, follow a series of significant changes that he recently announced to some of Southwest’s most popular perks.
Airline officials publicly disclosed their intentions last month to end open seating and to add premium seating to customers, alongside offering overnight flights for the first time. The changes follow the airline’s decision earlier this year to finally allow customers to book flights and compare prices on search engines such as Google Flights and Kayak.
The operational adjustments are occurring years too late, some employees and analysts told The News recently. They surface as the airline faces substantial financial pressures, one of which includes an aggressive effort by an activist investor that says it wants to shake up the airline’s business and oust its executives and board members.
For nearly five decades, Southwest racked up profitability, enjoying 47 consecutive years of profit and usually outpacing the industry in revenue for a company its size.
However, since 2017, the airline — which employs nearly 75,000 people — hasn’t produced a year-over-year improvement in its pre-tax margin. That’s among other financial troubles, such as costs outpacing the growth of unit revenues, resulting in declining profits.
Additionally, the airline is being audited by the The Federal Aviation Administration after several safety incidents on some of its flights this year.
The headwinds are why activist investor Elliott Investment Management has said it has been buying company stock in an effort, the hedge fund wrote in a letter to Southwest’s board last month, to “strengthen oversight, upgrade management and improve company performance.” Elliott is demanding Southwest leadership step aside. Other major airlines, such as United, have experienced similar efforts from activist investors, and sometimes, they have resulted in new leadership and other changes.
To analyze and understand why and how the recent steps Southwest leaders have announced might affect the airline’s future, The News spoke to a handful of aviation analysts, historians and authors, to more than half a dozen of its frequent passengers and two of Southwest’s major union leaders. The News also called and emailed all of Southwest’s 15 board members. None responded. Elliott Investment Management declined interview requests beyond its public letters to the board.
The News also requested an interview with Gary Kelly, executive chairman of Southwest’s board, and Jordan. Jordan agreed to answer questions only by email.
“We’ve shared that we have work to do to restore our financial returns to the levels our employees expect, I expect, and our shareholders expect,” Jordan wrote to The News. ” … Our board of directors, our leadership team, and I agree this is the right direction for Southwest.”
Several analysts, employees and loyal customers say they aren’t sure if the same leadership and now, changing hospitality, will be enough to hold back Elliott Investment Management.
William Swelbar, chief industry analyst of Swelbar-ZhongAir, said each of Southwest’s new additions is a “step towards profitability,” but not a “silver bullet.”
“One of the attributes that made Southwest a vaunted competitor was its balance sheet,” Swelbar said in an email. “They would stand and fight longer than anyone else and the balance sheet is still an envy of the industry. But they no longer have the cost advantage and productivity that worked in parallel with the balance sheet. In my mind that is why the next moves are so important.”
Brett Snyder, president of Cranky Flier who writes a weekly aviation blog and has worked at America West and United Airlines, said Southwest leaders need to spend time answering a few key questions: “‘How do we think about our product to appeal to more people? Do we need to make changes to things?’ I think the Southwest of the last 20 years just didn’t do that.”
Doing things differently
Southwest has a true homegrown story, according to Bruce Bleakley, an aviation historian who has penned books on Dallas Love Field, the North Texas airport where the airline is headquartered. Southwest was Dallas’ airline, he said.
“There was this really kind of a neat relationship feeling between the airline, airport and the community,” Bleakley said.
Southwest was incorporated in the 1960s in San Antonio and initially only flew Boeing 737 airplanes to three cities — Houston, San Antonio and Dallas, a plan famously concocted at a San Antonio bar by Kelleher and Kelleher’s business partner, Rollin King. Back then, it was known as “Air Southwest.”
The early days were colorful, and included flight attendants in go-go boots and free alcohol on flights. Today, some of those same friendly sentiments still exist, according to loyal passengers.
But Southwest is no longer “that little Texas airline,” Swelbar said.
“The same old low-fare airline (not the case today) or a culture over and above that of other airlines has long been the mantra and continues to be repeated … It is a much easier task to nurture culture when you are a 300-airplane airline than one with 800,” he said in an email.
Texas mother of three Jenai Bacon, 40, said she has made many memories with the airline, like the time a Southwest gate agent allowed her daughter to sing “Happy Birthday” to her over the PA system at Midland International Airport and when pilots allowed her children in the cockpit.
With those personal touches, Southwest grew its airline business and bottom line by keeping things simple, using the same practices founder Kelleher started. For example, Southwest’s only and preferred aircraft is the Boeing 737.
In recent years, the company’s loyalty to Boeing has been challenged.
In 2019, Boeing grounded its 737 Max aircraft after two deadly crashes killed 346 people in less than five months, both outside the U.S. As a result, dozens of Southwest’s Max airplanes sat idle for nearly two years.
The executive chairman of the airline’s board, Gary Kelly, was Southwest’s CEO then. He is also one of the leaders Elliott Investment Management has directly called on to leave.
Author and longtime friend of Kelleher’s, Kevin Freiberg, told The News the airline’s allegiance to Boeing aircraft is a direct reflection of Kelleher’s intent to keep things the same. Kelly took the helm of Southwest in 2004.
Kelleher felt simplicity made the airline easier to manage, Freiberg said. Crews only had to order parts and learn one type of plane, Freiberg said. It was also a cheaper way to operate. Freiberg co-authored Nuts!: Southwest Airlines’ Crazy Recipe for Business and Personal Success, and once spent one day a month for a year with Kelleher and his business partner, Colleen Barrett, in 1995.
That devotion to Boeing has been costly.
According to Southwest, Boeing’s safety issues cost the company hundreds of millions of dollars as the airline’s fleet was hobbled for nearly two years. Boeing settled with Southwest over the grounding with cash payments and discounts on future aircraft and Southwest granted $125 million of it to its employees through annual profit sharing distribution. Fort Worth-based American Airlines expected a $540 million operating loss in 2019 from the groundings.
Boeing has faced other issues. The most recent was in January when an Alaska Airlines flight on a Boeing 737 Max 9 aircraft experienced a gaping hole in the aircraft’s fuselage mid-flight. The FAA temporarily grounded the Boeing 737 Max 9. Southwest, however, does not fly the Max 9, but does fly the Max 8.
Southwest continues to order the airplanes like its competitors. This year, Southwest is waiting on 20 Boeing 737 Max 8 aircraft. Other airlines, like American, anticipate receiving fewer Boeing planes than they originally ordered.
The all-Boeing strategy has infuriated Southwest’s pilots, who have said the decision has left the company vulnerable.
George Ferguson is a senior aerospace, defense and airline analyst and research team leader at Bloomberg Intelligence who has followed Southwest for nearly 15 years. Southwest isn’t more vulnerable than any other airline with an all-Boeing fleet, but it could present another opportunity for investor Elliott Investment Management to criticize, he said.
Coupled with the FAA audit into aircraft incidents, Southwest faces some safety concerns.
This year, multiple Southwest flights experienced incidents such as a “Dutch roll,” jets flying dangerously low and instances of aircraft flying too close. The incidents are under investigation by the FAA and National Transportation Safety Board.
While other airlines have experienced similar situations, Southwest’s incidents prompted the FAA in July to conduct a Certificate Holder Evaluation Process, which will review everything from Southwest’s manuals to flight crew training. United Airlines is currently facing a similar review.
“I think Gary (Kelly) did a real disservice by just deflecting or genuflecting to Herb and Colleen as these almost Godlike creatures in the origins of the company and not trying to evolve it,” Snyder said. “You can stay true and still make a lot of change. Times change. The world changes. What people want changes.”
Snyder said the operational changes the airline has announced will help financially.
“This should improve revenue, but it really depends on how it’s implemented,” Snyder said. “It may not be enough for the airline’s activist investor, which seems more interested in short-term revenue hits that will spike the stock price than anything more sensible like what Southwest is doing.”
Meltdown unveils technology problems
Some of Southwest’s financial struggles have coincided with the airline’s need to invest in new and more advanced technology — especially its rescheduling software system.
Headlines across the country during the Christmas holiday season almost two years ago publicly brought attention to the airline’s rescheduling software system that stranded thousands of passengers for more than a week, their belongings strewn all over the country after a winter storm. The storm, coincidentally named Winter Storm Elliott, hit two critical hubs for Southwest — Denver and Chicago. Other airlines were able to bounce back sooner, but Southwest ended up canceling more than 16,000 flights and lost more than $1.1 billion.
Kelly took more criticism, this time along with Jordan, for failing to invest in the infrastructure upgrades that other companies adopted years before. Ironically, just before the meltdown, Jordan boasted about how the company was eliminating the physical paperwork needed before each flight — moving to computers.
After the meltdown, Southwest pledged to spend more than $1.3 billion on technology upgrades. Its crew optimization software and the airline’s customer phone systems have been upgraded for better surge protection and efficiency during high call-volume times.
This year, the company reported at its full-year results in January, that it expected to spend $1.7 billion in technology, upgrades and system maintenance.
There’s no question Southwest has suffered financially since the meltdown. In its latest quarterly earnings call July 25, Jordan told investors the results “are not where we need them to be, and they are not reflective of what (Southwest is) capable of delivering.”
The company sold too many seats for its peak summer travel period too early in the second quarter of 2024, Jordan said, leading to unit revenues declining 3.8% year-over-year.
In the second quarter this year, Southwest’s revenue rose 4.5% from last year to $7.35 billion, a record, but the carrier’s profit dropped more than 46% to $367 million, according to CNBC. Although Southwest doesn’t fly as many international routes as other airlines, it views the other major U.S. carriers such as United, Delta and American as competition and their results tell a different story.
Chicago-based United earned $1.3 billion for the latest quarter and reported a revenue of $14.9 billion. Delta is the most profitable airline in the industry. The Atlanta-based airline brought in an adjusted revenue of $15.4 billion, up 5.4% from last year.
American’s profit also fell 46% in the latest quarter to $717 million, despite revenue rising 2%. However, American lowered its financial expectations for the quarter, like Southwest, and even cut one of its executives.
“Time and time again, the purposeful investments we’ve made to improve our resilience and ability to recover from disruptions are demonstrating their value, and that investment will continue,” Jordan told Southwest investors during earnings in July.
The need to become more profitable
The airline’s financial struggles are why an activist investor, like Elliott Investment Management, might see Southwest as an opportunity to make money.
In June, Elliott disclosed a $1.9 billion stake, or 11% in economic interest. Activist investors put money into underperforming companies to improve their performance for profit. In doing so, Elliott has made three major demands: Elliott wants to oust leaders like Jordan and Kelly, reevaluate Southwest’s board of directors and conduct a business review.
Elliott investors declined multiple requests for interviews with The News, in response inquiries about the public letters they have issued. Other major investors, such as The Vanguard Group with a 10% stake in the company as of March, disclosed by Southwest in its latest proxy statement, did not respond to requests for comment.
Jordan told reporters two days after Elliott disclosed its stake that he won’t resign. He said he and Kelly remain focused on implementing the changes they have recently promised.
Elliott’s stake in Southwest has also triggered Southwest Airlines leaders to adopt a “poison pill” plan. The “poison pill” is often used to thwart activist investors.
Under Southwest’s plan, if Elliott purchases 12.5% or more of the airline’s shares, current shareholders gain the option to buy additional shares at a lower price. This action would dilute Elliott’s holdings, decreasing the value and making it more costly for Elliott to gain control of the company. In other words, it prevents Elliott from taking over Southwest, although it has said it has no plans to do so.
“Contrary to the company’s statements, Elliott is not seeking control of Southwest,” the hedge fund wrote in a July letter.
A few weeks after that letter to board members, Southwest ended its 53-year tradition of open seating. While it’s a push away from Southwest business practices, the company had been evaluating the plan for months, even before Elliott disclosed its stake, Jordan told investors.
According to Southwest, 80% of customers prefer an assigned seat and 86% of potential customers prefer an assigned seat.
“Our team does view this as a strategic transformation of the company,” Jordan said July 25 at second-quarter earnings.
So far, the open seating changes, scheduled to begin next year, are receiving mixed reviews.
Kim Samuels of Dallas said she has a strategy of setting her alarm for 24 hours and two minutes prior to her flight and then staring at her phone until it is time to check in to claim the best boarding position. The ending of open seating isn’t a deal breaker for her, she said.
“I think if they started charging for bags, I would consider American more,” Samuels said. “I live closer to Love, but DFW is not too bad.”
Rebekah Hughes, 44, of Seabrook, Texas, and her husband are Southwest frequent fliers. If things keep changing and their loyalty points don’t reap the same benefits, she said they’ve already discussed alternative travel.
“We’re actually considering purchasing a camper and a truck and going on the road that way, not necessarily switching airlines, but doing that,” said Hughes, who travels with Southwest’s companion pass alongside her husband on work trips.
Greg Kelminson, 40 of Richardson, Texas, has flown Southwest a lot in the last 15 years.
“My concern is this is maybe the first domino to fall that makes them lose some of their identity, and what helps make that customer base loyal,” Kelminson said.
Other Southwest frequent fliers, like Eric Kurland, 59, who lives near Sacramento, California, worries his preferred airline might become a streaming hit soon.
“(There are documentaries like), ‘The rise and fall of company XYZ, watch it on Netflix,’” he said. “I hope Southwest doesn’t fall into that.”
Under Southwest’s bylaws, a shareholder with 10% or more in beneficial ownership can call a special shareholders meeting where it could seek the election of new directors.
On Aug. 13, a regulatory filing was released with the Securities and Exchange Commission unveiling Elliott’s 8.2% beneficial ownership in Southwest and detailed an aggressive push to buy more shares, edging it closer to the ability to call a shareholder meeting when it reaches 10%.
Elliott said this month it intends to name 10 new directors. Those directors would have the power to push for more transformation, including the ability to replace executive leaders such as Jordan and Kelly.
That didn’t sit well with Jordan, who addressed his company in a Aug. 14 memo.
“… don’t be fooled – this is a battle for the heart of our company and our future – your future,” Jordan wrote.
Earlier this year, Carl Icahn, the 88-year-old activist investor who goes after undervalued companies, appointed two board members from his firm to JetBlue Airways’ board, avoiding a proxy fight. Icahn disclosed a 10% stake in JetBlue in February.
In 2016, United Airlines also bowed to an activist investor with two new board members. Activist PAR Capital Management and Altimeter Capital Management complained the Chicago-based airline didn’t have enough directors with airline expertise. The two hedge funds disclosed that year they had an over 7% stake in United.
What comes next?
Analysts and industry leaders eagerly await Investor Day for Southwest on Sept. 26 where executives have promised more details on the new seating method and premium options.
Casey Murray, a Southwest captain and union president of the Southwest Airlines Pilots Association, said the union raised concerns for years to management that it needed to modernize operations.
“There’s a reason that Elliott is on the doorstep,” Murray said. “We’ve been beating this drum for almost a decade.”
Kristina Peterson, first vice president of Transport Workers Union Local 556 and a Phoenix-based flight attendant, said their pleas for transformation are because they want the company to be more profitable. Transport Workers Union Local 556 represents Southwest’s 20,000 flight attendants.
“We are the frontline faces… We’re totally behind each other,” Peterson said.
Jordan said that while he can’t speak for what Kelleher would think about Elliott, Kelleher “never backed down from a battle, and instead went to work on the challenge.”
When The News asked whether there were any “non-negotiables” for other potential customer service changes, Jordan responded, “You can never say never ever in life.”
He quoted another famous Kelleher saying, “If you don’t change you die,” and reiterated this: Southwest will always take care of its people.
When asked what Kelleher would think of Elliott’s attempts, Freiberg, the friend of Kelleher’s of over 30 years, said:
“I think he would say to his executive leaders, ‘As big as we are, keep your thumb on the pulse of the people in the trenches. Do not lose connection to their hearts, their minds and their spirits.’”