Why Southwest’s pilots just rejected a massive pay raise by Shawn Tully @FortuneMagazine November 5, 2015, 4:02 PM EST E-mail Tweet Facebook Linkedin Share icons On Wednesday, Southwest Airlines’ pilots rejected a proposed contract that would have made them the best paid in the industry. Why did the pilots spurn an offer that would have given them a more than 17% raise and lifted their compensation above what any other carrier offers for flying 737 jetliners, Southwest’s signature aircraft? Two big issues scuttled the talks. First, Southwest wanted the freedom to enter “code share” agreements with other airlines. Under code share, Southwest could form partnerships with competing carriers so that its passengers could fly, say, from Seattle on Air Alaska to Nome, or another destination Southwest doesn’t serve. The pilots want to ensure that as Southwest serves more cities, it flies only Southwest planes manned by Southwest pilots. Second, the pilots were demanding what’s known as “retro-pay.” The pilots’ previous contract expired in 2012, and they are demanding that Southwest compensate them for the difference between the old rates and the newly negotiated, higher pay for all the hours worked during those three years. Southwest offered an extra bonus for the interval between the old and new contracts, but the pilots aren’t satisfied. The gulf between what the pilots want and what Southwest is offering comes to tens of millions of dollars. Largely because of those two issues, just over 60% of Southwest’s 8,000 pilots voted no on the agreement on November 4. Southwest is also seeking substantial changes in work rules. Starting around 2007, Southwest’s major competitors won far more flexibility in scheduling their pilots’ workdays, improving productivity. By contrast, Southwest was thriving while its rivals were re-working contracts in bankruptcy. So, it kept raising the pay it offered and did nothing to bring its highly restrictive work rules in line with the new freedoms aiding Delta, American, and United. It’s not clear if the pilots’ union is opposing Southwest’s work rule proposals, or if they will eventually agree to them. By around 2012, Southwest had gone from parity in overall costs to a 20% disadvantage compared to its competitors. As profits soared across the industry, the gap in compensation between what Southwest and its competitors offered narrowed substantially. What remained was the chasm between Southwest’s highly restrictive work rules and the flexibility offered by other carriers like American and United. Today, the other big airlines can generally assign their pilots to a maximum of 13.5 hours of “duty” per day, which includes the duration of the flight and the time required to prepare and lock up the plane. (That duty period can be shorter if, for example, the workday begins at 11 p.m.) But under Southwest’s rules, the duty day is isn’t nearly as long. In part, that’s because the carrier traditionally specialized in short-haul routes of one to three hours. Today, though, Southwest is challenging the other major airlines in coast-to-coast and other long-haul routes from Atlanta, La Guardia in New York, Washington Reagan, and other airports catering to lucrative business travelers. It’s also entering the international market for the first time, with flights to the Caribbean and Central America. As Southwest goes long-haul and overseas, its needs a longer duty day for pilots. The tighter cap on hours substantially raises its labor cost per mile flown. And during negotiations, the airline’s executives aimed to move the pilot schedule regulations closer to the industry norm. They were willing to boost pay to get there. Another point of contention: Southwest is introducing the new 737-max, a jetliner that both carries more passengers, and burns less fuel—a boon for the world’s largest budget carriers. But the current contract doesn’t require pilots to fly the new plane. Management needs that concession, giving the pilots further leverage in the negotiations. The airline industry’s current wave of big savings largely arise from recent work rule improvements in what was once one of American’s most handicapped sectors. Southwest, long the cost leader, now finds itself in the unusual position of playing catch up. Its impressive profitability will make winning concessions quite tough. The pilots, as well as flight attendants and other unions, have gone years without contracts. Now, they’re demanding a share of the spoils.