Southwest Airlines’ Business Model Gamble

Southwest Airlines recently reported their first net loss since Q3 2009. Southwest claimed the losses were primarily due to fuel hedge issues. However, I believe there may be a larger issue at play. While most other airlines have increased net revenue by nickel and diming their customers, Southwest has done the opposite. Last year, US airlines collected $3.4 billion in bag fees and a further $2.3 billion in ticket change fees. At the same time, Southwest Airlines attempted to endear itself to travelers by allowing them to check in up to two bags free with each ticket purchased. You have to commend Southwest for going against the crowd on this one.

The real issue here is whether the forfeiture of hundreds of millions of dollars in bag fees pays off in increased ticket sales. In 2010, Southwest carried 88 million passengers. Let’s assume that half of them would begrudgingly pay a $20 bag fee. Over a five year period, this equates to $4.4 billion in pure profit to Southwest if half of their passengers checked in one bag.

Southwest makes approximately $6.25 in profit per passenger trip. Therefore, in order for Southwest to justify no charging bag fees, they must sell over 140 million additional tickets each year. Do you think this is happening? I am not convinced that US travelers are giving Southwest as much credit for free bags as Southwest thinks.

Ryanair is one of the fastest growing airlines in the world. Ryanair recently removed all but one restroom from their flights and charges fliers $1.50 to use it. They are also debating installing standing room seating, and charging customers $47 to print a boarding pass at the airport. Ryanair is charging customers for everything imaginable but it is still growing; how can we reconcile the Ryanair business model with Southwest's business model? It’s simple: passengers only look at the ticket price and don’t consider add-ons when shopping around for a plane ticket. In my mind, Southwest is fighting basic buyer psychology, no matter how silly that psychology may be.

I predict that Southwest Airlines’ business model will eventually shift to the nickel-and-dime model used by the rest of the industry. Passengers can complain all day long about fees, but until they vote with their wallet, the Ryanair business model will rule the sky.

Do you agree? What changes do you see in airline pricing models?