Last week, Southwest Airlines (NYSE:LUV) finally began selling tickets for flights to Hawaii, more than 16 months after it first announced its intention to enter the Hawaii market. With introductory fares as low as $49 one way briefly available for flights from Oakland and San Jose to Hawaii, the launch of ticket sales elicited a huge response from customers.
Hawaii is an extremely popular tourist destination, and Southwest Airlines has a huge customer base in the continental U.S. -- and especially in California. That makes Hawaii flights look like a natural expansion opportunity for the low-fare airline giant.
Nevertheless, there's no guarantee that Hawaii will be a lucrative market for Southwest Airlines. Here are three potential pitfalls that could cause the carrier to struggle in this big market.
Check out the latest earnings call transcript for Southwest Airlines.
Does Southwest have enough amenities for six-hour flights?
One potential issue is that Southwest Airlines' business model is built around shorter flights. It's a roughly 2,500-mile trip from California to Hawaii, whereas the average Southwest flight today is less than 1,000 miles. The airline does operate a handful of transcontinental routes that are comparable in distance to California-Hawaii flights, but they are few and far between.
One disadvantage for Southwest Airlines is that customers have to bring their own food along. Hawaiian Holdings (NASDAQ:HA) still offers complimentary meals for customers in coach, and other airlines have buy-onboard options. By contrast, Southwest's planes have small galleys, so the carrier will only offer a "snack bag" on its Hawaii flights. Many travelers may want at least the option of a hot meal for what can be a six-hour flight.
In addition, while Southwest boasts that its planes have a generous 32 inches of pitch (legroom) at each seat, that's still not much if you're tall. Rivals offer both extra-legroom economy seats -- which typically have at least 34 inches of pitch, and frequently more -- and first-class sections. For Hawaiian Airlines, these upgraded seating options represent more than 30% of its West Coast-Hawaii capacity.
Southwest Airlines' egalitarian, single-class service works well for its current route network. By contrast, some business travelers who frequently fly Southwest's short-haul flights in the U.S. for convenience may prefer to splurge on an airline that offers meals and more comfortable seating options when traveling to Hawaii.
Companion pass redemptions could prove costly
Too little demand, especially among travelers who are less price-sensitive, is thus one risk facing Southwest Airlines' Hawaii service. But too much demand could also be problematic.
Hawaii is a popular option for travelers looking to redeem frequent flyer miles. That has led some analysts to worry that Southwest's flights to Hawaii could carry too many customers flying for free with award tickets. This concern is overblown, though -- Southwest Airlines gets lots of revenue from selling Rapid Rewards points to partners, and it doesn't really matter to the carrier whether they get cashed in for flights to Hawaii or flights elsewhere in its network.
However, Southwest Airlines also offers a big perk to its best customers: a companion pass. The companion pass can be earned by taking 100 one-way flights in a year or earning 110,000 points in a year. It allows the holder to bring a single named companion -- like a spouse, relative, or friend -- along for free on any flight.
This perk just became even more valuable. But if companion pass holders end up accounting for a significant proportion of traffic on Southwest's Hawaii flights, the carrier could find itself giving away a huge number of free companion fares. That would be extremely costly, especially during peak travel periods, when demand and fares are at their highest levels.
The market could be too competitive
A third potential pitfall is that while there may be plenty of demand for travel between the West Coast and Hawaii, heavy competition could prevent Southwest from being profitable in this market. Indeed, Hawaiian Airlines, Alaska Air, and the three legacy carriers all provide ample service to Hawaii already, keeping fares low except during the busiest parts of the year.
Southwest's low cost structure isn't a guarantee of success. Other airlines get a substantial amount of revenue from extra-legroom seats and first-class tickets. Rivals also charge for bags, change fees, and (increasingly) seat assignments, providing ancillary revenue streams that Southwest Airlines doesn't have. Lastly, the legacy carriers can earn big profits from travelers connecting from small cities, where there is less competition.
The net result is that Southwest Airlines will probably have a higher breakeven base fare than some (or all) of its rivals. Between free checked bags, no change fees, and friendly service, there are a lot of reasons Southwest might deserve a fare premium -- but that doesn't mean it will materialize.
Southwest Airlines has had success in most of the markets it has entered. But it has occasionally been forced out of big markets where its business model just wasn't competitive -- most recently, Mexico City. It's possible that Hawaii will also fall into that category.
Time will tell
Southwest's management sees Hawaii as a big opportunity, and the carrier almost certainly plans to give its new Hawaii routes several years to mature before considering any major changes.
The most likely outcome is that Southwest Airlines will carve out a nice niche for itself in Hawaii. Nevertheless, investors should recognize that Hawaii is quite different from any of the markets Southwest serves today. There's a real possibility that flying to Hawaii will become a drag on the carrier's profitability, leading it to eventually cut back its flight schedule dramatically -- or even exit the market entirely.