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Southwest Airlines Abandons Small Markets

For most of its history, Southwest Airlines (NYSE: LUV  ) has been an aggressive growth company. It terrorized legacy carriers like Delta Air Lines (NYSE: DAL  ) and United Continental (NYSE: UAL  ) by constantly pushing further into their turf.

With lower costs and friendly service, Southwest had a lot going for it. However, today Southwest faces tougher competition. As a result, it's looking to retrench to boost its earnings. Southwest's management has stated on multiple occasions that it will hold capacity roughly flat in 2014 in order to focus on completing the integration of its AirTran subsidiary.

As part of that plan, the company recently announced that it will pull out of three smaller markets: Jackson, Miss., Branson Mo., and Key West, Fla. This will free up capacity for more promising markets with plenty of passenger traffic, like New York.

The changing economics of air travel
In recent years, Southwest Airlines has expanded its route network significantly. Some of this growth has come organically through its entry into major markets like New York, Boston, Denver, and Minneapolis-St. Paul, which Southwest had historically avoided. More recently, Southwest bulked up through its acquisition of AirTran Airways, which gave it access to a variety of new cities.

However, the economics of flying to smaller cities has changed in recent years. With higher fuel prices, it's important to keep airplanes full (without discounting tickets too much). As recently as 2007, Southwest's full-year load factor -- the percentage of seats sold -- was just 72.6%; for the past two years its load factor has risen to over 80%.

In order to match capacity to demand, legacy carriers such as United and Delta hire regional airlines to fly small planes between smaller airports and their hubs. By contrast, Southwest only flies mainline aircraft: in fact, it's in the midst of phasing out all of its aircraft with fewer than 143 seats. Southwest's low-cost operating model is therefore hard to implement in small markets.

Focus on efficiency
The three cities Southwest is leaving are some of the smallest in its network. In Branson, it offers just three daily departures; in Jackson, it has four daily departures; and it operates three daily departures in Key West.

It's not very efficient for airlines to operate in cities where they have very few flights. At any airport where it operates, Southwest needs ticket agents, baggage handlers, and gate agents, as well as gate space and check-in counters.

In other words, there's a certain minimum of cost involved in setting up in a new city. For Southwest Airlines, operating three to four daily flights to a particular city means that it's not getting the most it can from its investment. Southwest will benefit by redeploying capacity from these smaller cities to large markets where it can operate more efficiently and thereby mount a stronger challenge to the legacy carriers.

In fact, on the same day that Southwest announced these service cuts, it also announced that it had acquired six new slot pairs from American Airlines at New York's LaGuardia Airport. (These slots were sold as part of American's merger with US Airways.) At LaGuardia, Southwest will now operate 33 daily departures, more than enough to efficiently utilize its fixed costs on the ground.

Foolish bottom line
Just a few years ago, Southwest Airlines was the clear king of the U.S. airline industry. Today, Delta Air Lines has already surpassed it in terms of profitability; American and United are hoping to catch up soon. In order to regain its leadership position, Southwest needs to be even more ruthless about keeping costs down by utilizing assets efficiently.

As a result, Southwest is pulling out of some of its smallest markets in order to double down on larger, more promising opportunities. For travelers headed to or from smaller markets, the loss of service on Southwest could lead to higher ticket prices. However, fliers in the biggest metro areas will be the beneficiaries, as continued growth by Southwest will help offset the impact of consolidation, keeping ticket prices in check.

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Read/Post Comments (5) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 09, 2013, at 6:56 PM, Tyeward wrote:

    Getting sort of expensive huh? LOL

    Might want to think about pooling those assets into a localized area and build an actual hub station and grow it organically. Might not be best to try it on turf already claimed, however you have plenty of abandoned hub cities that are within striking range of major cities where the airline could do some serious damage in the region. St. Louis is one that would be a good idea, and PIT is another one, that would be a really good idea (pending if they would be willing to lower landing fees to make it more attractive). Southwest has over 500 aircraft, so they can pull off a really major hub and still have way more than enough to cover it´s traditional network.

  • Report this Comment On December 10, 2013, at 11:38 AM, TMFGemHunter wrote:

    A true hub doesn't really make sense within Southwest's business model. Generally speaking, Southwest wants to maximize local traffic rather than driving lots of connecting traffic.

    It costs more to move a passenger from point A to point B on two flight segments as opposed to a nonstop. Yet passengers are generally willing to pay more for the nonstop. Hubs exist out of necessity, to gather traffic for small cities and long-haul international flights: two markets Southwest doesn't participate in.

    BTW, Southwest already has almost 100 daily departures in St. Louis, which makes it one of the bigger stations in its route network. PIT is also underserved, so there definitely could be a growth opportunity there.


  • Report this Comment On December 10, 2013, at 12:34 PM, joepalmetto wrote:

    Let me ENLIGHTEN you all as to what is going on with Southwest's SIMPLE: GARY KELLY is looking to BANKRUPT this airline (or make it look so) so that he can then go to a federal bankruptcy court and END all employee collective bargaining agreements. That's all. He is DESTROYING the family that Herb and Colleen built! Southwest no longer has employees or "internal costumers" We are just NUMBERS!

  • Report this Comment On December 11, 2013, at 9:09 PM, TMFGemHunter wrote:

    @joepalmetto: I think you're going a bit overboard. The fact of the matter is that all of Southwest's top competitors have reduced their costs in bankruptcy court within the last 10 years. The competition is a lot tougher today than it was under Herb and Colleen. All things considered, I think Southwest treats its employees pretty well.


  • Report this Comment On December 16, 2013, at 2:32 AM, Beanfarmer wrote:

    It may treat its employee well, but certainly not the small market customers. A few years ago, SWA cut the flights in JAN from eight to four. A great set-up to be able to claim too few flights to cover the overhead and drop the market. I was a stockholder and passenger during the bad times; looks like now I will be neither.

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