Southwest Airlines Co. (NYSE: LUV) has grown from a tiny airline with three planes serving three Texas cities in 1971 to one that serves almost 100 destinations across the U.S., flying 4,000 flights a day.
The company's low-cost business model has been an example of consistency, booking 45 consecutive years of profitability through the end of 2017. Even more impressive considering the volatile and economically sensitive airline industry. Southwest has also garnered market share from competitors.
There are many ways to measure market share. One could look at domestic revenue passenger miles, a measure of demand. Southwest Airlines had 18% of the domestic revenue passenger miles market share for July 2017 to June 2018. This falls just behind the market share leader, American Airlines (AAL) with 18.1%. Other larger competitors, Delta Air Lines (DAL) and United Continental (UAL), came in with market shares of 16.8% and 14.9%, respectively.
According to Southwest, its market share based on revenue passengers grew from 18% in 2006 to 24% in 2016. Also, according to its 2017 investor presentation, Southwest is the market share leader in half of the top 50 U.S. metro markets.
The Business Model
First and foremost, Southwest has a low operating cost structure. In fact, management states that unit costs are among the lowest in the industry. These are also referred to as cost per ASM (CASM) or operating expenses per ASM.
After posting a CASM of 12.5 cents in 2014, the airline managed to shrink that to 11.48 cents last year. This allows the company to profit even as it offers low fares to its customers.
The figure is also lower than its major competitors. For instance, operating expense per ASM was 15.15 cents for the first quarter of 2018 for American Airlines. At Delta Airlines, the figure was 15.07 cents for the fourth quarter of 2017. With United, its CASM for 2Q 2018 was 13.08 cents.
Southwest also provides point-to-point service rather than the hub-and-spoke that most major airlines offer. A hub-and-spoke system concentrates an airline's operations in major hub cities and serves other destinations through connecting services. Southwest's services are offered outside of this system, allowing the company to offer more direct nonstop flights. This also allows for low fares, since these airports typically have less air traffic, allowing Southwest to schedule more flights, minimizing downtime and employee productivity.
Southwest is undertaking an effort to modernize its fleet. This includes the Boeing 737 MAX aircraft. Southwest only flies Boeing aircraft, which helps keep maintenance and training costs low. The average age of its fleet is around 12 years, which should help keep the operating unit costs low.
Although lower gas prices will benefit the entire airline industry, it is particularly important for Southwest given its commitment to low fares. The cost per gallon has grown from 80 cents in 2003 (16.5% of operating expenses) to $3.30 in 2012 (37.2%). It was down to $2.09 per gallon as of 4Q 2017, thanks in part to its effective hedging program.
Aside from the cost perspective, Southwest is continuing to integrate its AirTran acquisition from 2011. This allows the company access to other areas such as Atlanta and the Caribbean.