TPG exclusive: Southwest CEO Gary Kelly chats about his legacy, new cities and change fees

Editor’s note: This Q&A with Southwest Airlines CEO Gary Kelly was originally published earlier this week. Subscribers to TPG’s new Aviation newsletter got an exclusive first look on Wednesday. Sign up for the newsletter so you can be first to see future interviews that debut in the newsletter.

Like all U.S. carriers, Southwest Airlines finds itself in uncharted territory as it tries to navigate the ongoing coronavirus pandemic.

Travel is down, and business travel has been hit especially hard. That's left airline executives scrambling to adjust.

Southwest CEO Gary Kelly is among those. He talked about his airline's response, new cities and other industry topics during an exclusive Sept. 10 interview with TPG.

He says the scope of the pandemic — and how long it might last — really began to sink in during July.

"I went on a family vacation to the beach the week of Fourth of July. [We] came back, and – as you know by now – the COVID-19 cases had spiked and our business had flat-lined and we were way off of our trend," he said. "That's when I knew … that we have a long, long way to go."

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And there's still no certainty about when the industry can put the pandemic behind it.

"Our feeling is that by the time we get to the end of 2021, things will be at a sustainable rate for us," Kelly said. "But that's predicated on a belief that you'll have a vaccine."

But that hasn't stopped Southwest from making more immediate changes. Three new destinations will be added this year: Miami, Palm Springs, California; and Steamboat Springs, Colorado.

"These additional dots to the map provide even more sources of revenue here at a time when we really need it," Kelly said. "That's our No. 1 challenge. We've cut our expenses. We've got more opportunities there. But the real need is, we’ve got to generate more customers and we’ve got to generate more revenues."

More: Southwest Airlines solidifies its dominance in California, even amid pandemic

Kelly also addressed the move by its "Big 3" rivals to drop change fees and whether that may erode Southwest's advantage of being the "no-fee" airline.

"They can eliminate all their fees and we don't care," he said. "It makes it easier for us.

Kelly had a lot more to say about all of those topics during his chat with me and Edward Russell, TPG's Senior Aviation Business Reporter. Scroll down to see the transcript from the interview. It's been edited for clarity and brevity, though we've opted to keep most of conversation in the transcript.

We had 30 minutes with Kelly, and it went by fast — meaning we didn't get to all of the topics we hoped to cover. But he discussed the questions we did ask at length, providing a lot of context that we think our readers will find interesting. There are three main topic areas below the response to the pandemic, schedules and destinations and change fees.

Enjoy!

More: Southwest Airlines CEO says Miami push part of long-term strategy, not ‘pandemic play’

Q&A: Impact of coronavirus 

Ben Mutzabaugh: With any conversation we have right now, it would be hard to not talk about the effect of coronavirus and COVID on the industry. For a long time, this felt like a “when things get back to normal by June or by July kind of thing.” But it’s become clear that this isn’t a short-term thing. For the airline industry, it not only seems like a long-term event, but a transformational one.

What was the moment that it sank in that this isn't a “back to normal by summer thing,” but rather more of a reset? Was there an event or a moment where that sunk in?

Gary Kelly: Yeah, there was.

You know what, no one has asked me that question, interestingly enough. So I'll tell you the story.

We've been here before, in a sense, with coronavirus. We had SARS and then we had MERS. Since we're mostly domestic, that was a problem that was “over there.” It just never impacted Southwest directly. Even H1N1, I don't remember that being all that much of an issue. It was relatively short-lived.

So to this situation, which burst onto the scene back in January. I was I was worried about it a little bit in February, but I went to a conference of CEOs in late February – Friday, Feb. 21 – and Dr. [Anthony] Fauci was there.

And after talking to various colleagues with international operations and hearing their experience and then hearing Dr. Fauci and his concern about the unusual nature of this human-to-human transmission with this particular coronavirus, I was really worried.

The thing that really struck me at the time is that right is that the market hadn't caught on to this risk. And I'll be darned if it wasn't the next week – so that was Friday, Feb. 21 – If you go back and look, the stock market collapsed the following week. Then, into that week, our bookings were down 25%.

So that’s not really an answer to your question, [but] that was sort of the first shock. And that, just the speed with which the reality came into focus was breathtaking. We mobilized quickly and did all of the things that other companies have done and the things that we needed to do there in March.

On the heels of that you get into late March, early April, and our business was 2% of what it was a year ago at that time. We were virtually shut down. So we were beginning to guess, well, where do things go from here?

And you're right. We thought, well, the cities and the economies will shut down here in March and April. Then we'll assume that things start to improve in May … that things are sort of getting back to normal with a seasonal flavor of this virus by … let's say July, August.

That was our assumption. It wasn't a forecast. It wasn't a prediction. It wasn't anything other than our guess as to what might happen.

In May, in fact, did begin to recover as cities began to open and back up. We had an encouraging Memorial Day weekend. Our business continued to strengthen throughout the month of June … and we more or less drew a straight line on that trajectory between June 1 and the end of this year.

And it was like, “OK guys, as long as we stay on this trajectory, I'm comfortable with the planning assumptions that we're using.” And the planning assumptions are primarily, “how many flights are we going to offer?”

Our goal was – and is – we've got to reach break-even cash flow. We must do that. We have to make sure that the company survives this … without the enormous debt burden.

Now, to finally answer your question: I went on a family vacation to the beach the week of Fourth of July. [We] came back, and – as you know by now – the COVID-19 cases had spiked and our business had flat-lined and we were way off of our trend.

That's when I knew … that we have a long, long way to go.

So it was really two things. The spike in the cases, which was really discouraging. And then the not-unexpected effect on our bookings and our business.

We at least we stabilized through July. In other words, we sort of took a step back, but it didn't continue to fall. As we've gotten into August and September, things have continued to gradually improve week by week.

But that experience taught us a lesson. It's not going to be a straight line up out of this. We all know that we've got to get to a vaccine and crush this pandemic before things begin to trend back towards normal. But that was it. It was the spike in July and the impact on our business.

Mutzabaugh: I have one more immediate question on COVID. If I would have asked you in January – or in late 2019 – what you thought you would be most remembered for regarding your time at Southwest, you could have thought about a number of things. Changes to Rapid Rewards, adding international flights, Hawaii. There are a number of things that you might've answered. But now, do you think now your legacy at the airline will end up being measured on how you steer Southwest during the current crisis?

Kelly: [Laughs] You know, I hadn't really thought about that. But yeah … If your career is long enough, it will encompass a number of different things.

The repeal of the Wright Amendment was another one that I always felt was sort of a highlight for Southwest during my tenure. But, oh yeah, there’s no denying that this is the worst crisis in a century –well, next to World War I and II, I guess.

But there's no question about that, and we're going to lose some iconic companies I'm afraid. You just can't ignore the significant risks that we live with this situation.

I'm not at all worried about my legacy. I don't even think about that.

But just in terms of thinking about Southwest Airlines, [a colleague] and I were talking yesterday about our 50th anniversary, which is coming up next year, and all the things that we want to do [to] celebrate and have events. And it just puts it in kind of a stark contrast that, “Wow.”

I'm not at all pessimistic that we will not have something to celebrate. At the same time, I know we're going to have to work hard to make sure that that we don't let this risk get out of hand here.

In my lifetime, it's the ultimate challenge. I am very grateful that I'm here at Southwest still to be a part of this.

I don't think any of our leaders shirk the task here at all.

Do we welcome it? No. I think we’d all wish for the kind of year we thought this was going to be, which was going to be an all-time record year for Southwest. But it's here and there's nothing we can do to change that reality. And, by golly, we're going to fight our way through this and we're going to more than survive. We're going to get to a point where we are thriving again. So yeah, I’m very glad to be here. It’s certainly the biggest challenge that we've had in 50 years at Southwest.

Mutzabaugh: And just to make sure I've got the context. You mentioned that you think there are some iconic companies that are going to fail. Am I correct in understanding that's just general and not necessarily a reference to the airline industry?

Kelly: Yeah, it's just a generic point.

You have odd winners and losers in sectors in this environment, which is not shocking. And there's no rapid or easy way out of it. So you have to assume that you're going to see some really good companies that are meaningful in our society [fail]. It's just tragic to witness, but that's where we are. We just need to make darn sure that Southwest is not one of those casualties.

Mutzabaugh: Are you worried that other airlines may not make it through?

Kelly: Where we are, it just can't be sustained as an industry.

If things continue to improve, now it's a matter of just treading water, staying power … . Our feeling is that by the time we get to the end of 2021, things will be at a sustainable rate for us. But that's predicated on a belief that you'll have a vaccine; that the vaccine, in some reasonable period of time – as in one to two quarters – will effectively end the pandemic, at least functionally.

Then as a consequence of that, then people will be confident that they can return to more normal behaviors. I don't think it's a snap back to 2019, but at least it's at a much healthier level than where we are today.

So those are our underlying assumptions. And based on that, I'm very comfortable that we survive. I don't know enough about our competitors to be as confident with that prediction.

As you all know, there's no one who is financially stronger than Southwest. And some are significantly financially weaker. It's going to be much more touch and go with a fair number of our competitors.

Q&A: Route map, schedules

Mutzabaugh: We could probably keep going on this topic for the next hour, let alone what we have left. But I want to shift a little bit to your strategy with your route map and network. I'll start with one, and then I think we'll have a follow up from Ned.

First the biggest picture, you've had some interesting additions to the route map recently. Steamboat Springs and Miami and Palm Springs. Especially the latter two: Miami and Palm Springs.

Palm Springs seems a little unusual for the Southwest network, but it fits. Miami, to me, feels like the real outlier. It's a high-cost airport next door to a place where Southwest is already well-established. Is this a new normal during COVID? Is it a temporary normal for COVID. Or is this just a broad shift in strategy at Southwest?

Kelly: I don't think it's a radical departure for us since I've been CEO. You're looking at a 17-year videotape at this point.

Southwest has changed a lot, not because of me, but just during my tenure. We were pretty point-to-point, short haul, all domestic … one size fits all, all the way through 9/11 and then beyond.

Then, we began transforming ourselves to be less dependent upon short-haul travelers in the mid-2000s. In hindsight, that proved to be a really good move. So the transformation work that began in earnest in 2010 – and it actually started four or five years earlier – has worked very well.

Part of that transformation, was to add cities that -- before – we said, “Well, we won't serve [them].”

The logic there [in starting to rethink those types of cities] was, “we're the largest airline in the country now” [in terms of domestic passengers]. And that was as of 2004. If we want to keep growing, we've got to have a very broad appeal.

By the time we got to 2009, the Great Recession, we had already committed to a need to replace our frequent-flyer program; a need to improve our long-haul product and pricing; a need to upgrade our revenue management system. And a recognition that … we felt like we were a business airline. And we built the airline for business travelers’ convenience.

There was an image that we created that we were more leisure. Well, we can't depend on just leisure customers. So there's been a significant element of our transformation that was focused on improving our standing in the business travelers’ minds. And it's worked beautifully.

Part of that is let's say: All right, we're the No. 1 airline in Midway. We go to Chicago corporate customers, and say, “We want to sign you up with Southwest.”

[Previously, they might say], “Well, we love you guys. But the problem is you don't fly to Minneapolis. You don't fly to Boston. You don't fly to New York.” And so those became important enablers of us to continue growing the airline. So, you take yourself back in time, that was a pretty radical departure for the way people viewed Southwest.

I'll parlay that now. And again, Boston sort of is the analogy to your Fort Lauderdale question.

We were serving the Boston metro area with alternative airports … i.e., Manchester, New Hampshire, and Providence Rhode Island. That strategy worked beautifully, as long as we were the low fare, low cost carrier. That meant that whatever airport you chose, it was served by high-cost, high-fare airlines.

Well, that all changed because you had a lot of copycat airlines taking a page out of the Southwest book. You know turning it, perhaps in different fonts, but nonetheless, a more low-fare, low-cost approach. Now all of a sudden you have a low-fare competition at every airport.

It also meant that we needed to be thinking more about adding San Francisco International to our route map; adding Washington Dulles to the route map; adding Boston, Logan. The same analogy applies here in South Florida, where there are elements of distinct markets that separate Fort Lauderdale from Miami.

Said a different way: Yes, we have low fares. Yes, we have a lot of flights at Fort Lauderdale. That does not mean that we're going to be able to grab customers from Miami and get them to drive to our airport. Twenty years ago, maybe. But not now.

The other way to think about this is – that's our San Francisco example. Our primary operation in the Bay area is Oakland. But we have a substantial presence at San Jose. [And a] substantial presence at San Francisco; it's the smallest of the three, but it's still very meaningful.

For people who are looking to the Bay Area as a destination, they don't want to go to San Jose, in some cases. They want to go to San Francisco. And the same applies here in Miami.

The other thing I want to – and I’ll speak to Palm Springs too – but I know you're interested in all of this, so hopefully I'm not taking too much of your time.

The element that I'd like you to know is that if you go back in time to 2010 – and certainly in 2019 – with the transformation that we had done adding the 737-800, adding the capability to fly international, changing our boarding process to again at least provide more amenities for business travelers …

It put us in a position where all of a sudden now we had dozens of destinations that were now in our line of sight. Whereas in 2010 – before we made a lot of these changes – we were sort of out of options to add destinations.

Acquiring AirTran was a catalyst for us. It added Atlanta. It added Washington, D.C. And it has also worked out beautifully. But we had all kinds of growth opportunities that were unleashed with that transformation and the addition of AirTran. If you’ll remember, we've been saying since 2010 that we have 50 more years destinations in North and South America that we can add to our route map. We're still only serving about 100 destinations.

One of the things that has happened as the economy finally began to improve [after the Great Recession and] travel demand improved, is we saw significant needs to add capacity to California, to Denver, to Chicago Midway to Nashville, to Austin, to BWI. We had more needs for flights in our existing system than we had airplanes.

We struggled with competing needs to add more and more destinations. So I haven't added many over the past five years. Now what's happened is pandemic has created this situation where there's no depth in a market.

In fact, you've lost the depth. We're still serving Dallas-Houston, but with 70% less demand right now. Obviously temporarily, we all hope. But what is an opportunity for us is to go back to that list of cities where we can add to our route map and add new customers – or add new itineraries for existing customers.

We're not the only airline pursuing this opportunity. But if you look at the three legacy carriers, what dots are they going to add to the route map?

I’ll bet you at this point, we've got 70 or 80 potential destinations that we can add to the route map. They’re not all equal. Some are risker than others and some may not work in this current environment.

But with our point-to-point system – and the significant presence that we have in dozens of cities –we're not dependent on a hub-and-spoke system. We’ve got dozens of major service points that we can tie into.

We feel like Palm Springs, as an example, is the largest California city that we do not serve. We are the No. 1 airline in California by every measure. So here it's an opportunity for us to plug it in. It will primarily be a destination. It’ll also be counter-seasonal because it's high season is in the first quarter, which is attractive to us. Steamboat Springs kind of fits the same mode. We won't have a lot of flights, but we should have sufficient demand on those flights to contribute cash in this environment.

And the other test that it has to pass is it has to be a city that we would add in normal times. In other words, this can't just be a pandemic play. It has to fit both.

We have extra airplanes sitting around doing nothing, costing us money. We have employees that are not fully utilized, so you have that idle capacity. So you're really just talking about paying for the extra maintenance burden, some landing fees and some gas. And for the most part, there's minimal investment required to open up these new cities. So I'm very excited about that opportunity. And that's why that all makes sense now, and even once we get past the pandemic.

Now, if things get back to normal, those kinds of opportunities will have a hard time competing for our need to invest in St. Louis or Nashville or Austin.

It just creates a really unique opportunity to expand the route map. I know it will be successful.

These additional dots to the map provide even more sources of revenue here at a time when we really need it. That's our No. 1 challenge. We've cut our expenses. We've got more opportunities there. But the real need is, we’ve got to generate more customers and we’ve got to generate more revenues.

Edward Russell: Gary, one of the changes that has struck me to Southwest’s schedule and network since the pandemic began is there's been more of a focus on funneling travelers through some of your largest bases. Keeping the connectivity, but not necessarily all of the nonstops Southwest is known for. Is that something that will continue post-pandemic or will it be back to Southwest’s normal point-to-point legacy. What's going to happen there.

Kelly: My belief is that, yes, things will get back to “normal.”

People want to travel. We’ll be dependent more in the near term – which may be, I don't know, years – on leisure travel than business travel.

[But the large drop in passenger traffic during the pandemic has an effect.] It forces us into an environment where we're more dependent on flow [connecting] traffic than normal. It's just a matter of trying to get that balance right.

What you'd like to do is crush the number of seats low enough to match the demand. In other words, if, revenue is down 70%, I'd love for our seats to be down 70. It's really hard for us to do that without destroying the network. In the meantime – because we have more seats than the local market needs –thank goodness we're at least able to rely a little bit more than normal on flow traffic.

I think the way to understand this is that in normal times we would have a load factor of 85% throughout the year. That means that you were not meeting all of the demand that we could potentially serve. And the demand that we would spill in that environment would be connecting demand, because we're more focused on carrying nonstop passengers.

I don't think what we're doing here is anything unnatural. We've got these lanes in place, and it's just now we have more seats available to accommodate people who are willing to fly on a connecting itinerary. And we need it. I'm glad to have it because it's very meaningful revenue at a time where we really need it.

Russell: I have relatives in Hartford and the local press there has been reporting about Southwest pulling back to just Chicago and Baltimore temporarily. So, expanding that thinking to the other similar types of markets in Southwest’s network, it’s been on my mind whether some of the nonstops to more places are going to be coming back.

Kelly: That would be the objective, absolutely. There's been no strategic decision that we have to change our spots here, at all. We're very much devoted to our point-to-point system. Right now, we're just living more of connecting itineraries.

More: Southwest Airlines is cutting more than 100 routes from its ‘full’ schedule this winter

Q&A: Change fees

Mutzabaugh: I know we’re already past our time limit, so we'll make this the last topic: Change fees.

I know historically you’ve been eager to talk about at Southwest Airlines. Now, you've got some competition there all of a sudden. Are you surprised that the big so-called “Big Three” have eliminated change fees, mostly domestically? Did you see this coming? Did they have any other choice right now? And, does it affect you? Does this erode your position as the no-fee leader?

Kelly: It's a welcome change as far as I'm concerned, for us. It's certainly a welcome change for the traveling public.

What is harder for us is to make sure that the universe of customers and potential customers understand the differences between Southwest and our competitors … because we really feel like we're in a category of one. We've invested a lot of marketing effort over a long period of time to make sure that people understand that we don't charge bag fees, we don't charge change fees. And that's complicated.

For people that take the time to understand our brand, we score well because we are by far the most-trusted brand. And we cherish that. It will eliminate one example of why you should trust Southwest, but it won't render us at par with our competitors on that trust factor at all.

Said a different way: Our competitors could not compete with us on cost. They couldn't compete with us on fares. And the technique that they used was a page from the Ryanair book – which is a bait and switch.

I think competitively, it's always been a concern of mine that they had a revenue source that we couldn't [match]. We needed to make sure that we somehow offset that with other techniques … i.e., this brand technique.

I'd much rather compete with them head-to-head – you fares versus our fares. They can't compete. They can't make money at that. Change fees never went on sale. Now they will. It's definitely advantage Southwest. But it was advantage Southwest before with the tactics that we used. Either way I feel like we win. This will, quite frankly, make it easier for us to compete.

Mutzabaugh: Did it surprise you that they went that route or was that something you'd kind of anticipated?

Kelly: It wasn't anything that I had premeditated. It's nothing that we're worried about, as you can tell. They can eliminate all their fees and we don't care. It makes it easier for us.

In retrospect, because they've been waiving change fees – because it is such a hated feature – I'm not at all shocked that they've done it. You know, they've spent years defending why that all made sense and now they're all denigrating change fees, which I find humorous.

The other thing, as you know – and you've got to point this out, the hypocrisy of it – is they're saying the “most” change fees, not all. So we'll have fun with all of that. But we'll remain the most trusted brand. I don't think that we'll have to do anything different. In fact, our tactics will probably be simplified here.