With air travel demand remaining depressed relative to pre-pandemic levels, Southwest Airlines (LUV 1.73%) has made route map expansion a core recovery strategy. Rather than trying to deploy more capacity in existing markets where demand won't fully recover for a while, the low-fare airline giant is entering new markets to put more of its aircraft and crews to work.
During 2020, Southwest announced plans to begin serving 12 new destinations. It isn't done yet. In recent weeks, the carrier has added five more airports to its route map. This ongoing route map expansion is becoming a meaningful threat for Southwest's biggest rivals: American Airlines (AAL 4.07%), Delta Air Lines (DAL 3.71%), and United Airlines (UAL 3.63%).
Trying out a variety of new markets
In expanding its route map, Southwest has mainly focused on leisure-friendly destinations. Its first new additions included popular ski areas (Montrose and Telluride in Colorado) as well as warm-weather destinations (Miami; Sarasota, Florida; and Palm Springs).
However, Southwest has cast a wide net as it looks to grow its route network and isn't limiting itself to leisure destinations. For example, it launched service at Chicago's business-centric O'Hare International Airport last month. Similarly, it will add flights to Houston's Bush Intercontinental Airport next month. The airline will also resume service to Jackson, Mississippi in June.
New destinations keep coming
Southwest Airlines has continued to find a broad range of expansion opportunities in 2021. Late last month, the carrier announced that it would launch service to two new leisure destinations in May: Bozeman, Montana and Destin/Fort Walton Beach on Florida's Gulf Coast.
This Monday, the airline added three more cities to its expansion plans. It plans to launch service to Myrtle Beach, South Carolina next quarter, followed by Eugene, Oregon in the third quarter and Bellingham, Washington in the fourth quarter.
Myrtle Beach is a classic leisure destination. By contrast, Eugene -- home to the University of Oregon -- is more of a business market, if anything. Finally, Bellingham sits just south of the Canadian border, and its airport has historically attracted leisure travelers from Vancouver looking to avoid higher fares on transborder flights from Canada to the U.S.
A threat to network airlines
Since the pandemic began a year ago, Southwest Airlines has entered or announced plans to launch service to 17 new airports. Over time, this expansion could put pressure on profitability at American Airlines, Delta Air Lines, and United Airlines.
The threat from Southwest's entry into big hubs like Miami, Chicago O'Hare, and Houston Intercontinental is obvious. (The former two are American Airlines hubs; the latter two are United Airlines hubs.) However, its move into smaller leisure destinations and business markets could be even more significant in the long run.
Network carriers like American, Delta, and United earn their highest margins in small and midsize cities where they face little or no competition from low-fare airlines. Most of the smaller markets Southwest is entering have limited low-fare service today, typically from ultra-low cost carriers like Allegiant Travel.
Ultra-low cost carriers can provide some price discipline where they compete with network carriers on point-to-point routes. However, their appeal is generally limited to the most price-sensitive travelers. Furthermore, they offer few if any connecting opportunities beyond the small-city routes they serve nonstop, limiting their impact on network carriers' results in these markets.
By contrast, Southwest Airlines is a more serious competitor for higher-fare traffic. And while it isn't a hub-and-spoke carrier, it operates more than 250 daily departures from its biggest focus cities: Denver and Chicago's Midway Airport. That means it can typically offer efficient connections to each of its new destinations from dozens of cities across its route network.
Thanks to its low costs, Southwest should be able to earn strong margins in most of its new small and midsize destinations even as it undercuts American, Delta, and United on price. Thus, its new routes are likely to become nice contributors to the airline's profitability once they mature. Conversely, facing major low-cost competition in a slew of new city-pair markets will cut into the network carriers' profits in smaller cities.
The good news for American, Delta, and United is that their route networks are optimized to maximize the number of efficient connecting opportunities, whereas Southwest still focuses primarily on point-to-point traffic. For now, the majority of the network carriers' small-city traffic probably remains protected from meaningful competition.
That said, Southwest Airlines may well add frequencies in the smaller markets it is entering -- and it may not be done expanding its route network. As the carrier continues to grow in smaller markets, it could steadily chip away at a huge profit center for its biggest rivals. Thus, airline investors should keep a close eye on Southwest's ongoing small-city expansion.