Southwest Airlines is famous for being a profitable low cost carrier. A huge part of their profitability has been their skill at aggressive hedging of oil futures to protect against a rise in the price of jet fuel. In the last 15 financial quarters SWA claims that in eight of those quarters, Southwest would not have been profitable without hedging. All carriers hedge but some do it better than others. Alaska Airlines is also very good at it.
To give a real life example of how hedging gives Southwest an advantage, I recall in the fall of 2005 standing in the aisle of a Delta jet before disembarking. I was talking to the pilot, who was lamenting the wage concessions DAL pilots were in the midst of making. The pilot made the statement that Delta had a hard time competing with carriers like Southwest. While Southwest had oil hedges at $26.00 a barrel, the Delta CFO had sold all Deltas hedges for $80 million that same fall. Apparently she was the only one who thought oil would go DOWN. Delta needed that money desperately to make a payroll. The immediate impact was having to buy jet fuel at 3 times the price that SWA did. No wonder Delta was getting its rear-end kicked. Such was the advantage that SWA had against big carriers like Delta, Northwest and United who were in financial difficulty.
My, How Times Have Changed.
Delta has now emerged from an 18 month stint in Chapter 11 bankruptcy. It comes out with new international routes, forgiven or restructured debt, and 7000 fewer employees. As a major air carrier with a new low cost basis, Delta is ready to fight. That puts carriers like Southwest, who have always had an advantage on fuel, having to rethink their strategy. Big guys with low cost to serve threaten the traditional Southwest business model. The impact of that is that SWA is now thinking about slowing network expansion and changing services to add things like in flight entertainment systems.
What's Good for the Goose may be Good for the Gander...
Delta and other major carriers have been expanding their international routes because those routes have few, if any, discount competition. Now some discounters are considering joining the international routes when the European Open Skies treaty becomes effective in 2008. That will make flying to Europe considerably cheaper than it is today, but still may present new revenue opportunities for discount carriers. It will also open some unique international route pairings. How about flying from Birmingham, Alabama to Birmingham, UK?
Now comes Virgin.
Virgin America has gotten US route authority this spring and will be flying on selected US East and West coast routes. Couple the Virgin domestic discounter with Virgins established Virgin Atlantic services and a power player in the US airline business is in the making.
The Southwest Airlines that Herb Kelleher and Rollin King started and has been a poster child for low cost but profitable operation AND super corporate culture, now has to reinvent itself. Im looking forward to seeing that happen. Markets change and the best companies change to meet the market. What will be interesting is whether SWA can find a way to disrupt a market that has morphed to meet its model.
Eric
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