Southwest stays optimistic

The Baltimore Sun

Amid the airline industry's stomach-churning plunge, Gary Kelly, chief executive of Southwest Airlines Co., already is plotting a course for the next upswing in air travel.

While United and American airlines park planes, retreat from cities and lay off employees, Southwest, the No. 1 carrier at Baltimore-Washington Thurgood Marshall International Airport, is flying high. Seeking to capitalize on his competitors' weakness, Kelly is buying dozens of jets to accommodate higher passenger loads and planning the budget carrier's first overseas expansion. He wants to steer the Dallas-based carrier into Canada, Mexico, Hawaii and the Caribbean, and eventually Europe and Asia, via marketing alliances. The foray would be Southwest's first outside the United States in its 37-year history.

Kelly, 53, has an enormous advantage over his peers: about $2 billion that Southwest will gain this year from complex financial hedges he put in place to offset rising fuel costs. As oil prices hit the stratosphere, Southwest's bounty continues to grow, while airlines without similar hedges buckle under the financial strain.

The pressure is on Kelly not to blow it. And the responsibility is his alone now that Herb Kelleher, the chain-smoking iconoclast who molded Southwest over nearly four decades, retired as chairman of its board in May.

"He's got to evolve the airline much more rapidly than Herb ever had to because of the changing market, changing costs and changing fuel prices," said Capt. Carl Kuwitzky, head of Southwest's pilots union.

Kelly, a lanky Texan, is measured and deliberate, while Kelleher is outspoken and impulsive, say people who know the two men. But he shares Kelleher's ability to connect with employees and to make the most of a competitive edge.

Among longtime colleagues, Kelly is known for his practical jokes and guitar mania, sometimes cranking out "Smoke on the Water" at company parties. He participates in Southwest's elaborate Halloween festivities, the annual pinnacle of a freewheeling culture that makes its employees the most productive in the industry. Kelly's get-up last year: Edna Turnblad, the John Travolta character in the movie Hairspray, complete with shaved legs and women's shoes.

Kelly is also a fierce competitor. In his first months as CEO in 2004, Kelly engineered a deal to take over troubled ATA Airlines' gates at Chicago's Midway Airport, establishing Southwest's dominance there. In January 2006 he got Southwest flights into Denver International Airport, which is a hub for United and Frontier airlines.

As American, United and other carriers pare flight schedules because of rising fuel costs and a slowing economy, Kelly's team is looking for openings to strategically grab market share. One day after United said it planned to stop flying to Fort Lauderdale in late June, Southwest added five daily flights to the Florida vacation spot.

"They're the nightmare of every airline out there," travel expert Tom Parsons said.

Kelly sees the steps by competitors to reduce fleets by 10 percent to 15 percent as a futile exercise that will fail to give them pricing power to offset soaring fuel bills.

"It's not radical enough," he said.

He's part of the reason. Southwest's low fares, subsidized by its fuel hedges, make it difficult for rivals to boost prices, analysts said.

"That $2 billion allows [Southwest] to keep fares lower than they otherwise would," said Vaughn Cordle, CEO and chief analyst of AirlineForecasts LLC, a Virginia-based market research firm. "That's a strategic decision that forces other airlines to match fares and lose significant amounts of money, or retreat. So Southwest wins the war of attrition."

The strategy isn't winning Kelly new friends among his peers. A senior executive at a major airline, who asked not to be named, described Southwest as a "significant destructive force in the industry."

If other carriers falter, Southwest will scout cautiously for acquisitions. Kelly said he is open to a wholesale purchase of another airline, although he thinks the probability of it happening is low.

"Would we be open to buying a handful of airplanes from a competitor, along with some gates? Well, yes. I think that's much less risk, much more appropriate to think about," he said.

For the first time in its history, Southwest is preparing to venture outside the U.S., to Canada, via a code-sharing agreement with WestJet, a Canadian carrier modeled after Southwest.

Next up: Mexico, the Caribbean and Hawaii, not necessarily in that order, through code-sharing pacts to be rolled out next year and possibly into 2010. After that, Kelly will look for alliances that take Southwest passengers to Europe and Asia. Southwest also will explore its own shorter-haul international flights.

Kelly is trying to alter a business model that Southwest has operated to near perfection, turning an annual profit every year since its third year in business, without destroying it. The discounter once known for its zany promotions is now the largest domestic carrier, looking for ways to boost sales and to connect with customers disillusioned with other airlines.

Kelly joined the company in 1986 and was named chief financial officer three years later, at age 34. He convinced the carrier's board to begin buying fuel hedges on the eve of the first Persian Gulf War in 1991, then to adopt costlier but more comprehensive hedges as oil prices plunged at that decade's end.

Julie Johnsson writes for the Chicago Tribune.

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