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A chat with Herb Kelleher: Why Southwest Airlines succeeds

In the International Herald Tribune May 24, 2008 Joe Nocera (“A chat with Herb Kelleher”) reports on the annual meetings of two major airline meetings in America. “The Dallas-Fort Worth area is home to two of the country’s biggest airlines, American and Southwest, and for years, they’ve both held their annual meetings on the same day. This year was no exception: Wednesday was the big day.

“The American meeting started first, at 8 a.m. An hour before it began, members of the Association of Professional Flight Attendants and the Allied Pilots Association, which is in the midst of brutal contract negotiations with the company, began picketing. Shareholders were handed anti-management packets as they walked in.”

Gerard J. Arpey, the chief executive of AMR, American’s parent company told shareholders the industry could not continue in its current state. It would cut out money-losing routes and lay off workers. And begin charging fees to check baggage. By the end of the day, AMR’s stock dropped 24 percent.”

Nocera reported a totally different situation at the Southwest Airlines meeting which began a few hours later. “Southwest, of course, is the great success story of the airline business ” the only company that has been consistently profitable through these tumultuous times, even as many competitors have filed for bankruptcy or gone out of business. In 2007, it earned $645 million. It maintains a healthy balance sheet and has plenty of cash. Its annual meetings tend to be love fests.” This year, co-founder, 77 year old Herbert D. Kelleher was stepping down as chairman after 37 years. “So many shareholders showed up that the company had to set up an overflow room to accommodate the crowd. When Kelleher entered the main meeting room, shareholders gave him the kind of standing ovation usually reserved for rock stars.”

The pilots union, also in the process of negotiating a new contract with management, did not set up a picket line; they took out a full page ad in USA Today thanking Kelleher for all he had done. “..when [Kelleher] brought up the pilots ad” and when he talked about how much the company’s employees meant to him” he wept. “I’m Lucky Herbie for having all of these years with all of you,” he said. More than a few people in the audience wept right along with him.”

“Over the years, whenever reporters would ask him the secret to Southwest’s success, Kelleher had a stock response. “You have to treat your employees like customers,” he told Fortune in 2001. “When you treat them right, then they will treat your outside customers right. That has been a powerful competitive weapon for us.” As he stepped away from the company this week, his line didn’t change. “We’ve never had layoffs,” he told me the day before the annual meeting, sitting on the couch of the single messiest executive office I’ve ever seen. “We could have made more money if we furloughed people. But we don’t do that. And we honor them constantly. Our people know that if they are sick, we will take care of them. If there are occasions or grief or joy, we will be there with them. They know that we value them as people, not just cogs in a machine.”

“Several analysts I spoke to marveled at Southwest’s remarkable fuel hedges, which have saved it hundreds of millions of dollars in fuel costs” and have probably been the single most important reason the company has remained profitable. For most airlines, fuel today constitutes 40 percent of their costs, up from 10 percent just a few years ago. But not Southwest. Kelleher told me that right now, 70 percent of the company’s fuel is hedged at $51 a barrel” “which ain’t bad when oil is $126.” “I also wound up thinking that Kelleher had the good fortune to build this airline during the great bull market of the 1980s and 1990s. Though the company was tiny during its first decade, it grew rapidly during the 1980s, and its stock became a powerhouse. Much of that stock was in the hands of employees, because Kelleher believed in handing out stock options liberally. The rising share price relieved a lot of pressure when bargaining time came ’round. It meant the unions weren’t scrapping for every penny either.

“And yet, when you look at a company like American, with its poisonous employee relations and its glum customer base, and compare it with Southwest, with its happy employees and contented customers, you can’t help thinking that Kelleher’s was on to something when he put employees first.” Gary Kelly was named chief executive in 2004 and, “on Wednesday, he became chairman as well. It was Kelly who made the big fuel hedge bet, and it will be Kelly who will decide how to best take advantage of Southwest’s rivals’ pain.” Nocera asks, “Can that [concern about staff by Kelleher and the executive] really be the reason Southwest is still making money while its competitors are bleeding red ink? Can it really be that simple? Actually, that depends on whom you ask.”

Robert Crandall, former chief executive of American Airlines, attributed Southwest’s success to the fact that it was allowed to operate out of Love Field in the heart of Dallas, instead of having to move to Dallas-Fort Worth International Airport, a half an hour away, like all the other airlines. On the other hand, Robert W. Mann Jr., the president of airline consulting firm R.W. Mann & Co observed Southwest had refused to stray from its core mission of combining low fares with first-rate customer service. “Southwest ” always knew who their customers were: They were people who had to make the choice to either fly or drive.”

Nocera also reported Gordon Bethune, the former chief executive of Continental Airlines, and an old friend of Kelleher’s, “There isn’t any customer satisfaction without employee satisfaction. He recognized that good employee relations would affect the bottom line. He knew that having employees who wanted to do a good job would drive revenue and lower costs.”

Nocera concluded, “Even as Southwest’s salaries climbed to parity with the legacy airlines” indeed, one reason the unions loved Kelleher so much is that he never believed in holding out for every penny during labor negotiations” the company still kept its ticket prices low because its employee productivity was so much higher than its competitors. Its pilots spent more time flying and less time on the ground. Southwest could turn around an airplane in 20 minutes. Its short hauls were more fuel-efficient than most big airlines’ long hauls. One reason the old-line carriers are in trouble and Southwest is that they just can’t operate as efficiently as Southwest.”

Why does it seem to take so long for these lessons to be learned by executives in so many different enterprises including directors and boards of museums? Why are we still driving for efficiencies, restructuring, being as competitive as possible? It isn’t as if it is paying dividends!