In a brutally competitive business, Southwest Airlines' Herb Kelleher has built a continuously profitable $1.2-billion company that inspires uncanny loyalty in customers and employees alike. How?
"This is the one guy in a troubled and extremely difficult industry who has done something that has worked for a long period of time now" -- Don Burr
Wreathed in a gauzy haze of cigarette smoke, Herb Kelleher paces his office like the trial lawyer he used to be. He recounts his airline's stormy advent, telling how the company finally got off the ground in 1971, flying four planes in varying states of emptiness between three Texas cities. Four years earlier, in 1967, when Kelleher had cofounded Southwest Airlines Co. and first applied for certification to fly, Braniff, Texas International, and, to a lesser extent, Continental had jumped all over the upstart, dragging it into court and claiming to any judge who would listen that the Texas market couldn't possibly support another carrier.
Three years of bitter legal skirmishes followed, culminating in Kelleher's pursuing the case all the way to the U.S. Supreme Court. By then Kelleher, Southwest's corporate counsel, was getting heat from cash-drained investors to throw in the towel, and he'd resorted to providing his legal services pro bono to the fight. "Braniff and Texas International would later be indicted for trying to chase our investors out of the underwriting syndicates and boycotting our vendors," he says, disbelief rising in his voice. "I felt enraged by this. You know, anger can be a great motivator. For me, this became a cause. I was a crusader freeing Jerusalem from the Saracens."
Kelleher, a serious chain-smoker, throws himself into an overstuffed chair and fishes through a pack of smokes on the glass-topped coffee table before him. He is so enveloped in his recounting of Southwest's fiery baptism that he places the cigarette in his mouth backward and readies to light the filter before being warned off.* * *
To understand the essence of Southwest Airlines, you must first know that Herb Kelleher is a man of extreme tenacity and depthless energy. He sleeps four hours a night; he reads two or three books a week. The rest of the time, when he isn't lighting cigarettes, he is inhaling naphtha fumes and loving the high. "We tell our people all the time, 'You have to be ready for change.' In fact, sometimes only in change is there security," says Kelleher, leaning forward in his chair.
Kelleher is a keen student of military history. He likens his early fight against much larger rivals to the ruinous trench warfare of World War I, an over-the-top frontal assault by massed forces against Southwest, withstood only by dint of Kelleher's will. In the aftermath, Kelleher moved his troops up into the hills, where he could husband his strength and in the future engage the enemy on his terms, not theirs.
That Southwest has done, having methodically expanded its franchise from its fragile Texas base to now include 124 planes flying between 34 mostly midsize airports, mainly in the Sunbelt and the Midwest. That "hit 'em where they ain't" strategy has yielded results. In 27 of those airports, Southwest is the leading carrier in passenger boardings. "We deliberately formulated a policy of geographical distribution -- a corporate trust fund, you could say -- by diversifying our assets," says Kelleher, now propping a foot up on the coffee table before him. "Now you can't fight us like you would a war in Europe. This is more like a war in the Pacific. You have to take us pillbox by pillbox, palm tree by palm tree."
Structurally, Southwest is unique among major American airlines. Its competitors have built centralized empires -- most of which are now distended and in danger of collapse. Wedded to the "hub-and-spoke" system, those carriers fly huge planes between major airports and link them with a galaxy of "feeder" flights from lesser sites. On paper, the hub-and-spoke concept makes sense, but in practice it ties up too many valuable assets at a handful of pressure points in the system.
Southwest's layout is more akin to a spiderweb, spun one strand at a time, flexible enough to disperse assets and dissipate stress. In airline jargon, Southwest is a "short-haul, point-to-point" carrier. It has no recognizable hub. It flies short distances nonstop, the average flight being 55 minutes. Southwest flights do not make connections with others, do not transfer baggage, do not serve meals, do not offer assigned seats. Southwest does not subscribe to expensive computerized reservation systems. It does relatively little business through travel agents because the margins on its fares are too thin. But by eschewing such services, the airline offers passengers rewards of more lasting value: frequent, reliable service and rock-bottom fares.
"People always want higher-quality service at a lower price, provided by people who enjoy what they do," says Kelleher, summing up Southwest's reason for being. The results have been astonishing. Since the U.S. airline industry was first deregulated, in 1978, 169 airlines have failed, merged, or died before their first flight ever left the tarmac. Southwest, meanwhile, has been profitable in each of the past 18 years. In 1990 it was the only major U.S. carrier to show a net profit based solely on operations -- while offering the lowest fares in the industry. Southwest's overall costs are the lowest of any major carrier (defined as one that brings in more than $1 billion in revenues), yet its work force is among the industry's best paid.
Southwest's ability to produce those kinds of numbers seems the stuff of smoke and mirrors. It springs, however, from two essential sources: the Southwest culture as embodied and promulgated by Kelleher, and a coherent business strategy to which the airline has religiously clung.* * *
Esprit de Corps
Herb Kelleher, the industry maverick, inspires deep loyalty at even the lowest ranks in a $1.2-billion company that now employs 9,500 people. That loyalty arises from employees' keen awareness of the quixotic dimensions of Kelleher's early struggle to get Southwest off the ground and see it survive. That struggle long ago became part of Southwest lore.
Employees' loyalty, in turn, is nurtured by their knowledge of who Herb Kelleher is. He studied philosophy and literature at Wesleyan and graduated at the top of his law-school class at New York University. Gary Barron, Southwest's chief operations officer and formerly one of Kelleher's legal partners, calls him "the smartest, quickest lawyer -- not to mention the best judge of people" he's ever seen. Yet Kelleher, for all his credentialed brilliance, is just plain "Herb" to his workers. Jim Wimberly, Southwest's head of ground operations, says Kelleher has "a knack for really being with you, even if you're one person in a crowd of 1,000." Wimberly likens the gift to that of a master politician -- minus the insincerity.
Wimberly pauses a moment to turn down the rock and roll blaring from a radio nearby, before putting his feet back up on his desk and addressing another facet of Kelleher's persona that is central to keeping the Southwest magic alive. "Herb has a nice, light perspective on life. I'm like that, too. We both like Wild Turkey, and we smoke a little too much."
Kelleher, 60 years young, is best known perhaps for his amply articulated antic side. He has appeared at company bashes as Elvis Presley and Roy Orbison, doing barely credible renditions of "Jailhouse Rock" and "Pretty Woman." One Halloween night he turned up at Southwest's hangar in drag, as Corporal Klinger from "M*A*S*H," to thank mechanics for working overtime.
Jeff Sullivan, director of corporate development and training, says Southwest's ethos is founded on the idea that "people don't want to be managed, they want to be led." That, in turn, implies a bias for management example, not executive fiat.
One day each quarter Kelleher hits the front lines to sling bags, work the ticket counter, or serve drinks at 25,000 feet. It appears to be more than blue-collar slumming by the boss. Last year, when the Gulf Crisis hit and the price of jet fuel spiked, ground employees at Southwest's Dallas operation spontaneously -- and without Kelleher's knowledge -- started a payroll-deduction program to defray fuel costs. Dubbed "Fuel from the Heart," it soon gathered steam and raised $130,000 -- still a token sum, given the airline's energy bill, yet a strongly symbolic one. And voluntary payroll deductions to aid fellow employees with terminal illnesses and their families are routine at Southwest.
The airline's Dallas headquarters eschews corporate art in favor of hundreds of framed photos of employees (usually snapped at company parties), print ads, and mannequins sporting the various uniforms Southwest personnel have worn through the years. That mine of memorabilia -- much of it whimsical -- is arrayed so that if you walk from one side of the building to the other, you pass through Southwest's 20-year history. The feeling is of being in the den of your neighbor's house, with a generation's worth of family photos staring back at you from the pine paneling.
Southwest's work force is an anomaly. It is about 90% unionized, but it owns 11% of the company -- the highest percentage by far of any major airline. The age of the average employee (34) is among the industry's lowest; yet in average pay ($42,000 per employee), the company ranks among the very highest. In an industry noted for its fractious labor relations, Southwest and its workers make peace. Because employees know they have a large stake in the efficient operation of the company, Southwest and its unions are able to write labor contracts devoid of overly restrictive language. Most of the time, Southwest uses one gate agent, not the standard three, to board an aircraft. Typically, ground crews of six, half the industry average, service the plane -- and are responsible for Southwest's vaunted 15-minute "turn," while the planes of other major airlines typically spend an hour at the gate.
In 1990, 62,000 people applied for jobs at Southwest, where annual turnover, 7%, is the industry's lowest. The airline hired 1,400. Southwest assiduously looks for extroverted people who understand that the company's mission is to work hard and have fun, and who feel that by joining Southwest they're becoming part of an extended family, not a $1-billion corporation.
The circle of family widens to include customers. Each month Southwest invites its most frequent fliers to come in and interview prospective employees. "We hire people who match our customers in personality," says head of sales and marketing Don Valentine. "That reinforces the culture."
Adds Jeff Sullivan: "Our customers are as protective of our niche as we are. If we do something they don't like, we hear from them." The airline receives 5,000 letters a month from customers, and they are all read and answered by the staff. (Kelleher usually reads a couple hundred a week. A lot of the letters come from first-time Southwest fliers who want to know when the airline is coming to their city.) At smaller airports, Southwest flights can occasionally be delayed by customers chewing the fat with Southwest personnel they have come to know. Recalls Jim Wimberly, "I was in Lubbock the other day, standing at the gate with our station manager there, and I'll bet half the people getting on that flight said, 'Hi, Ernie.' "* * *
That seamless, well-defined culture enables Kelleher to run his airline guerrilla-style. The mission at Southwest is straightforward: Keep it cheap, keep it simple, focus your energy. "We search out markets that are overpriced and underserved," says chief operations officer Gary Barron. Those tend to be smaller cities where the airport is closer to downtown and is less congested. Southwest can get its planes in and out faster. Its passengers can reach their final destinations faster.
Barron labels the airline "opportunistic." And fleet of foot. Within five days of deciding to serve Little Rock, Southwest had set up operations there and with two gates garnered 25% of the market almost immediately. In early 1991 USAir retrenched in California. Southwest quickly filled the void and took over USAir's abandoned gates in Sacramento. "The city had been after us for two years to come," says Kelleher. In the second quarter of 1991 Southwest carried 20% of all passengers between Sacramento and L.A.'s Ontario airport. It carried 39% of the traffic between Sacramento and Burbank. Those figures are none too shabby when you consider that Southwest started flying out of Sacramento just three weeks before the quarter ended.
Through the early and mid-'80s Southwest had waited patiently for gates at California airports to open up. In the meantime, airfares grew increasingly more gilded in the Golden State. By the time Southwest could attack key California routes, a one-way ticket between the Bay Area and the Los Angeles Basin varied from $79 to $220 -- with all but a handful at the upper end of the range. Southwest's seats went for between $29 and $59. The airline now carries 15.6% of all intrastate travelers -- and would carry a lot more if it flew between San Francisco and Los Angeles. Instead, it flies between less crowded Oakland and Burbank, which, according to Department of Transportation figures, was the 200th-busiest air route in the United States at the end of 1989. Southwest started flying that route on April 16, 1990. By the end of 1990 it had become the 21st-busiest route.
"We're not competing with other carriers," says sales-and-marketing director Valentine. "We want to pull people out of backyards and automobiles, and get them off the bus." Wherever Southwest goes, three things quickly happen: fares come down, traffic usually triples, and the airline rouses a rabid following. Last year 34 cities formally petitioned Southwest to set up operations at their airports. Kelleher didn't let the flattery turn his head and unleash an air armada. In 1991 Southwest went into just one new city, Sacramento, and only after USAir had pulled back.
Kelleher, flamboyant though he may be, is an innately cautious businessman. When Southwest decides to open a route, it does so only after careful consideration. And then it moves with considerable force.
The airline immediately attacks with many flights, to provide timely, frequent service. "That gives the customer a lot of options and spreads our fixed costs over more seats," explains Barron. With Southwest, a passenger can simply go to the airport, buy a cheap ticket, and get on the next flight out, which he or she knows is often not more than an hour away. Each day Southwest flies 78 times between Dallas and Houston, 46 times between Phoenix and Los Angeles, 34 times between Las Vegas and Phoenix. At Southwest the average number of flights per gate each day is 10.5. The industry average is less than half of that -- 4.5.
Such a high level of frequency yields what Barron calls "critical mass." Customers come to see Southwest, suddenly omnipresent (and so affordable), as the airline of choice. Under the pressure, competitors wilt. Two casualties, recently gone bankrupt, are America West and Midway, which sustained mortal wounds when Southwest attacked them at their very hubs, Phoenix's Sky Harbor International Airport and Chicago's Midway Airport, respectively.
Southwest's low fares and high frequency might make it appear as though the airline were dumping airline seats on the market. It isn't; it makes money on a route from day one. On a typical day, its planes are in the air 11 hours a day, versus an industry average of 8 hours. That comparison is particularly noteworthy given that Southwest's flights are the shortest of any major carrier. With such a high utilization of its costliest assets -- planes -- the airline need only achieve a load factor (that is, the number of paying passengers per total number of seats) of 55% to break even.
In 1990 Southwest's cost per available-seat-mile -- a major industry yardstick -- was the industry's lowest, 6.5¢. (American's was 9¢, USAir's 15¢.) Again, that number takes on greater importance when you consider that because Southwest planes are taking off and landing more often than those of other airlines, the rate of fuel consumption is higher and the number of landing fees it must pay is greater.
How, then, does Southwest do it? First, its short-haul, frequent point-to-point flights lend themselves to reliable, no-frills service. Second, Southwest flies three versions of only one type of aircraft, the Boeing 737. That standardization of service and product yields savings in everything from fuel costs, to training flight crews, to the stocking of spare parts. (Southwest's fleet is also the youngest, most fuel-efficient pure jet fleet in the country.) Third, says Barron, "Our employees bust their butts out there."
"When that plane hits the ground, there are 40 to 50 things that have to happen in 15 minutes," says Jim Wimberly. "It's almost like a ballet." Flexibility, responsiveness, and initiative typify the Southwest culture -- and reinforce its strategy. Wimberly offers this example: Say a nearly full, "buttoned-up" plane is pulling away from the ramp when three faithful frequent fliers run up at the last moment. Should the plane turn back? "Well, our policy is, we have no policy. It's up to the person there on the ground," says Wimberly. "Everything we do is like the old Moody Blues song, 'It's a Question of Balance.' "
At most Southwest ticket counters, there are now boxy, nondescript automatic ticket machines that will take a credit card and dispense a ticket in just 20 seconds. These marvels were not produced by IBM, working under a two-year, multimillion-dollar contract. Southwest employees built them in their spare time, using off-the-shelf computer parts. "The machine was thought up by a bunch of our guys in a bar one night in Denver," says Audy Donelson, Southwest's station manager at Dallas's Love Field. A similar bootstrap effort is now under way to build PCs at corporate headquarters. Worker motivation at Southwest has its counterpart in a strong management focus. "The hardest thing in business is to stay true to your niche," says Don Valentine, who says the airline is committed to its short-haul, point-to-point strategy -- unlike its foundering competitors. "Their focus is global. Ours is the neighborhood."
"We don't get greedy," says Barron, echoing Valentine. The industry, he notes, is littered with wrecks of companies that did just fine shuttling between Dayton and Detroit, but when that came to seem mighty unglamorous, they put out fleets of 747s heading for London and Honolulu. "Suddenly, they were competing with big people who knew what they were doing," says Barron. "They got their brains beat out." Southwest just wants the neighborhood. It'll take Lubbock to Little Rock any old time.
And all Kelleher wants to do is increase the number of Southwest's seats by 15% each year -- and zealously watch his costs. The rest should then fall into place.* * *
To say the airline industry is one that is constantly in flux is an understatement. Half the U.S. fleet flies under a cloud of bankruptcy, scrambling for advantage -- and survival. High debt and the specter of soaring energy costs loom persistently over the business like twin swords of Damocles.
Kelleher -- whose airline makes 1,200 flights a day -- isn't daunted. In fact, he warms to this state of affairs. "You become used to a life of quick change. This is an operating business. There's nothing passive about it when your principal assets are moving at 540 miles an hour."
In fact, Kelleher roundly fears the absence of change, the lulling sense of calm that overtakes "successful" companies. "Our job is to never lose focus on keeping our costs low and to never suffer an excess of hubris so we take on too much debt." He adds a factual postscript to that abstract thought. In 1989 Southwest enjoyed a record second quarter. Kelleher immediately circulated a cost-cutting memo, warning that a recession was nigh. "When you think you've got it all figured out, then you're probably already heading downhill."* * *
($ in thousands)
Year ending 12/31/90 12/31/89 12/31/88
Employees 8,620 7,760 6,467
Net sales $1,186,759 $1,015,052 $860,434
Pretax income $74,753 $110,982 $85,360
Total assets $1,471,138 $1,415,096 $1,308,389
Net owners' equity $604,851 $587,316 $567,375