The Journal. - Southwest Changed Flying. Can It Change Itself?

Episode Date: June 24, 2024

An activist investor says Southwest Airlines is stuck in the past. Elliott Investment Management says it has amassed a $1.9 billion stake, making it one of Southwest’s biggest shareholders and one of its most vocal critics. WSJ’s Alison Sider explains what Elliott wants, and why critics say some of the things that made Southwest great are now holding it back.  Further Reading: - Southwest Changed Flying. Now It Can’t Change Fast Enough  - Meet the Southwest Superfans Who Don’t Want the Airline to Change  Further Listening: - Ryanair: Cheap, Cramped and Making Its CEO a Fortune  - The Love Triangle Over Spirit Airlines  Learn more about your ad choices. Visit megaphone.fm/adchoices

For decades, Southwest Airlines was the financial envy of the airline industry. I mean, Southwest was incredibly successful. That's our colleague Allison Sider. She covers airlines. I mean, the airline industry is like really boom and bust. And most of these airlines that we know today are the result of, you know, several mergers and trips through bankruptcy. And it became so common that, you know, Herb Kelleher, the co-founder of Southwest Airlines, referred to bankruptcy court as a health spot for airlines. And Southwest has never filed for bankruptcy. Up until the pandemic, they had 47 straight years of consecutive profits. I mean, that's just unheard of in the

airline industry. But these days, even as Americans are returning to travel in droves, Southwest is struggling. It's very unusual for Southwest to be doing badly when some other airlines are doing well. I mean, that's kind of just the opposite of how things normally go. And that's very unusual for Southwest and really frustrating for Southwest investors. And some of them are getting pretty vocal about it. One big investor is getting particularly vocal, Elliott Investment Management. Elliott bought up a giant stake in Southwest and is pushing for change. They're very formidable. I think they're known for kind

of going in with big plans and finding a way to win. They're patient and they're willing to wait and they're serious. So it's not something Southwest can just shrug off. Welcome to The Journal, our show about money, business, and power. I'm Ryan Knudson. It's Monday, June 24th. Coming up on the show, the fight over the future of Southwest Airlines. Attention all soccer fans. From Orlando to Los Angeles, We'll see you next time. and diverse cultures. You'll love it so much, you'll want to extend your stay beyond the matches. Get the ball rolling on your soccer getaway. Head to visittheusa.com.

I feel like Southwest Airlines is one of the most interesting companies in the world of business. Yeah, I think that's probably right. Like, I went to business school, and I feel like we probably did, like, a million case studies on Southwest. And now it's time to add another one to the books. Yeah, probably a couple more. The reason Southwest Airlines is so studied in business schools is because it completely changed the airline industry. Back in the 1950s and 60s, flying was expensive,

and airlines sold their flights on the promise of comfort and luxury. But Southwest Airlines disrupted all that and based its business on a different promise. This is your basic one-of-a-kind airline. No gimmicks, just your money's worth. Southwest Airlines invented low fares. That's true. Instead of promising luxury, Southwest Airlines promised simplicity and affordability. We're Southwest Airlines.

We're fast, we're fun, we're inexpensive. Come on, let's go to Phoenix. The man behind Southwest's rise was its charismatic co-founder, Herb Kelleher. He became Southwest's CEO in 1981. Herb is kind of one of the great characters in American business. Chain smoking, wild turkey drinking, effusive, just a real outsized personality. And the airline was really kind of built in his image. Kelleher was often featured in the company's ads.

We have low operating costs, so we can offer you low fares on a regular basis. That's our philosophy. It's the way we have done business. We're really dedicated to low fares. It's something that we believe in with all of our fiber. Other airlines try to copy Southwest, but they're just facsimiles of the real thing. What were the things that he was introducing that were disruptive and that Southwest became known for? I mean, really built an airline that kind of could appeal to the everyman

and democratized air travel. How so? You know, so Southwest's network was really unique. It flew between, you know, a bunch of smaller or medium-sized cities, and otherwise you would have had to go through a hub. So it really connected people. It replaced car trips for a lot of people. For a long time, Southwest said its real competition was the road trip,

not other airlines. They just got rid of a lot of frills, meals. They only served peanuts as snacks. So it was just of a lot of frills, you know, meals. They only serve peanuts as snacks. So it's just about a real simple business model, affordable, you know, low fares, no fees, no surprises. Southwest streamlined flying in other ways, too. For example, the airline only offered one type of ticket, meaning no first class. In fact, Southwest never even assigned seats. The airline also just used one type of plane, the Boeing 737, to keep everything from maintenance to boarding the same.

They were sort of meant to be cost-cutting. Like, you know, the technology to assign seats was expensive. And it's complicated to have planes with different configurations and different layouts for different markets. And not having those things kept Southwest's operation really simple and kept its costs low and sort of were part of how it was able to out-compete. Southwest passed some of those savings on to consumers. Like, it's never charged change fees. And it lets customers check two bags for free. No bag fees. That's huge.

Especially in the last 20 years or so as airlines have started charging for bags, and bag fees have gotten really high, you know, $35, $40. Two free check bags is just a huge selling point for a lot of people. Another thing the airline became known for was its silly culture. In the event that you have not been in an automobile since 1942, we're going to show you how to fasten the seatbelt. And how flight staff would often turn safety announcements into a form of stand-up comedy. We love you. You love us.

We're much faster than a bus. We hope you enjoy our hospitality. Marry one of us and you'd fly free. All of this made a lot of people love Southwest, and the company was massively successful as a result. They were able to out-compete everyone. They grew really quickly. They always had the lowest cost. So anytime they did go into a market,

you know, competitors would have to pivot really quickly to compete with them and slash their own fares. For decades, airlines really struggled to compete with Southwest. I mean, there was even a name for it. The government gave a name, the Southwest effect. Pulling people out of cars, putting them on planes, bringing fares down. It really upended the entire effect. Pulling people out of cars, putting them on planes, bringing fares down. It really upended the entire industry.

To this day, Southwest hangs on to Kelleher's legacy. After Kelleher died in 2019, the company preserved a replica of his office for employees to view. In another part of the headquarters, there's a button people can press to hear a recording of his laugh. But now, there's a big investor that wants it to let go of the past. That's after the break. And you can now get almost anything you need for your sunny days delivered with Uber Eats. What do we mean by almost? Well, you can't get a well-groomed lawn delivered, but you can get a chicken parmesan delivered. A cabana? That's a no.

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New Balance has the running shoes, clothes, and accessories to push your run further and help you run your way. Find yours at newbalance.ca slash running. New Balance. Run your way. After decades of uninterrupted success, Southwest has started to struggle. So when did things start to turn for Southwest? I mean, there have been strains that have emerged, like, you know, over the last 20 years, I'd say. The rise of budget airlines like Spirit that really challenged Southwest on low costs and other airlines kind of went through bankruptcy and cut their own costs

and figured out how to compete with Southwest. But I think, you know, coming out of the pandemic, I think is really when some of these latest, these most significant challenges have started to emerge. Yeah, and what were those challenges? Well, so during the pandemic, every airline was suffering. Nobody was traveling.

Air traffic dried up almost completely. And Southwest took the opportunity to repeat what had been a really familiar playbook for the airline, that when other airlines are down, they're going to expand. Everyone is pulling back. Southwest is going to be aggressive. And so they went into 18 new cities. And I think that has not gone the way that it has when Southwest expanded in other downturns. Partly for reasons that are not in their control.

All the airlines got aid from the government, so they didn't pull back, you know, as much as maybe they had in previous downturns. And then they've got this Boeing issue where Southwest is uniquely dependent on Boeing. It flies in all Boeing 737 fleets. Boeing is having a lot of its own troubles. You know, it can't produce planes at the levels that it had hoped to. So Southwest is getting like a quarter of the planes it thought it was going to this year.

Another issue facing Southwest is that some of the things that used to make it great don't make as much sense in the modern airline industry. For instance, Southwest's fares now look a little high compared to other airlines. Most airlines nowadays offer basic fares with hardly any amenities, but then allow customers to pay more for things like choosing a seat,

checking a bag, or getting extra legroom. People traveling now seem just really interested in buying up and buying up to a nicer product that Southwest just doesn't offer. So, you know, the airlines that are doing well are ones that just offer things that Southwest doesn't have. And other airlines have also done away with change fees. Southwest used to be the only airline that didn't charge you a change fee or a cancellation fee. And that kind of flexibility was huge, you know, for business travelers, for leisure travelers.

Southwest still says they have an advantage, but, you know, it's really not as much of an advantage as it used to be. And some passengers find some of Southwest's quirks, like not having assigned seats, kind of annoying. They do not assign seats. It is the Hunger Games out here. You need to make sure that you check in 24 hours a day. As a result, Southwest is no longer the financial titan that it used to be.

Over the past two years, the company's stock is down almost 25%. Meanwhile, United Airlines' stock is up nearly 25%, and Delta Airlines is up 58%. I mean, it's not that they're losing tons of money, but Southwest has been known for having the best profit margins in the industry, and now they're lagging behind competitors. I think people expected them to come out of the pandemic as they have in other downturns just grabbing market share.

It just kind of hasn't worked out that way. Southwest's situation got the attention of Elliott Investment Management. Elliott is an influential hedge fund that has a reputation as a tough investor that always gets what it wants. Changes that it says make companies stronger and more profitable. How did Southwest Airlines get on Elliott's radar? I think what they saw in Southwest is an airline that's kind of lacking direction,

that's sort of floundering, but that can be fixed. You know, I think activists sometimes shy away from the airline industry. It's really volatile. There's a lot of regulation. There's unions, you know, labor stuff. It can just be sort of a tricky industry that isn't that profitable in the best times. But I think what they saw in Southwest is an airline that has historically done much better

and that they believe can, again, do much better if it was managed differently. For the past year and a half, Elliott says it's been studying the airline industry, and it thinks it's come up with a plan to make Southwest stronger. A few weeks ago, Elliott presented its plan to Southwest's leaders.

Elliott puts out, you know, this pretty fiery letter to the airline's board and a lengthy PowerPoint deck sort of just walking through everything that it kind of sees as a problem at Southwest. It's all

posted at this website that Elliot created called Stronger Southwest. StrongersSouthwest.com. I'm going to pull it up too. It looks exactly like the Southwest homepage, pretty much. Yeah, the website uses all Southwest colors. It's not their precise branding,

but it looks like they're even using the same font as the Southwest website. This is a 51-page PowerPoint presentation. Yeah, it's quite extensive. And their demands are substantial. They want the CEO, Bob Jordan, to be fired. They think the board is too entrenched. They've been there too long. They want big changes on the board.

In its presentation, Elliott argues that Southwest is too insular and unwilling to adopt new ideas for revenue. It points out that only one of the company's executives, its chief operating officer, has worked at another airline. If a new leadership team is installed, Elliott says it wants it to review Southwest's business top to bottom. They've called out in their presentation a couple things they see as

possibly missed opportunities, you know, things like not charging for bags, which, you know, some analysts say could bring in a billion dollars of revenue if Southwest charged for bags. Not having a premium cabin, not having a basic economy product, not having assigned seating. So some of these things, they're not necessarily saying explicitly,

we insist that you do this, this is how to fix Southwest, but they're examples of things that other airlines are doing that Southwest is not, that they think Southwest is missing out on revenue. How did Southwest respond to all this? I think Southwest itself says, we know we're underperforming, we know we have a problem, we know we have to turn some of this stuff around. I think they agree that there have a problem. We know we have to turn some of this stuff around. I think they agree that there is a problem.

Obviously, they do not agree on the fix. Bob Jordan, the airline CEO, said he's not resigning. They've said they are already looking at some of the things that Elliott called out as potential things to look at. Southwest has said, on the topic of checked bag fees, Southwest said, absolutely not. That's something that they say they are not planning to change. It's not on the table. And, you know, I think Southwest is saying, like, we have a plan. It's going to be good.

Elliott's not in charge of this company. We aren't. And so, you know, trust us. We've got this. The airline is planning to unveil its own plans in September, and it says it's willing to sit down with Elliott to discuss changes. It could be months before the confrontation is resolved. So we were talking earlier about all the business case studies that have come out of this company, Southwest Airlines. What do you think the lesson will be for the next case study that comes out of this chapter? I mean, I think it will be really interesting. I think there might be lessons and I don't know what the outcome will be yet. I don't know if in hindsight, Southwest will feel it was too slow to change or, you know, maybe some of these changes get imposed and they lose some of what was special.

So something to say about how quickly should an organization change? Which of these practices is Southwest not embracing just because it wants to be different, and which of them is it not embracing because they really are important to Southwest and to its appeal. That's all for today, Monday, June 24th.

The Journal is a co-production of Spotify and The Wall Street Journal. Additional reporting in this episode by Don Gilbertson. Thanks for listening. See you tomorrow.