In late December of 2022, an “extratropical cyclone” introduced all method of menacing winter situations to two-thirds of the U.S., together with your complete Jap Seaboard and elements of Canada. Wind-chill warnings, whiteouts, and extraordinary snowfall sophisticated journey for hundreds of thousands.
Flight cancellations from what was unofficially dubbed Winter Storm Elliott had been inevitable, creating chaos at most airways for a day. However for Southwest Airways and its outdated crew-scheduling software program, the insanity dragged on for over 72 hours because the service canceled greater than 16,000 flights. An undisclosed variety of folks had been pressured to sleep in airports or improvise highway journeys with strangers to salvage their holidays. The meltdown was so dangerous that Southwest was pilloried by Saturday Evening Dwell.
The corporate ultimately received again to enterprise as regular, till this yr, when a barrage of assaults from one other Elliott—this one an activist hedge fund—led to a high-profile reckoning and main management shakeup.
The battle alarmed Southwest’s loyal flyers, who’re legion. Over 50 years, the Texas-based firm has constructed a cult-favorite model on a mix of economy-class-only flights, free bag checks and flight modifications, and sometimes self-deprecating humor. Flight attendants are recognized for bookending their security process bulletins with comedy bits and dad jokes.
However some traders say Southwest’s foundational practices haven’t aged properly as trade working prices have risen. For the reason that pandemic, Southwest has lagged rivals in monetary efficiency, and its share worth is down 50% in comparison with 2021.
Seeing a turnaround alternative, Elliott Administration, an activist hedge fund with an 11% stake within the $18 billion airline, launched an aggressive marketing campaign earlier this yr to push out CEO Bob Jordan, in addition to chairman and former CEO Gary Kelly, and exchange half of Southwest’s board. Elliott asserted that the corporate’s management is simply too entrenched within the airline’s current working and pricing mannequin to make modifications to spice up income. “Southwest’s rigid commitment to a decades-old approach has inhibited its ability to compete in the modern airline industry,” the hedge fund stated in its opening salvo.
The 2 sides reached an settlement this week, averting a proxy battle. Southwest agreed to tackle six new board members, 5 of whom had been Elliott nominees, together with former CEOs from Virgin America and WestJet. The board additionally added former Chevron CFO Pierre Breber. Kelly, who had led Southwest for 18 years, will now retire sooner than beforehand deliberate as a part of the truce. However Jordan, a 30-year firm veteran who turned CEO in 2022, will maintain on to his job.
Southwest Airways and Elliott Administration declined to remark.
Not way back, such activist drama at Southwest would have been unthinkable. The airline’s outstanding development story from startup to a top-four U.S. airline—together with American Airways, Delta Air Traces, and United Airways—made it a business-school case-study favourite. And earlier than the pandemic, Southwest was worthwhile for 47 straight years. No different home or international airline can declare the identical profitability streak. In actual fact, all three of Southwest’s essential U.S. rivals have gone bankrupt not less than as soon as prior to now half-century.
However the identical distinctive traits that made Southwest soar—its egalitarian seating and anti-fee stance—have paradoxically weighed it down, says Donald Sull, an MIT Sloan Faculty of Administration professor of enterprise observe and writer of Revival of the Fittest: Why Good Firms Go Unhealthy and How Nice Managers Can Remake Them.
Sull, who has adopted Southwest’s story for years, tells Fortune that the airline’s present disaster is harking back to corporations like Blockbuster and Compaq. Briefly, Southwest has been responding to modifications within the enterprise panorama by doubling down on its current technique.
“Business history is littered with the corpses of companies that have fallen prey to active inertia,” he provides.
No frills and few charges
Herbert Kelleher cofounded Southwest greater than 50 years in the past as an area, low-cost airline serving Texan cities. Because the airline grew, it took a radically totally different method to air journey than its rivals. Along with making a no-frills, few-fees expertise, Southwest adopted a point-to-point routing system, permitting passengers to fly between cities with out transferring, slightly than the hub-and-spoke mannequin, which requires fliers to cease over in one other metropolis. Southwest additionally used just one sort of airplane, a Boeing 737, to standardize operations. And most famously, the startup embraced an open seating plan and, till 2007, a first-come, first serve coverage.
Over time, Kelleher turned often known as a lot for his enterprise prowess as his humorousness. In a 1994 profile, Fortune known as him “the airline industry’s jokemeister, the High Priest of Ha-Ha, a man who has appeared in public dressed as Elvis and the Easter Bunny, who has carved an antic public persona out of his affection for cigarettes, bourbon, and bawdy stories.” However he was revered as a strategist too. After Kelleher died in 2019, administration guru Roger Martin paid tribute to the founder, writing that he was one of some who understood that “the only path to distinctive results is with distinctive choices.”
On the time, these decisions had been working for many years. There was little deviation, except for a tweak to its seating coverage following elevated safety necessities after 9/11. And 2015 to 2019 was a very heady time for the U.S. airline trade on the whole, characterised by sturdy demand and profitability, Nicolas Owens, airline analyst at analysis agency Morningstar, tells Fortune. Low oil costs had been the important thing tailwinds on the time, Owens argues, since airways are inclined to move on gas prices to passengers when oil is pricey, and chop ticket costs when gas prices drop.
However the pandemic and momentary airplane groundings introduced an abrupt halt to this era. “COVID comes along and totally disrupts the industry,” says Owens. “Planes aren’t flying, people aren’t flying, etc etera.”
The pandemic briefly despatched airline valuations right into a free fall. However one other change got here because the pandemic eased and airways started ramping up once more. Buyer preferences shifted, and extra People selected to fly internationally or revenge-spend on premium providers, whereas taking fewer same-day enterprise journeys between U.S. cities.
The airways weren’t prepared for the surge in demand, Owens explains. Simply discovering pilots was difficult; a lot of those that hadn’t been furloughed had retired. Nonetheless, apart from Southwest, the big U.S. airways had been ready to satisfy the flying public’s new inclinations, having the correct journey networks and merchandise in place to benefit from pent-up demand for Paris getaways or adventures in Tokyo. Earlier than the pandemic, that they had constructed up their capability by means of mergers, and given themselves many levers to tug to reply to {the marketplace}. For instance, that they had three or extra ranges of passenger service to promote, together with airport lounge entry. They may cost passengers for additional leg room or sooner boarding privileges. With their worldwide routes or airline partnerships, they had been ready to serve globe-trotters, vacationers, short-haul enterprise vacationers, and anybody else. “You had really strong financial results in general, where you had airlines reporting record revenue compared to 2019,” even with fewer flights, Owens says.
Southwest’s rivals have additionally been introducing primary financial system seats, reducing into its no-frills technique and “flooding the price-conscious-traveler space with additional seats within their existing networks,” says David Vernon, an analyst with Sanford C. Bernstein. Briefly, main airways have been modern with their fare-segmentation methods in a method that Southwest has not.
“The Elliott criticism that the Southwest experience hasn’t changed much is fair,” he provides.
Because of the shift in client tastes and elevated competitors for price range vacationers, to not point out increased labor and gas prices, Southwest has been struggling within the post-pandemic setting. This yr, Boeing’s personal struggles and its expectation of slower manufacturing additionally impacted the corporate, which was pressured to minimize its capability.
Winter Storm Elliott was additionally a blow, and one that would have been averted had the corporate prioritized an replace of its crew-scheduling system. The software program had no method of robotically reassigning crews to planes following cancellations, and as an alternative required staffers to manually discover and schedule crew members. That was a manageable subject when comparatively few flights had been canceled, however a logistical nightmare when it got here to hundreds. In an inside report, the corporate additionally recognized “insufficient winter infrastructure and equipment in key airport locations” as a root explanation for the disaster.
CEO Jordan apologized for the chaos, saying in a video message that “we know even our deepest apologies—to our customers, to our employees, and to all affected through this disruption—only go so far.” The airline vowed to refund prospects, later spending $600 million to take action.
A cultural blindness
The 2022 meltdown left Southwest with a $140 million tremendous from the Division of Transportation and quickly stained the model. It was additionally a damning signal of Southwest’s cultural insularity, in line with Rob Britton, an adjunct professor at Georgetown College’s McDonough Faculty of Enterprise and a former American Airways govt.
Like Sull, he argues that Southwest leaders created and presided over a tradition that relied too closely on previous success, and didn’t prioritize innovation. To his thoughts, that’s what led to its failure to take a position adequately in know-how. Even in its heyday, the corporate was too happy with its personal methods, for instance rejecting Wall Avenue recommendations that it cost for luggage as different airways have performed for greater than a decade, says Britton. For context, American and United earned $1 billion every in bag charges final yr. (Southwest not too long ago shared buyer analysis displaying the airline would lose $300 million yearly if it charged for luggage, primarily based on the variety of customers who would cease flying Southwest.)
Firms must be continuously reviewing which entrenched practices are working and that are holding them again from even larger development, Britton says. Had Southwest dropped a few of its trademark insurance policies that preserve prices down for patrons, it could have been higher ready to climate rising prices.
To be truthful, says Britton, “the industry tends toward insularity.” Airline leaders are sometimes reluctant to rent leaders from the automotive or consumer-goods classes since they consider that airways are simply too complicated for outsiders to grasp. “Southwest is an extreme version of that insularity,” he continues, pointing to the corporate’s dedication to selling from inside and longtime aversion to establishing alliances with different airways.
However Sull cautions towards portray Southwest executives as conceited, complacent, or not forward-looking. “None of that has to be true for a company to struggle to adapt to changing circumstances when its commitments have hardened,” he says. Executives who’ve seen their distinctive system work and have been respiratory the identical air for years battle to check options.
Making modifications
To flee “active inertia,” in line with Sull’s analysis, corporations do must make drastic modifications, however not essentially by embracing an outsider CEO. As an alternative, they need to look to insider-outside leaders, or executives from the corporate who’ve institutional data but additionally sufficient distance to see the corporate’s predicament. That individual may run a world enterprise, for instance, or a non-core division. Suppose Jack Welch at GE, who ran the corporate’s plastics enterprise earlier than taking up, says Sull.
Vernon, the Bernstein analyst, means that Southwest’s management won’t have been burying their heads within the sand as a lot as “hoping that things would go back to the way they were”—that’s, with extra folks taking low-cost, high-frequency, short-haul flights.
“I think the market changed really quickly,” he says, “and they weren’t sure if the change was permanent.”
That Jordan was spared within the modifications pushed by Elliott didn’t shock analysts. Simply final month, the CEO revealed plans for seats with extra legroom and assigned seats, changes the corporate stated had been within the works earlier than Elliott started agitating for change. Final month, Southwest additionally launched its first airline partnership, linking with Icelandair. The corporate had signaled that it, too, noticed the necessity for change, and had already agreed to Kelly’s departure.
Southwest’s subsequent huge problem is creating a granular understanding of its buyer segments, Owens says. However he cautions that labor prices and different points are nonetheless working their method by means of the extremely aggressive airline trade.
“I don’t think any given airline is really in control of its economic destiny,” he provides.
