Southwest Airlines' strategy for growth is in the bag: Southwest says no-luggage-fee policy is paying off in new customers

Nov 08, 2009 (Chicago Tribune - McClatchy-Tribune Information Services via COMTEX) -- LUV | Quote | Chart | News | PowerRating -- Southwest Airlines is landing new customers with its "bags fly free" strategy, even as passenger volume declines at other airlines.

The carrier's no-fee ad blitz persuaded Jen Benzer and her brother and sister, Aaron and Robin Hazelwood, to fly Southwest.

They arrived at Chicago's Midway Airport on Thursday from Dallas with six large suitcases, including an empty one they planned to fill with Chicago Bears merchandise.

"It would have cost $300 to check all these bags (on another carrier)," said Benzer, 31.

Southwest is the lone U.S. carrier to buck the trend of introducing fees to make up for ticket prices that have fallen to historic lows, and some analysts and investors remain skeptical of that contrarian course charted by Southwest CEO Gary Kelly.

For them, the $500 million question is whether the Dallas-based discounter can attract a sufficient number of passengers to offset the money it is forgoing as other airlines roll out charges for everything from luggage to access to shorter security lines.

Southwest would gain $450 million to $500 million per year if it charged for the first and second checked bags, estimated AirlineForecasts LLC, a Virginia-based market research firm.

"There's no way Southwest is going to pick up enough traffic to compensate for the amount of revenue that the other airlines are garnering because of the baggage fees," said Robert Herbst, a commercial airline pilot and founder of AirlineFinancials.com.

Yet Southwest is confident its strategy is paying off. It believes about 2 percent to 3 percent of its customers are defectors from other carriers because of fees, said Kevin Krone, the carrier's vice president of marketing, sales and distribution.

"When you step back and look at the whole picture," Krone said, "to me it shows we're winning here, and winning new customers. To us, that's much more profitable than charging an existing customer to bring along their luggage."

Vaughn Cordle, a former airline pilot who is managing director and chief analyst at AirlineForecasts, calls Southwest's moves "a smart strategy." The discounter is gaining market share, even as it reduces its overall flying, by exploiting a competitive weakness at other airlines: the perception they are out to "nickel and dime" passengers with fees for services that were once part of the base airfare.

For Southwest, the bags-fly-free campaign caps a long history of moving aggressively during industry turmoil. This decade the discounter has emerged as the nation's largest domestic carrier by one measure, carrying about 20 percent of people who fly within the U.S. each year. Delta Air Lines, the world's largest carrier, still holds a slight lead over Southwest in domestic capacity measured by available seat miles, according to AirlineForecasts.

Taking advantage of fuel hedges, light debt and high employee-productivity rates that kept its costs low, Southwest added planes and kept prices low. That pressure forced other airlines to also reduce pricing, to outsource domestic flying and shift resources to more lucrative international routes where low-cost carriers have little or no presence.

Since 1999, Southwest's domestic market share has increased by 48 percent, while the five network carriers have seen their combined passenger base shrink 20 percent. This year, Southwest will fly about 28 million more people than it did in 1999, while its rivals will haul a total of 62 million fewer passengers.

"It's indicative of Southwest winning the war of attrition in the domestic marketplace," Cordle said.

Still, Southwest has lost some of its luster. This year it reported quarterly losses for the first time in its history, reduced flying and saw its fuel hedges become a drag on earnings. Analysts ridiculed Southwest's latest scheme to win market share when consumers initially were slow to respond.

But that changed over the summer, as Southwest blanketed the airwaves with commercials pointing out that checking two bags could add $100 to the cost of flying on other airlines.

The airline, which advertises far more heavily than any other U.S. carrier, boosted its ad spending by 20 percent, to $112.6 million, during the first six months of 2009 as it hammered home the "bags fly free" message, according to The Nielsen Co.

"This is a complex thought: That you have to pay for your bags," Krone said. It didn't resonate with leisure travelers until they took their annual, or semi-annual, vacation and encountered luggage fees for the first time, he said.

"I think we're really starting to really build up a lot of momentum. People are now really searching out an alternative," Krone said.

Southwest's passenger traffic increased by about 5 percent during the third quarter versus 2008 totals, even as it reduced flying by 6 percent.

Passenger volumes headed in the opposite direction for Southwest's five largest competitors: Delta, American, United, Continental and US Airways, all which introduced or increased fees over the past year.

Revenue passenger miles, a common traffic measure, declined by 6 percent during the third quarter for the five network carriers, combined, according to AirlineForecasts.

Representatives for the five legacy carriers say that neither their new charges nor Southwest's contrarian strategy have appreciably changed passengers' purchasing decisions.

Instead, they say a host of other factors also affected traffic: Southwest also gained passengers with a midsummer fare sale, while traffic declines at the network carriers could also reflect the fact that they have made far deeper cuts to flight operations than Southwest did in response to the economic downturn.

"We are not seeing any shift in market share from one to another as a result of our decision on fees versus Southwest," said Greg Kaldahl, vice president for resource planning at United Airlines.

United's internal data show that customers tend to rate their experience on United more highly than their peers if they purchase one of the new services, including charges for roomier seats and fees for access to check-in and security lines reserved for elite frequent fliers, Kaldahl said.

Customers of Texas-based American Airlines, meanwhile, are checking less luggage: one bag per customer, on average. That is down from the 1.1 to 1.2 checked bags that American saw before implementing its luggage fees last year, said American spokesman Tim Smith.

"The bottom line: The implementation of service charges for services customers choose to use has gone well and is generally accepted," he added.

Tribune reporter Julie Wernau contributed to this report. jjohnsson@tribune.com

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