Now that American, the last legacy to enter bankruptcy, is under the courts protection, it seems as though even Southwest is a little nervous about what the future holds for them.  Their Chairman, President, and CEO Gary Kelly sent out a letter to employees yesterday taking about American’s bankruptcy, the industry as a whole, Southwest’s situation, and what they expect going forward.

The foundation of the letter is about controlling costs (preferably through increasing productivity), and the importance of having low costs in the industry.  Southwest was classified as a “major” in 1989, and Kelly notes that Southwest is the only major still around that has not filed bankruptcy.

All the majors from 1989 have gone bankrupt. Pan Am. Eastern. Braniff. Continental. America West. TWA. US Air. United. Delta. Northwest. And now, American. Every single one failed.

It is humbling to think that every last one of those carriers has been in bankruptcy, from which some of them never returned (I suppose Pan Am is a TV show now, but that is hardly the same thing as an airline!).  Kelly says they did not fail because of their customer service, but because of their high costs.  He once again affirmed his conviction that great customer service cannot overcome high costs, quoting his own article written back after 9/11:

While an airline needs to be good at many things to be successful; low costs and profitability, ultimately, mean the difference between survival or not.

He talks about how Southwest has lost much of their competitive advantage due to the lower cost structures of their peers.  What they have been doing will not be as effective as it has been in the past.

In the good old days, when the Legacy Carriers costs were higher, we brought our low costs and low fares to their markets, stimulated demand, and expanded dramatically. Now, while our costs are still lower, our advantage has been cut in half. We currently do not have a sufficient cost advantage to stimulate the market because our fares are much closer to our New Airline competitors. These New Airlines, reconstituted from their Legacy ashes, join younger, lower-cost airlines like JetBlue and Frontier, as well as an even newer group of ultra low-cost airlines like Allegiant and Spirit. As predicted, the industry has transformed to lower costs.”

He talks about how the other majors (at least the ones who have survived bankruptcy), have reinvented themselves through their chapter 11 proceedings, lowering their cost and making them much more formidable competitors. After a long struggle, American will presumably rise to join “New Untied” and “New Delta” to present additional intense competition for Southwest.  Further pressures on Southwest come from their labor rates, which have become increasingly lofty over time.

Our labor rates are now, far and away, the highest in the industry. Through bankruptcy, very large New Airlines have emerged with lower rates than us and better productivity. Next to fuel, labor is our highest expenditure. We cant have lower overall operating costs if our labor costs aren’t lower.

He claims that by being more productive, they can lower labor costs and preserve pay rates.  The letter really does hint towards turbulence up ahead as Southwest tries to remain competitive-something that will not be particularly easy if their costs continue to rise while their competitor’s are lower than ever before.  It is noted that “the enemy is our own cost creep, our own legacy-like productivity, and our own inefficiencies.”  Despite this, Kelly is proud of what Southwest has accomplished, and he should be.

No 1989 major airline has survived without bankruptcy except Southwest. We are the maverick. We are different. Thats how we have prevailed with a Warrior Spirit, a “Never Give In” resolve, and a burning desire to be the very best. The sloth-like industry you remember competing against is now officially dead and buried. We fought them, and we won.

He finishes by taking about the importance of their people and their role in the future success of the airline.  What he says provides a little bit of insight into the company’s strategy going forward, which appears to be based on four big changes.

It is our People who will continue to transform Southwest with four big initiatives: AirTran, All-New Rapid Rewards, B737-800, and a new reservation system.

Summing up the letter and his point, he ends in a very somber way saying:

Finally, please remember, all the great things our People do will be for naught without low costs. Just ask the old “Legacy” airlines.

It will be interesting to see how Southwest fares in the environment the industry seems to be evolving into.  The employees of the airline have been living the good life for so long, it is hard to predict how they might react to some hardship.  In the end, Kelly knows the airline needs to reign in costs to stay competitive.  Now we just have to wait and see how they do it.

If you are interested, click here to read Gary Kelly’s entire letter.