The 737 built Southwest, and the 737 Max could be its undoing

Southwest Airlines began 2019 by celebrating its 46th straight year of profitability and a record-setting $2.5 billion in profits. Its low fares and wide network, with 753 aircraft serving 101 cities in North America, made Southwest the airline of choice for one out of every five domestic air travelers today. But now, Southwest’s bet on the Boeing 737 Max as its airplane of the future might end its streak — and threaten its bottom line for years to come.

Since 1987, Southwest has almost exclusively flown a single airplane model: the Boeing 737. That allowed the airline to save on training and maintenance (they would only need one type of simulator, and one common spare parts inventory), and to make skilled personnel such as pilots and mechanics essentially interchangeable, in case someone calls in sick or misses a connection. Southwest was scheduled to replace the oldest jets in their fleet with brand-new 737 Max airplanes, allowing them to burn 5 percent less fuel per flight while carrying up to 20 percent more passengers. And according to one analyst, almost 8 percent of Southwest’s flight capacity was supposed to be flown on its 34 new 737 Maxes.

In an industry that famously obsesses over the cost of each olive, these penalties can add up quickly. Legacy carriers, such as American Airlines, have estimated that each grounded Max costs them just under $50,000 a day in lost revenue and efficiencies. For Southwest, it’s closer to $67,000 per day, per airplane. As the largest operator of Maxes in the world currently, Southwest has estimated that the groundings reduced their income by $225 million for the first six months of the year. For the remainder of the year, the number might balloon: American Airlines, for example, now believes the groundings will cost it $400 million for the full year, $50 million higher than it estimated back in April. And it only has 24 Maxes flying 5 percent of its total flight capacity. 

Boeing, for its part, has earmarked over $5 billion before taxes to reimburse airlines for Max-related costs — enough to weather a yearlong grounding, assuming that most operators incur something like American Airlines’ estimate of $50,000 per day.

And airlines have little choice but to eat the costs. They can’t buy Airbus’ competing airplane, the A320neo, because it has over 5,000 backorders; an order placed today won’t arrive for three years. And it can be prohibitively expensive to lease their way out, with short-term lease rates for 737s increasing by 40 percent since the groundings. Carriers with mixed fleets can at least make do with a motley collection of older airplanes. But this isn’t an option for most low-cost carriers.

Originally founded in 1967 to connect Dallas, Houston, and San Antonio, Southwest Airlines brought its low-fare strategy beyond Texas following the Airline Deregulation Act of 1978 — the law that permanently removed route and price controls for airlines in the United States (and which it had previously argued successfully did not apply to it as a single-state airline). 

Southwest built its business around three competitive advantages that deregulation basically created. First, it flew out of secondary airports (Providence instead of Boston, Oakland instead of San Francisco, Midway instead of O’Hare), which were less congested and cheaper to operate out of. Second, it stuck to a point-to-point network system instead of the hub-and-spoke system favored by legacy airlines; although this made routing more complex, it allowed Southwest to offer more nonstop flights, which flyers loved. And finally, it flew its planes hard, averaging one or two more flights per airplane per day than its competitors. 

Combined with the lower costs from using only Boeing 737s, all this made a Southwest flight half as expensive to operate as a comparable one from a legacy carrier for at least the past decade or so. But rather than padding its margin, Southwest has consistently passed those savings on to its customers. In 1979, a full-fare, one-way ticket from Chicago to St. Louis cost around $134 in today’s dollars on Southwest, and $285 on competitor airlines. (Today, it’s $132 Southwest, and $167 on a competitor.)

Its low fares allowed it not just to steal cost-conscious frequent flyers from other airlines. It also attracted people who would previously have just hopped in the car to drive between, say, Dallas and Houston or Chicago and St. Louis. It invented a new, untapped market for commercial aviation and created an entirely new type of airline: the low-cost carrier. Southwest rode that market to 46 years of profit, most recently boasting an 11 percent profit margin in an industry where 2 percent is closer to the norm.

“Our outlook is bright,” said Southwest’s CEO Gary Kelly in January, “barring any unforeseen events.”

On March 10th, 2019, the unforeseen happened. A brand-new Boeing 737 Max 8, operating as Ethiopian Airlines Flight 302, crashed shortly after takeoff from Addis Ababa, killing all 157 people on board. It was the second fatal crash of Boeing’s newest airplane in just five months. 

Regulators around the world grounded the 737 Max days later, as preliminary investigations indicated that the same critical software flaw caused both crashes. After seven months, the Max has still not been cleared to fly, making this the longest grounding of a commercial airliner in history. There isn’t a clear timeline for the Max’s return to service, as new software issues have cropped up, while tension between Boeing and international regulators is on the rise. 

And for low-cost carriers that fly mostly 737s — including Southwest, flydubai, Norwegian, SpiceJet, and a dozen others around the world — the Max grounding has gone from inconvenience to existential threat. A spokesperson from Southwest declined to comment for this story.

Even though regulators will eventually clear the Max to fly again, the question remains: will people want to fly on one? Commercial aviation depends on a kind of equipment-blindness — people might care about seat recline and class of service, sure, but not the particular make or model of their airplane. 

But after two crashes and seven months of unrelenting bad press, the flying public has taken notice. In June, 70 percent of those surveyed by UBS said that they would “hesitate” to book a flight on a 737 Max; another survey run by Atmosphere Research Group found that 40 percent of likely flyers would be willing to take more expensive or “less convenient” flights to avoid the Max, and 20 percent would wait six months before flying one. To address their fears, airlines have announced that they will let passengers switch flights without penalties or change fees — although this is, for the time being, purely a hypothetical. 

To help manage public perception, a rebrand is likely: even though Boeing’s CEO has publicly denied that the company will rename the Max, a Ryanair 737 Max was photographed sporting a new designation, the “737-8200,” in July.

And for good reason. At Southwest’s current average fares and present load factors, a Max flight would generate 22 percent more revenue and 14 percent more profit than one on the comparable 737-700 that it’s scheduled to replace. But if one in five passengers refuse to fly the Max and switch to another airplane, that same flight would generate 3 percent less overall revenue and 75 percent less profit than the 737-700 flight. No amount of fuel efficiency can compensate for that many lost seats.   

In the meantime, those low-cost airlines that hedged their future on the 737 Max will have to tighten their proverbial belts — preemptively canceling flights, halting service to and from certain airports, and raising fares. And, perhaps, revisiting their commitment to the 737 — and a central pillar of the low-cost carrier formula.  

Correction: This article initially got the first name of Southwest’s CEO wrong. He is Gary Kelly, not Greg Kelly.