Southwest Airlines 2013 Annual Report Download - page 35

The Company’s low-cost structure has historically been one of its primary competitive advantages, and
many factors have affected and could continue to affect the Company’s ability to control its costs.
The Company’s low-cost structure has historically been one of its primary competitive advantages, as it
has enabled Southwest to historically offer low fares, drive traffic volume, and grow market share. The
Company’s low-cost structure has become increasingly important as a result of the Company’s decision to limit
capacity growth in response to high fuel prices and uncertain economic conditions. While the Company has in
the past been able to cover increasing costs through growth, the combination of capacity control and increasing
costs has contributed to an increase in the Company’s costs per available seat mile.
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 35 percent of the Company’s operating expenses during 2013, and the
cost of fuel is subject to the external factors discussed in the second Risk Factor above. Salaries, wages, and benefits
constituted approximately 31 percent of the Company’s operating expenses during 2013. 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,” approximately 99 percent of Southwest’s unionized
Employees, including those represented by nine of Southwest’s eleven unions, are in unions currently in negotiations
for labor agreements or have labor agreements that become amendable in 2014, 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 can result 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.
If the supplemental coverage is not extended, the Company will be required to obtain war-risk insurance coverage
commercially. Such commercial insurance could have material differences in coverage than is currently provided by
the U.S. government and may not be adequate to protect the Company’s risk of loss from future acts of terrorism. 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, in recent years the Company’s maintenance costs have been pressured 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 better fuel efficiencies, and lower maintenance costs. Some of the Company’s
competitors have taken advantage of reorganization in bankruptcy, and even the threat of bankruptcy, to decrease
operating costs through renegotiated labor, supply, and financing agreements. In addition, some airlines have
consolidated and reported significant expected cost synergies.
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