Southwest Airlines 2012 Annual Report Download - page 34

The Company has limited control over fuel and labor costs, as well as other costs such as regulatory
compliance costs. Jet fuel and oil constituted approximately 37 percent of the Company’s operating expenses
during 2012, and the cost of fuel is subject to the external factors discussed in the second Risk Factor above.
Salaries, wages, and benefits constituted approximately 29 percent of the Company’s operating expenses during
2012. The Company’s ability to control labor costs is limited by the terms of its CBAs, and increased labor costs
have negatively 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 vast majority of Southwest’s unionized Employees, including those represented by Southwest’s five largest
unions, have labor agreements that are either currently in negotiation or become amendable in 2013, 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 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 or improve upon its current level of low-cost
advantage. For example, 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. Further, some of the Company’s competitors have achieved substantially
lower employee pay scales through bankruptcy than the Company. Additionally, 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. Further, other competitors have continued to grow their fleets and expand their networks, potentially
enabling them to better control costs per available seat mile. 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. In addition, technology is critical to the success of the Company’s strategic initiatives. In recent years
the Company has been committed to technology improvements to support its ongoing operations and initiatives.
26