The basic problem with Southwest Airlines is that they’ve outgrown their model. They were the most consistently profitable airline for decades – racking up 47 straight years of profits, even through 9/11 and the Great Recession – with a simple formula. They had low costs, a single fleet type, and simple customer-friendly policies.

Now, however, Southwest:

• Is no longer a low cost carrier. They don’t have the Gary Kelly fuel hedges anymore and have expensive contracts with pilots, flight attendants and other work groups. Headquarters staff has grown.

• They lack long haul flying and partnerships. Southwest takes you to the biggest domestic markets but can’t sell tickets to Europe or other worldwide destinations that customers want to fly. And they don’t benefit from the tickets foreign airlines are selling to their customers. A passenger from Asia can’t land in Los Angeles and transfer on the same ticket to a Southwest flight, or from Europe in New York. That’s a lot of business lost.

• They can’t serve small markets bringing connecting feed to their larger planes. With nothing smaller than a Boeing 737 they can’t serve the markets that other airlines reach with regional jets. Those passengers then can’t flow through the rest of Southwest’s route network.

• They don’t offer premium products. Customers have increasingly wanted more room and other conveniences, and Southwest hasn’t had anything to offer those passengers. This also cashes out in fewer high income customers than legacy airline peers.

• Customers don’t know about their flights. Southwest largely sells tickets through their own channels only. They don’t sell to leisure travelers through online travel agencies or distribute their fares through Sabre and similar systems. That also means customers don’t directly compare prices, which is great since Southwest generally doesn’t offer the lowest fares… but they also don’t sell restrictive basic economy tickets and they include free checked bags with every fare. However this means that they sell tickets largely to customers living in their major cities who know about the option, but have far fewer customers at their spokes.

It was a great model until it wasn’t anymore. They just can’t keep growing without changes, and won’t return to their historic lower costs. They need to abandon simplicity for growth, but that complexity will mean greater costs too. And that means Southwest is unlikely to be Southwest again, though they still have advantages – primarily that they are still a differentiated product in the market, and with employees who largely don’t hate their jobs and that difference shows against American Airlines and United.

Covid accelerated changes in the market. Activist investor Elliott Management complains that Southwest management has been slow to adapt, and that’s true. But they don’t offer solutions beyond vague notions that Southwest fails to ape policies and practices of even less successful airlines (American Airlines, JetBlue). They don’t have answers and shouldn’t be put in charge. But they have accelerated change at Southwest.

Southwest is presenting a new plan at Investor Day this morning.

• Southwest wants to increase aircraft utilization. Part of that is redeye flying, which will help expand the reach of their Hawaii service since Hawaii flights to the mainland need to operate overnight to connect to most markets in the middle of the country eastward. They’ll operate other redeyes, which will be of marginal value, but they already have the planes so this can make strategic sense.

  It’s a little bit insane that it is going to take three years to have all of their redeyes running?

  

  They also think they can reduce the time planes are on the ground, but assigned seats will work against that (the current model has passengers lining up in advance to board and getting seated quickly). If they started charging for bags, there would be more carry-ons, slowing boarding further. That’s one reason they aren’t going to charge for bags even thought they don’t say so. They’re already the quickest for turning around planes, it seems unlikely that this will get even lower as boarding times presumably get longer.

  

  Boarding is still going to look the same, but of course there will be no more reason to line up in your boarding order since you get your assigned seat even if you board just prior to doors close.

  

• Southwest is cutting unprofitable flying. They have already slashed Atlanta, which had already retrenched since their acquisition of Atlanta-based AirTran. This is a gift to Delta.

  It’s tough to cut to profitability, they shouldn’t fly unprofitable routes but

  1. need to do the accounting correctly, since pulling back in markets will hurt other flights and even brand awareness in those markets, especially important to Southwest which needs to drive customers to its website to learn about its schedules, and because airlines often fail to account for credit card revenue that comes from a market appropriately [American learned this lesson about New York, and United after cutting domestic flying under CEO Jeff Smisek, and
  2. need to replace it with other flying which is tough for Southwest without a more diversifie fleet.

  They’ll keep flights to slot-restricted New York LaGuardia and Washington National. Much of their operations at congested Northeast airports gained from AirTran have previously been pulled back. They will re-align money-losing Hawaii inter-island flying and, it seems, Oakland. California non-stop business flights haven’t recovered from pandemic drops.

  

• Adding extra legroom seats. Southwest is expected to add legroom to about one-third of seats. They can’t do this without assigned seating. And assigned seating changes their boarding process. They think selling seat assignments will earn more than Early Bird and Early Boarding fees. They get extra legroom by squeezing legroom in the rest of the cabin. Boeing 737-800s and MAX 8s won’t even lose any seats.

  

  They’ll still offer one more inch of distance between rows than American, Delta or United’s standard economy, however.

  

  Meanwhile, though they will retrofit planes quickly, assigned seating won’t start until 2026. That means there’ll be a period of time where customers can get free extra legroom seats with an early boarding number under the current system. So for awhile flying Southwest for one-third of customers will be great! Still, the actual start of assigned seating is too far away.

  A-List and A-List Preferred elite customers will gain access to free seat assignments with extra legroom seats available to A-List Preferred at booking, and to A-List 48 hours prior to departure.

• Bags will continue to fly free. Southwest thinks they’d generate $1 billion to $1.5 billion per year charging for bags, and lose $1.8 billion in ticket revenue. 97% of their customers are aware of free checked bags on Southwest. I have to wonder, though, whether adding themselves to online travel agency sites would partially offset this revenue loss (and the biggest reason not to is that comparing fares isn’t like-to-like, since Southwest… includes bags in its fares) and whether they’re accounting for the 7.5% domestic excise tax savings from moving checked bag costs out of the fare and into fees… in other words, whether they’re cherry-picking their numbers.

  

• Will begin partnering with other airlines Icelandair out of Baltimore will be first starting next year. With this partnership Rapid Rewards members will be able to redeem points for travel to Europe which is also the beginning of an improved incentive for co-brand credit card spend, the way that the introduction of Hawaii service was as well. A second partner will come in 2025 as well.

  Despite companion pass driving card spend today, the lack of destinations and partnerships means that customers still spend less today on Southwest credit cards. Route cutbacks won’t help here (they will capture less spend in the Atlanta market!) but partnerships can help.

  

These are the beginnings of mostly smart changes, but don’t go far enough or fast enough. In the end, though, they’re likely directionally correct given the constraints the airline fares. There’s no going back to historic profitability metrics and growth potential under the old model. That means their future is different; closer to a legacy airline. That’s largely inevitable both in terms of product and financial performance, and thus stock performance.

To be clear, this is probably an improvement and the market’s initial reaction is positive – it just isn’t likely to return them to historic performance. (And the stock pop may come from the bump in guidance Southwest offered alongside their new plan, though better revenue is attributed to macro issues and to the July Crowdstrike meltdown which Southwest averted – and which led to bookings on them rather than struggling peers.)

Interestingly, Southwest’s pullback on intra-Hawaii flying is, in large measure, a consequence of the federal government’s efforts to ensure intra-Hawaii service. They demanded that Alaska Airlines maintain Hawaiian’s service as a condition of the merger. Since Alaska can’t reduce capacity, the market will remain bloody, and Southwest needs to pull back on its service. Oops.

If DOT’s new rule on displaying fees with fares at first instance is sustained in the courts (it is currently enjoined by the 5th Circuit), that’ll help Southwest and allow it to effectively sell to more customers through global distribution systems – they can appear on Expedia without a disadvantage, because their free bags-inclusive fares would be shown against fares from American, Delta and others including their bag prices.