Southwest Airlines 2006 Annual Report Download - page 24

Airlines; and United Airlines/US Airways. These alli-
ances are more extensive than ours and enable the carriers
to expand their destinations and marketing opportunities.
The Company is also subject to varying degrees of com-
petition from surface transportation in its shorthaul mar-
kets, particularly the private automobile. In shorthaul air
services that compete with surface transportation, price is
a competitive factor, but frequency and convenience of
scheduling, facilities, transportation safety and security
procedures, and Customer Service are also of great impor-
tance to many passengers.
The competitive landscape for airlines has changed
significantly over the last few years. Following the ter-
rorist attacks on September 11, 2001, the airline indus-
try, as a whole, incurred substantial losses through 2005.
The war in Iraq and significant increases in the cost of
fuel have exacerbated industry challenges. As a result, a
number of carriers have sought relief from financial
obligations in bankruptcy, including UAL Corporation,
the parent of United Airlines; ATA Airlines; US Airways;
Northwest Airlines Corporation, the parent of Northwest
Airlines; and Delta Air Lines. UAL Corporation and
ATA Airlines emerged from bankruptcy in 2006.
US Airways’ emergence from bankruptcy in 2005 cul-
minated in its merger with America West Airlines in
September of that year. Northwest Airlines Corporation
and Delta Air Lines remain under the protection of
bankruptcy proceedings. Other, smaller carriers have
ceased operations entirely. In addition, post-9/11, many
carriers shrank capacity, grounded their most inefficient
aircraft, cut back on unprofitable service, and furloughed
employees. Reorganization in bankruptcy has allowed
carriers to decrease operating costs through renegotiated
labor, supply, and financing contracts. As a result of those
events, as well as actions taken by some carriers outside of
bankruptcy, differentials in cost structures between tra-
ditional hub-and-spoke carriers and low cost carriers have
significantly diminished. Nevertheless, throughout this
entire time period, Southwest has continued to maintain
its cost advantage, improve Employee productivity, pur-
sue steady, controlled growth, and provide outstanding
Service to its Customers. The factors discussed above
have, however, led to more intense competition in the
airline industry generally. Some carriers reported profit-
able results in one or more quarters in 2006 for the first
time since 9/11.
The re-emerging competitiveness of some of the
larger carriers, such as United, US Airways, and Amer-
ican, has put pressure on smaller carriers such as AirTran
Airways, JetBlue, and Frontier. AirTran Airways and
JetBlue have announced scaled back growth plans, and
many carriers have expressed interest in industry
consolidation. For example, US Airways is pursuing a
merger with Delta Air Lines, and AirTran Airways has
recently announced an unsolicited offer for Midwest
Airlines. The Company cannot predict the timing or
extent of any such consolidation or its impact (either
positive or negative) on the Company’s operations or
results of operations.
Insurance
The Company carries insurance of types customary
in the airline industry and at amounts deemed adequate to
protect the Company and its property and to comply both
with federal regulations and certain of the Company’s
credit and lease agreements. The policies principally
provide coverage for public and passenger liability, prop-
erty damage, cargo and baggage liability, loss or damage
to aircraft, engines, and spare parts, and workers’
compensation.
Following the terrorist attacks, commercial aviation
insurers significantly increased the premiums and
reduced the amount of war-risk coverage available to
commercial carriers. The federal Homeland Security
Act of 2002 requires the federal government to provide
third party, passenger, and hull war-risk insurance cov-
erage to commercial carriers through a period of time that
has now been extended to August 31, 2007. The Com-
pany is unable to predict whether the government will
extend this insurance coverage past August 31, 2007,
whether alternative commercial insurance with compa-
rable coverage will become available at reasonable pre-
miums, and what impact this will have on the Company’s
ongoing operations or future financial performance.
Frequent Flyer Awards
Southwest’s frequent flyer program, Rapid Rewards,
is based on trips flown rather than mileage. Rapid
Rewards Customers earn a credit for each one-way trip
flown or two credits for each roundtrip flown. Rapid
Rewards Customers can also receive credits by using the
services of non-airline partners, which include car rental
agencies, hotels, telecommunication companies, and
credit card partners, including the Southwest Airlines
Chase»Visa card. Rapid Rewards offers two types of
travel awards. The Rapid Rewards Award Ticket
(“Award Ticket”) offers one free roundtrip award valid
to any destination available on Southwest after the accu-
mulation of 16 credits. The Rapid Rewards Companion
Pass (“Companion Pass”) is granted for flying 50 round-
trips (or 100 one-way trips) on Southwest or earning
100 credits within a consecutive twelve-month period.
The Companion Pass offers unlimited free roundtrip
5