The Initial Costs of Southwest’s Meltdown

Edward Russell

January 9th, 2023 at 12:05 AM EST

Southwest Airlines faces a $725-825 million hit to its pre-tax income in the fourth quarter from its operational meltdown during the year-end holiday season.

The Dallas-based carrier disclosed the initial hit last week. In addition to the top line reduction, which will push its fourth quarter net result into the red, Southwest estimated it lost $400-425 million in revenue as a result of the event where it cancelled roughly 16,700 flights over the Christmas and New Year holidays.

The December quarter hit was higher than most Wall Street analysts estimated. Bank of America analyst Andrew Didora wrote last week that the disruptions could cost the airline between $600-700 million in lost revenue and higher costs in the fourth quarter. And Raymond James analyst Savanthi Syth put the lost revenue from the operational distress at an up to 9 point reduction in the quarter, or by as much as $515 million based on Southwest’s revenue outlook in December.

“Our desire is to go above and beyond,” Southwest CEO Bob Jordan said on December 30, regarding how the airline plans to make travelers whole. That would include, he added, refunding tickets and covering disrupted travelers’ rental cars, hotel rooms, meals, and tickets booked on other airlines.

The full cost of all of that — the refunds, rental cars, flights, hotels, plus all the expenses incurred in Southwest’s own business, like repositioning crews and planes — will play out over several quarters. Southwest is expected to offer additional details on its 2022 earnings call on January 26.

In addition to promising to reimburse any added expenses travelers incurred during the disruption, Southwest has also offered those affected vouchers and points to get them to return. For example, every traveler has been offered 25,000 Rapid Rewards points, which the airline said is equal to at least $300.

“We are going to be putting Southwest Airlines under a microscope in terms of their delivering these kinds of reimbursements and refunds to passengers,” U.S. Secretary of Transportation Pete Buttigieg said on the Today show on December 30.

Buttigieg, in a video posted on December 29, also said that where Southwest does not refund and reimburse travelers where it is obligated to, the Department of Transportation would “penalize Southwest, as we would any airline, to the tune of potentially tens-of-thousands of dollars per violation.”

DOT penalties are rarely material for large airlines. In 2022, the agency assessed over $8 million in total penalties, which it touted in November as “the largest amount ever issued in a single year.” Southwest, for perspective, made $6.2 billion in revenue in the third quarter of 2022 alone.

And, finally, there is the lingering fallout among consumers from the meltdown. Many are likely to harbor some ill-will towards Southwest for some time to come. Syth at Raymond James expects a hit a roughly 2 point unit revenue hit to Southwest in the first quarter as travelers book elsewhere, and that the situation will moderate in the second quarter.

Southwest “will recover,” wrote Marty St. George, the commercial chief at Latam Airlines Group and a former long-time JetBlue Airways executive that worked at the airline during its own operational disaster in 2007, tweeted on December 28. “It will mean a lot of work, a lot of IT, and a lot of soul searching but [Southwest] will recover.”

Edward Russell

Southwest’s Meltdown a Technology Warning for Airlines

The primary reason for the operational meltdown at Southwest of the holidays was its outdated optimization technology, which the airline has outgrown over the past couple of decades. Company executives have admitted to prioritizing other things over investing in technology for operations, despite warnings from staff and some close calls previously. Paired with a staff shortage, the issue became too much for Southwest’s system to handle.

“This one clearly pushed it over the cliff,” said Robert Mann, airline industry veteran and president of aviation consultancy R.W. Mann & Co. “While they’re working this problem out, they’ve got to be absolutely certain that this never happens again.”

But whether this can happen again is a legitimate question for the entire airline industry. Being behind technologically is a common criticism experts make of the aviation industry.

Southwest’s disaster over the holidays should serve as a reminder for other carriers to take stock of their operations to ensure nothing like this happens again, and when it comes to looking where to cut costs, leave the technology alone.

Now the question is what Southwest will do next. There is always a backlog of updates that need to happen in the airline industry, but they get pushed aside in a system where safety and regulatory issues are paramount. It appears that was the case for Southwest — to the extreme. 

Unions said they had been warning Southwest of tech inadequacies for years and that the problem could have been avoided if the company would have invested in its own operations. Southwest had invested in some new technology, mostly customer-facing applications like self-service capabilities, as outlined in a public filing in early 2022. The filing also said the company had deferred a “significant number of technology projects” during the pandemic, though it did finish the “long-awaited milestone” of establishing a single system for all aircraft maintenance and record-keeping.

Jordan told employees in a memo obtained by CNN that the airline has a lack of tools, and there has been talk internally about the need to modernize further. 

The main piece of failing tech was the airline optimization software called SkySolver, which is supposed to assign crew to flights using a complicated mathematical system. Southwest has grown beyond the capabilities of that old technology, which it began using when it was much smaller. On top of that, the airline flight crew has no front-end technology to input its whereabouts into that system, meaning the crew has to call a crew scheduler on the phone to share that information.  

The shortcomings of that system and its inability to catch up with the problem snowballed into the mass cancellation, which was needed to allow the system to reset. 

“As good as these companies are, as good as their brand halos seem to be, they all have warts that maybe people don’t see every day, but boy, they become pretty clear when you have a problem that involves them,” Mann said.

Hand-in-hand with the tech issues, Southwest had a lack of workers that led to the CEO declaring a company state of operational emergency in Denver just before Christmas. The airline has relied on employee overtime to staff operations. And the union representing ground workers at Southwest said many of the employees had worked up to 18-hour days during the holiday season, and some experienced frostbite. 

The company sent a memo to its Denver ramp agents on December 21 threatening their jobs if they did not comply with the operational emergency rules.

“Looking particularly at that memo to the Denver staff, I think that’s illustrative of a serious cultural failure,” Mann said. During a time when the entire industry is facing a worker shortage, he believes that approach was counteractive. 

“This should have been done the way many other carriers did it, particularly after last summer. A lot of them decided to use a carrot, not a stick. They would be able to offer incentives for peak demand,” Mann said. “They don’t actually pay very much on those incentives, but at the end of the day, they get people to volunteer for work on their vacation days. The result is you take the stress level right out of the airline, and you get better results.”

An immediate solution to keep a backlog from occurring would be to put a front end on the optimization system so employees don’t have to use the phone to update their whereabouts. Long term, the company would need to either build or contract an optimization system that it can grow into over its next phase of development, not one that it will outgrow again. 

It would likely take months to implement such a system. 

“We’ve already taken immediate actions to mitigate the risk of this ever happening again, and the review work will inform additional actions and investment as well,” CEO Jordan said on January 5. “We’ve asked our unions to participate in this review effort as well.”

Southwest will also need a plan to have more staff on hand. In response to a question about employee attraction and retention, an airline spokesperson said: “We’re proud to be an employer of choice and hired more than 17,000 new employees in 2022 with more hiring planned in 2023.”

The Department of Transportation, as well as Democrats in both the House and Senate, have already they will investigate Southwest’s holiday meltdown.

Justin Dawes

In Other News

  • Ryanair, citing “stronger than expected peak” holiday demand, now expects a roughly €200 million ($212 million) net profit in the December quarter. With the adjustment, the discounter forecasts a profit of €1.33-1.43 billion in the fiscal year ending in March, an at least €125 million increase. Ryanair group CEO Michael O’Leary had previously spoken cautiously on the outlook due to the concerns of an unexpected Covid surge, similar to what the industry saw over the 2022 year-end holiday season.
  • Gol has outlined its first guidance for the 2023 calendar year. The Brazilian carrier expects revenues to increase 32 percent year-over-year, and an operating margin of roughly 14 percent. Unit costs excluding fuel are forecast to decrease by nearly 3 percent on 20-25 percent more capacity. And average fuel expenses are forecast to decrease by roughly 9 percent to 5.3 Brazilian reais ($0.97) per liter. Gol plans to fly roughly 120 aircraft during the year — up from 102 at the end of 2022 — including ending 2023 with 53 new Boeing 737 Maxes.
  • Hawaiian Airlines added two additional Boeing 787s to its existing order, bringing the total to 12. Hawaiian is acquiring the -9 version of the Dreamliner. The airline, however, won’t start taking deliveries until the final quarter of this year. It was supposed to get its first plane last quarter. The deferral likely reflects Hawaiian’s preference to give some more time for Asian markets to recover.
  • The new $2.7 billion Terminal A at Newark Liberty International Airport will open its doors to travelers on January 12. Air Canada, American Airlines, JetBlue, and United Airlines will initially operate from the terminal with Delta Air Lines joining them later this year. The old Terminal A, which opened in 1973, will be demolished. The opening of the facility was planned for December 8, however, it was delayed over concerns of possible teething issues affecting operations during the peak year-end holiday travel season.
  • In people moves, Etihad Airways has named Arik De, who joined the airline from TAP Air Portugal in April 2022, as its new chief revenue officer. De is the first revenue chief at Etihad.

Edward Russell

Edward Russell

January 9th, 2023 at 12:05 AM EST