Southwest Airlines 2011 Annual Report Download - page 31

Company’s operating expenses during 2011. The Company’s ability to control labor costs is limited by the terms
of its CBAs, and increased labor costs have impacted the Company’s low-cost competitive position. As discussed
further under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the
Company’s unionized workforce, which makes up the majority of its Employees, have had pay scale increases as
a result of increased seniority and contractual rate increases. Furthermore, as indicated above under “Business-
Employees,” a majority of the Southwest Employee groups have labor agreements that are either currently in
negotiation or become amendable in 2012, which could continue to put pressure on the Company’s labor costs. In
addition, the Company anticipates that the combination of the various Southwest and AirTran labor contracts and
frontline workforces will increase AirTran labor costs over their historical levels. As discussed above under
“Business-Regulation,” the airline industry is heavily regulated, and the Company’s regulatory compliance costs
are subject to potentially significant increases from time to time based on actions by the regulatory agencies.
Additionally, when other airlines reduce their capacity, airport costs are then allocated among a fewer number of
total flights, which has resulted in increased landing fees and other costs for the Company. The Company is also
reliant upon third party vendors and service providers, and its low-cost advantage is also dependent in part on its
ability to obtain and maintain commercially reasonable terms with those parties. As discussed under
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the Company’s
maintenance costs have increased with the aging of its fleet, which has required the Company to spend more to
maintain a portion of its fleet and to implement a related fleet modernization and replacement plan.
As discussed above under “Company Operations – Cost Structure,” the Company’s low-cost structure has
historically been facilitated by, among other things, Southwest’s use of a single aircraft type, the Boeing 737, its
point-to-point route structure, and its service to and from many secondary or downtown airports. The Company’s
increased presence in bigger markets, as well as the addition of the Boeing 717 aircraft, could continue to add
pressure to the Company’s operating costs and diminish its low-cost advantage.
As discussed above under “Business-Insurance,” the Company carries insurance of types customary in the
airline industry and is also provided supplemental, first-party, war-risk insurance coverage by the federal
government at substantially lower premiums than prevailing commercial rates. If the supplemental coverage is
not extended, the Company could incur substantially higher insurance costs. In addition, an accident or other
incident involving Southwest or AirTran aircraft could result in costs in excess of its related insurance coverage,
which costs could be substantial. Any aircraft accident or other incident, even if fully insured, could also have a
material adverse effect on the public’s perception of the Company.
The Company cannot guarantee it will be able to maintain its current level of low-cost advantage. In
response to volatile fuel prices and economic uncertainty, some of the Company’s competitors have taken
additional efficiency and cost reduction measures, such as capacity cuts and headcount reductions, which have
reduced the Company’s cost advantage. In addition, some competitors have announced plans to add a significant
number of new aircraft to their fleets, which could potentially decrease their operating costs through fleet
simplification, better fuel efficiencies, and lower maintenance costs. Prior to the recent economic downturn,
some of the Company’s competitors took advantage of reorganization in bankruptcy, and even the threat of
bankruptcy, to decrease operating costs through renegotiated labor, supply, and financing agreements. Most
recently, in November 2011, AMR Corporation, the parent company of American Airlines and American Eagle,
sought bankruptcy protection through filing for Chapter 11 reorganization. In addition, some airlines have
consolidated and reported significant expected cost synergies.
The Company is increasingly dependent on technology to operate its business and continues to implement
substantial changes to its information systems; any failure or disruption in the Company’s information
systems could materially adversely affect its operations.
The Company is increasingly dependent on the use of complex technology and systems to run its ongoing
operations, as well as to support its initiatives, including its integration of AirTran’s operations and initiatives. As
discussed above under “Business – Management Information Systems,” during 2010 and 2011, the Company
continued its commitment to technology improvements to support its ongoing operations and initiatives. Among
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