Towards the end of low-cost airlines?

Last June, an event went a little unnoticed and yet it marks an important change in the air transport sector. The activist fund Elliott Investment Management has invested $1.9 billion in Southwest Airlines, which represents a little more than 10% of the capital, with the aim of getting rid of the current management, which in the eyes of the investor is incapable of changing the company’s business model.

This is not insignificant. Southwest Airlines is the creator of the concept and the largest low-cost airline. Founded on June 18, 1971 by Herb Kelleher, who managed it until 2008, the Texan carrier really invented the “low cost” model based on simplicity of operation: a single model of aircraft, a very efficient operation and very low fares offset by the sale of many complementary products or services. And it worked tremendously from 1978, the year in which Jimmy Carter, the President of the United States, signed the “Deregulation Act”, in other words, the freedom of traffic and marketing of air transport within the United States. The system has since been copied in Europe from 1992 and is now expanding to Asia and Latin America.

The economic results were up to the mark, with Southwest Airlines becoming the airline of record in terms of the number of passengers carried and the company’s bottom line. But with the help of history, a drift was taken: the company gradually lost its fundamentals, going so far as to employ 74,800 employees for a turnover of 26 billion dollars, a ratio close to the Air France/KLM group for example, while the latter represents the quintessence of traditional airlines. And the results have been affected, from more than $2 billion in net income between 2015 and 2019 to only $465 million in net income and $224 million in operating income in 2023

Add to this the catastrophic management of the huge operating irregularities of December 2023, admittedly due to catastrophic weather on American territory, which has greatly deteriorated the company’s image. It was also subject to an official investigation by the DOT (Department of Transport) which resulted in a fine of 140 million dollars for having mishandled passenger compensation claims.

The story of Southwest Airlines is representative of the forward march of air travel. Initiator of the only major evolution of this sector of activity with the creation of the “low cost” concept, it has gradually been led to bring its model closer to that of traditional carriers. Because the latter, after a moment of stupefaction in the face of this unprecedented competition, have put themselves in a position to regain control by putting such low fares on the market, even if they only concern a very small number of seats, and by adopting a price model based on one-way trips and not return trips as was previously practiced,  while keeping a minimum of services that ensure a certain difference compared to the pure “low cost” concept.

We can therefore wonder if what is happening to Southwest Airlines with the entry of Elliott Investment Management into its capital and the latter’s demand to change the model, will not be repeated with other companies in Europe or Asia or even in Latin America. Why should not the same causes produce the same effects? Is there a real difference on short/medium-haul flights between the services and fares of traditional carriers and those of “low costs”?

Since the end of Covid, we have seen a move upmarket in the product of traditional airlines and at the same time a clear rise in fares, without customers having deserted flights. Basically, we see the incumbent carriers regaining strength and regaining new prosperity by bringing back to them a clientele that they had lost to their new competitors. They still have one last step to take, to take over the commission of travel agents, who are indeed the essential partners to keep rates at a reasonable level.

The models that had converged are starting to separate. Traditional companies have taken the turn and are strengthening their product even if there is still a lot to do. The “low costs” must also renew themselves if they want to maintain the enviable position they have conquered. This is undoubtedly the meaning of Elliott Investment Management’s message. Customers are now asking for something other than basic transport. Who will meet their expectations?