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Southwest Airlines: Pricing New Focus Now That Fuel Hedging Has Expired

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The global airline industry is estimated to have a value of more than $532 billion in 2014, an almost 40% increase since 2009. (Photo: Stock.xchng)
The global airline industry is estimated to have a value of more than $532 billion in 2014, an almost 40% increase since 2009. (Photo: Stock.xchng)

BUSINESS

  • Southwest forced to re-examine pricing strategy
  • Southwest’s average ticket price up 39% in past 5 years
  • Ticket pricing key for airline profitability going forward

With Southwest's lucrative hedges now expired, the US's largest low-cost airline has to come up with a new strategy to drive profit. 

In the past, Southwest Airlines was the envy of the industry with its long string of repeated profitable quarterly reports thanks to fuel hedging. Southwest had locked-in buying options that guaranteed it low costs for fuel at a time when gas prices were dramatically rising.

“Hedging gave Southwest a significant advantage over rivals as fuel followed oil futures to a record high in 2008,” writes Reuters.  

Southwest still hedges some fuel costs but its time of a massive advantage is over, company officials say, and now the layer of hedging is more inclined to be “catastrophic coverage” in case of serious market disruptions.

That raises the question of whether the biggest airline for domestic flying can still be the low-cost leader. The perhaps not-so-surprising answer: perhaps they can’t. Fares are climbing. 

Customers: Cheaper Prices Elsewhere

Southwest has eagerly pushed its widespread reputation as a low-cost carrier. But as Scott McCartney, the award-winning columnist ofThe Wall Street Journal’s “Middle Seat” column, writes: “Prices have gone up significantly at the carrier, which built its large and loyal following with a potent combination of good service and low prices. You can find cheaper prices on other carriers, Southwest customers note.”

Delta Air Lines Chief Executive Richard Anderson earlier this year was asked about the impact of his airline on Southwest’s acquisition of Air Tran Airways. He noted that Southwest had higher prices and costs than AirTran.

Government data showed that the airline industry overall raised prices 10% in the past five years, while Southwest’s average ticket price went up 39% over the same period. “On some routes where Southwest dominates, its average price is higher than the No. 2 carrier in that market,” said McCartney.

One of the problems for Southwest is its greatest strength: the much-advertised lack of fees. Economists say that means Southwest must cover its cost in the price of its tickets.

There is a narrowing cost differential between the so-called Legacy airlines that even Southwest executives have noted.

SeekingAlpha.com, a site that covers the stock market, predicts that the stock in other airlines will rise faster than Southwest as fuel prices stabilize.

“Southwest has invested in offering better service than other carriers, yet has been unable to thereby achieve a revenue premium,” the site says. Southwest has to operate with less profit because unlike other carriers, it does not charge for bags or other fees.

“Southwest (like the other airlines) needs to support a baggage crew on the ground, but unlike other carriers, has to pay these costs out of the base airfares it charges, instead of baggage fees,” the site says.

Southwest, for its part, points out that it almost invariably lowers fares when it enters new markets, which sometimes drives down the cost but that is often temporary.

Bloggers Complain Southwest Was Never Low-Fare Carrier

Bloggers at The Wall Street Journal are becoming dubious. One writes: “SW has always been my first ‘look’ at fares. NO MORE! Their rates are comparable to major airlines. If I travel in nice weather (usually to FL), I don’t need to change my flight and I don’t need to check a bag. That is the only advantage they offer.”

“Southwest is a Legacy carrier. They are not low-cost or discount. People are brainwashed to fly them,” writes another

Gary Kelly, Southwest Chairman, President and Chief Executive Officer, in a look back at last year termed it a “stellar revenue performance” with “record load factors, record yields and record revenues.”

He also said the airline had no plans to slowdown and planned an expansion in March with the introduction of new 737-800 aircraft that would offer some “enhanced economics” on long-haul routes.

“We continue to expect our 2012 combined capacity to be roughly flat or slightly down compared to combined 2011. And again, given the fragile economic environment and persistently high fuel prices, we continue to cautiously manage our 2012 capacity plans,” he adds.

Key Statistics – Global Airline Industry (source: MarketLine)

  • The global airline industry is estimated to have a value of more than $532 billion in 2014, an almost 40% increase since 2009.
  • The world airline industry will have a volume of more than 2.5 million passengers in 2014, which is an increase of more than 27% since 2009.
  • US domestic travel, the largest segment of the global airlines industry, will account for more than two-thirds of the industry’s total volume in 2014.

By David Wilkening for
David Wilkening is a former newspaperman who worked in Chicago, Detroit and Orlando. He now specializes in travel and real-estate business writing.

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