A strategy session at 40,000 feet: How Southwest Airlines used the pandemic to outmaneuver the majors
Gary Kelly had no visibility. The numbers that the Southwest Airlines CEO surveyed in April of last year were unspeakably catastrophic, and he had no indicators to foresee if the pandemic signaled a brief nosedive or a slow-motion crash. “Each week when the finance team sent me the figures for our operations, they would provide commentary that was typically upbeat,” he told Fortune. But the “color” that accompanied the report for the week of April 5, 2020, evoked the lowest of low-down blues. “I’d never read a message from the finance staff anything like that dark. It said, ‘We have no words to describe the damage. How do we recover?’”
Marveling at a 97% drop in traffic from 2019, and a cash burn of $200 million that week, Kelly couldn’t help wondering the same thing. He recalled that in the days after the World Trade Center attack, when he as CFO sent similarly disastrous figures to the budget carrier’s legendary cofounder, and his own mentor, Herb Kelleher. Yet within months Southwest roared back to post steady profits. This time, Kelly, whose 17-year tenure makes him the longest-serving CEO for a major U.S. carrier, couldn’t even guess at how long the mysterious virus would ground America’s travelers. COVID might not be a short, quick shock like 9/11, but a long-lasting plague that hammered commercial aviation harder than any other big business. And that’s what happened. “9/11 was awful, but we recovered quickly,” he observes. “The COVID hit was far more damaging because we kept getting false dawns, then it would go on and on.”
You’d think that to weather the worst devastation in modern airline history, a tempest whose ferocity and duration were totally unpredictable, Kelly would play defense by onboarding a strategy of chopping costs and otherwise hunkering down. Southwest already entered the crisis hamstrung by the grounding of the aircraft it’s counting on for future expansion, the Boeing 737 MAX. To stanch the bleeding, Kelly indeed slashed outlays. But at the same time, he showed the vision and moxie to pursue a superambitious flight plan for growth. While rivals were exiting market after market, Southwest has opened no fewer than 17 new destinations, a campaign that encompasses key hubs Chicago O’Hare, Miami International, and Houston Intercontinental. Over a dozen vacation destinations joined the network, from Sarasota to Colorado Springs to Palm Springs, important new dots since vacations and adventures rather than business trips are leading the recovery in air travel.
Put simply, Kelly grabbed plans off the shelf scheduled to take five years or more and exploited the pandemic to fast-track the campaign. He achieved that feat by deploying planes parked at desert airfields, and crews grounded by the pandemic, that Southwest still paid for, and dispatching them to the new routes, a gambit that brought sorely needed revenue. Before the crisis, O’Hare wasn’t even on Southwest’s wish list. But when its rivals pulled back, precious landing slots opened, and Kelly pounced. “For decades, Southwest has been able to expand during crises because of its low costs, then come back stronger,” says industry expert Robert Mann. “But what they did during the pandemic is the Big Gulp version of what they usually do. This time, they took advantage of once-in-a-lifetime opportunities.”
Southwest has achieved its biggest expansion ever in its deepest downturn just as it prepares to celebrate its 50th anniversary on June 18. On that date in 1971, America’s first low-cost airline flew between Dallas, Houston, and San Antonio, following a model that cofounder Rollin King illustrated for Kelleher in a hotel bar by drawing lines connecting those three cities on a napkin. As Americans line up once again at the ticket counters, it’s likely that Southwest will begin its second half-century in a much stronger position versus American, United, and Delta than before the pandemic.
It owes that edge to two factors: the land grab orchestrated during the pandemic, and its financial strength. Southwest holds the most cash and carries the lowest debt of the major carriers. That super-solid position should enable it to greatly expand its fleet in the months and years to come, providing the extra seats to capture an outsize share of the overall market’s growth, and in promising markets, pull passengers from its rivals’ planes. The FAA approved the 737 MAX to fly again in December, and by March Southwest’s MAX fleet had returned to service. That month, Southwest laid the runway for the liftoff ahead by purchasing a big new batch of the super-fuel-efficient aircraft.
In two in-depth interviews with Fortune, Kelly described how Southwest navigated the pandemic. “You get to bat in a crisis a couple of times in 50 years, and how you do proves what you stand for or disproves it,” he said. “We’re still America’s top low-cost airline, we’re still number one in democratizing the skies, and coming out of the crisis, we’ll take lots of market share from our competitors.”
Southwest’s already seeing huge improvement in its fortunes: It’s estimating that for June, operating revenues will be down just 20% from 2019 versus three-fourths at this time last year, possibly bringing cash flow into balance and suggesting that it will make the turn to generating cash soon. Remarkably, Kelly tells Fortune that at least on a quarterly basis, he “hasn’t given up on” achieving Southwest’s biggest revenues ever by sometime next year, a record no other major is likely to match, or would have the nerve to predict.
Flying empty planes
A comeback on that scale would be heroic, considering the depth of the drop, and how long the pandemic crunched air travel to the levels of the 1970s. In Q2 of last year, Southwest suffered an 87% drop in passenger revenues from $5.5 billion to $700 million, causing a staggering loss of $1.1 billion. “We almost lost a zero,” says Bob Jordan, EVP of corporate services. The picture improved only slightly for the rest of the year; by Q4, ticket sales were still almost 69% below 2019 levels. For the full year, the total miles flown by all Southwest paying passengers dropped by 60%, and on average, its fleet of Boeing 737-700s and 800s flew half-empty.
The losses swelled Southwest’s debt level from a slender $1.85 billion at the close of 2019 to $10.55 billion in Q1. The $5.4 billion Payroll Support Program (PSP) grants and loans from the Treasury kept that number from going far higher. And the $1.54 billion Southwest owes in PSP debt carries extremely low rates. Still, Southwest’s balance sheet is in the best shape by far among the majors. Delta ($27.4 billion) and United ($29.8 billion) are shouldering over two-and-a-half times Southwest’s burden, and American owes three times as much at $32.5 billion.
Clayton White, a veteran flight attendant, shares vivid memories of the year that grounded America’s road warriors and vacationers. “We were flying around the country with four or five passengers on the 737-700 and 800s that carry 143 and 175 passengers,” White tells Fortune. “We’d regularly book 40 people on the ‘busiest’ routes, and 16 would board. One time on a scheduled flight from Chicago to Houston, four people were booked, and nobody showed up. We had to make the flight anyway so that the plane could make the return trip.”
It wasn’t uncommon to make the 2,400-mile trek from Los Angeles to Honolulu with a dozen passengers. White recalls a trip from San Diego to Baltimore with one passenger aboard, a physician going to the Washington, D.C., area to treat COVID patients. “We had to keep flying to take passengers like that doctor, plus we were carrying medical supplies,” he says. The atmospherics were like something out of a disaster movie. “In the spring, you’d walk through Chicago Midway, one of Southwest’s busiest hubs, and see 15 people,” says White. “You’d look out the window when arriving at one of our maintenance airports like Dallas and see dozens of planes parked in the maintenance hangars.” Flying over the Victorville Airport in California’s Mojave Desert, passengers would spy a sea of Southwest heavy metal ribboned in red, yellow, and blue.
Kelly took the idle planes off the tarmac and back to work, laying the groundwork for a fast ascent once the crisis lifted.
Going for growth in the worst downturn ever
For the previous half-decade prior to COVID, Southwest, which had been a domestic-only carrier, made a major shift by focusing its growth almost exclusively on vacation locales in the Caribbean and Latin America, adding flights to 20 destinations such as Cancún, Mexico; San José, Costa Rica; and Nassau in the Bahamas. In 2019, Southwest went to a new playbook: The goal was to first finish the last legs of the “over-the-water network” by adding Honolulu and gateways to four other Hawaiian airports from the West Coast. Then Kelly planned to launch a long-term offensive in the U.S. by flying to new places.
The airline assembled a list of 50 domestic airports where it wanted to start service. At the time, it planned only one addition, Houston Intercontinental, for early 2021, as part of the fanfare for Southwest’s 50th anniversary, since it had flown there in the early days before moving to smaller William P. Hobby Airport. “We came into 2019 with very strong growth opportunities,” says CFO Tammy Romo. “We wanted to make our network more dense, to get more connectivity. We were planning hundreds of aircraft worth of growth.” The blueprint called for around three or four new destinations a year. But it also encompassed a second front, a major push in markets where Southwest was already strong, but could fly far more customers by adding flights. “We had more customers than we could serve in Denver, Austin, Houston, Fort Lauderdale, Nashville, and more cities,” says Kelly. “From 2020 to 2024, we planned on a big, five-year growth run.”
The shockwaves from two of the worst tragedies in airline history left Southwest short of the horses needed for the charge. On March 13, 2019, the FAA grounded the MAX following the Lion Air and Ethiopian Airlines crashes that killed 346 passengers. Southwest was already flying 34 of the MAX and had 26 more on order for the year, meaning that its total fleet for 2019 was almost 10% smaller than expected. Southwest had no extra planes, since it had already retired 67 of its aging Boeing 737-300s to make way for the MAX. And despite losing the MAX aircraft, Southwest honored its commitment to serve Honolulu and the other Hawaiian destinations in 2019 and early 2020, worsening the shortage. “Our growth plans were stymied by losing the MAX,” says Andrew Watterson, Southwest’s chief commercial officer.
But the pandemic opened an unexpected new lane. Kelly reckoned that by deploying planes that would otherwise sit idle, and crews flying a lot less than before, Southwest could generate higher revenue serving new places than the extra cost of those flights, consisting primarily of jet fuel and airport fees. “It was a great way to help us offset big fixed costs that are impossible to cut,” says Kelly. Adds Watterson: “We were looking for ways to keep people busy and reduce cash burn.”
Plus, as competitors retreated, the top budget carrier had a chance to gain footholds in congested airports that it might never see again. Kelly perceived that Southwest’s strategy dovetailed with the market’s trend as the pandemic lifted. Dominating the wish list of 50 destinations were smaller, beach-or-mountain vacation venues. It was business travel that suffered most by far in the crisis, and it was clear to Kelly, as well as other industry leaders, that a rush of vacationers would lead the rebound, while it would take years for the business crowd to return in their old numbers.
Hence, Kelly predicted that for their size, those leisure destinations would generate far more new passengers than the business as a whole. Though most of the markets were small, Kelly figured that adding a lot of them fast would enable Southwest to expand more rapidly than under the original plan, where it would move slowly and deliberately by adding a couple of new airports a year. Starting in mid-November, Southwest introduced service to Colorado’s Steamboat Springs, Telluride, and Colorado Springs; California’s Fresno, Santa Barbara, and Palm Springs; Florida’s Sarasota/Bradenton and Destin/Fort Walton Beach; and Savannah/Hilton Head, as well as eight other first-time destinations. In these prime vacation markets, the goal is to lure totally new customers. “When we’re looking for leisure customers, the best places are those smaller locales,” says Watterson. “Southwest coming to town is a big deal in those markets. You get a lot more news coverage and buzz in places like Fresno and Colorado Springs than going to major airports.”
The ace was planting the flag in two major destinations, one where Southwest had no hopes of flying, and the other where the journey would have taken years. In Chicago, Southwest had long been the dominant carrier in Midway. But Midway, occupying just over one square mile, was operating at full capacity, preventing Southwest from adding more flights to cities where more of its Windy City customers wanted to go. Prior to the pandemic, giant O’Hare wasn’t even on Southwest’s list. The FAA had effectively frozen the number of landing and takeoff “slots” or times, making it impossible for Southwest to expand there, and challenge United and American, the two carriers that account for almost 80% of its traffic.
But the City of Chicago controlled a number of gates at O’Hare and deemed that if those gates went mainly unused, newcomers could step in. In the past, that didn’t happen because the airport was chockablock with takeoffs and landings. But in the pandemic, the carriers at O’Hare were operating maybe one-third of their regular flights. That pullback allowed Southwest to realize what it had only dreamed of—grabbing gates at the nation’s third-busiest airport. “We thought getting into O’Hare would be impossible,” says Watterson. “We had no plan for starting service there at all.”
Now, Southwest is offering a total of 20 nonstop flights a day to Dallas, Denver, Nashville, Phoenix, and Baltimore/Washingon. Many folks who live near O’Hare on the far north side didn’t take Southwest before because they dreaded making the long drive south to Midway. Now for the first time, they can fly the largest low-cost carrier from nearby O’Hare.
In Miami, Southwest benefited from another breakthrough courtesy of the crisis. It had a thriving hub in Fort Lauderdale, but not a single flight from much larger Miami International to the south. The problem was that the airport charged what amounted to big fees per passenger that were traditionally several times higher than in Fort Lauderdale. Kelly thought Miami was highly attractive but wasn’t rushing to invade. “The difference in fees made it extremely difficult for a low-cost carrier like Southwest,” says Mann. But the airport wanted to incentivize new entrants to help recover its costs. So Miami International is now charging flat monthly fees to carriers that provide high volumes of flights. That change significantly lowers Southwest’s overall costs, shrinking the gap with Fort Lauderdale. Suddenly, that new arrangement has made Miami much more attractive to low-cost competition.
Once again, Kelly leaped in. “Miami’s taking off like a rocket,” he says. Many of the folks flying Southwest are regular customers from such hubs as New York’s LaGuardia and Midway who vacation or do business in Miami, but couldn’t fly there on their favorite carrier and didn’t want to get stuck in traffic driving south on I-95 from Fort Lauderdale. “It turns out that for our customers, that drive is a much bigger hassle than we expected,” says Watterson. “Flying to Miami prevents our customers from Chicago or the Northeast from leaking to other airlines.”
Pre-COVID, Southwest was serving markets that sold a total of $63 billion in tickets a year. Entering the recovery, it will reach airports that do another $13 billion in business, a jump of 20% in what Watterson calls “the pond we can fish in.” The upshot: Kelly predicts that the surge in leisure travelers could by 2022 more than offset the decline in business traffic, lifting Southwest back to 2019 levels well before its big competitors get there.
Keeping the record of no layoffs or pay cuts
Southwest’s not just the sole major to grow its footprint big-time in the pandemic; it’s also the only one not to impose huge layoffs and pay cuts. In fact, it didn’t do either one. By contrast, the global industry lost 400,000 workers, and American alone laid off 32,000. Southwest prides itself on never imposing furloughs or chopping wages. Kelly tells Fortune that the most distressing part of the crisis was the prospect of punishing the workforce. “I echoed what Herb Kelleher said during 9/11,” says Kelly. “I can’t promise we won’t lay people off, but I can promise it’s the last thing we’ll do.”
Still, Southwest was hemorrhaging so much cash, for so long, that it came darn close to breaking that hallowed tradition, just as the half-century mark approached. “You can’t take care of people without taking care of the company,” says Kelly. “But I wanted to do everything I could to keep people in place and the blood flowing, so that we’d be staffed to zoom out into the recovery and create more jobs.” Kelly’s first move was to hammer nonlabor costs. He curbed such capital expenditures as tech investments and airport expansions. As flights dwindled, “variable” costs for the likes of fuel, oil, and landing fees dropped sharply. “A lot of operating expenses flow from customer volumes,” he notes. Overall, Southwest axed outlays of $8 billion in what Kelly calls “cold, hard cash.” That drive lowered combined operating expenses and capex by 40% versus 2019.
But airlines are capital on wings. Southwest had to keep paying for its fleet of 750 Boeing 737s, flocks of which were parked at maintenance hubs such as Victorville. Of course, its biggest single cost by far is wages, salaries, and benefits, accounting in 2019 for 43% of operating costs, and for Southwest to survive, that huge nut had to shrink drastically. The objective was to secure large reductions through voluntary programs that kept the largest possible number of workers officially employed, and poised to return in the upswing. In April 2020, Southwest introduced three options for flight attendants, pilots, maintenance workers, salaried employees, and all other groups. The first was called voluntary separation, or VSP. The early-retirement packages included cash buyouts plus generous health and travel benefits. The second: extended time off, or ETO, in which employees could elect to stop working for six, 12, or 18 months at half-pay. The third program allowed workers to take time off in short spurts, a few hours or a day, a week, or a month at a time, also at half-pay.
One-third of Southwest’s 60,000 employees chose one of the programs. The departures totaled 4,500. Another 4,000 to 5,000 chose to work on flexible schedules, and 14,500 opted for extended time off, often to supervise their schooled-at-home kids. Salaried employees switched roles. “One hundred people in personnel went to other jobs across the company, such as keeping maintenance records,” says Jordan. Still, it was clear by October that the crisis was dragging on so long that the aid Southwest had received from the CARES Act Payroll Support Program wasn’t adequate to prevent layoffs and pay cuts—unless Washington stepped up with more rounds of assistance. In one of his 71 online broadcasts to employees during the crisis, Kelly on Oct. 15 declared, “The Payroll Support program allowed us to operate without pay cuts or furloughs through Sept. 30, but it didn’t go far enough or long enough…Now it’s time to do what must be done to save Southwest.”
Even after the voluntary programs took effect, Southwest was still far overstaffed. Kelly’s contingency planned called for a 10% across-the-board pay reduction for nonunion staff, chiefly office workers, sans layoffs. For “contract,” or union workers, the airline directed each group to reduce its 2019 costs by 10% in 2021. But they could reach that goal through a variety of routes, by imposing layoffs, reducing pay, or hiking productivity, or a blend of all three. The union contracts required that Southwest provide advance notice of the cuts to come if the flight attendants, pilots, and other groups failed to present a plan to reach that 10% target. “About 1,500 of the 17,000 flight attendants got those ‘furlough’ letters late last year, and I was flying with some of them,” says White. “They’d never seen that from Southwest before.” If the unions didn’t come through, the workforce would shrink by 6,000, or over 10%.
But in December, Kelly reached an agreement with the Treasury for additional aid. The lifeline saved Southwest from imposing the first layoffs and pay reductions in its history, six months before the 50-year mark. Today, nine in 10 of the employees who went on leave have returned to full-time work. Kelly views a full workforce that’s ready to go and grow as essential to capitalizing on its move into those 17 new markets, soon to increase to 18 with the addition of Syracuse. “The beauty of the time-off program is the ability to ramp up quickly,” says Jordan.
Building a fleet for a fast takeoff
Now Southwest is backing its growth plans with the most ambitious aircraft expansion program of any major. Dominating its current fleet is the aging Boeing 737-700, averaging 12 years in the skies. Boeing also has over 200 of the larger 737-800s, which are far younger and have years of service ahead. It plans to replace the fast-retiring 700s with two MAX models: the MAX 8 at 175 seats, and the smaller MAX 7 that boards 143. The MAXs burn 14% less jet fuel, and are 40% quieter, than their Boeing predecessors. In March, Southwest made the biggest new purchase since the MAX returned to service, raising its firm orders by 100 planes, and on June 7 it cited the faster-than-expected rebound to add another 34 MAX aircraft to its book. As part of those two deals, it secured an additional 187 options on MAX aircraft. So in the first half of 2021, Southwest bet big on growth by almost doubling its roster of firm orders plus options on the MAX 7 and MAX 8 to 660 jets.
If Southwest exercises all options—a strong possibility if its growth opportunities match Kelly’s expectations—it could operate a fleet of almost 1,100 planes in 10 years, an increase in capacity of 50%. Kelly’s template for expanding Southwest’s reach in large part grew out of the crisis. Yet he always returns to the human factor, the view that the assets the carrier most prizes are its people. In his Oct. 15 warning on looming sacrifice, Kelly intoned, “We all realize Southwest is a cause. When our employees look back 50 years from now, they will say, ‘Those people saved Southwest, they saved Southwest’s jobs, that was Southwest’s finest hour.’” Kelly’s a showman like his hero Kelleher. But behind the Churchillian fervor is a solid plan to do once again what Southwest has always accomplished coming out of a crisis—to soar while rivals are still revving on the tarmac.
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