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Low-Cost Airline Wizard: Herb Kelleher
Southwest Airlines
But seriously, the airline business has been extraordinary. It
has eaten up capital over the past century like almost no other
business because people seem to keep coming back to it and
putting fresh money in. You’ve got huge fixed costs, you’ve got
strong labor unions and you’ve got commodity pricing. That is
not a great recipe for success. I have an 800 (free call) number
now that I call if I get the urge to buy an airline stock. I call at
two in the morning and I say, “My name is Warren and I’m an
aeroholic.” And then they talk me down.
—Warren Buffett, Telegraph interview
According to the unofficial records of Airlines for America, there have
been 198 airline bankruptcies since the aviation industry deregulated,
in 1978, and since then the U.S. airline industry alone has lost $60 billion. No industry can match these staggering statistics. Even so, neither
Airlines for America nor the Department of Transportation has official
statistics on the number of bankruptcies—likely because everyone has
lost count. Multiple carriers have declared Chapter 11 reorganization
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multiple times during that period. One U.S. airline, however, has
bucked the trend.
Southwest Airlines is nearing its forty-third consecutive year of
profitability. That means it has made a profit nearly every year of its
corporate life, minus the first fifteen months of start-up losses. Given
such an incredible track record in a horrible industry, luck cannot be
the only factor. There had to be at least one intelligent fanatic behind
its success.
In Southwest’s case, there were many intelligent fanatics behind the
company, led by Herb Kelleher. Early on, it could have been apparent
to investors that Southwest had some special people behind it.
In 1973, the upstart Texas airline, Southwest Airlines, with only
three airplanes, turned the corner and reached profitability. This was
a significant achievement, considering that the company had to overcome three and a half years of legal hurdles raised by two entrenched
and better-financed competitors: Braniff International Airways
had sixty-nine aircraft and $256 million in revenues, and Texas
International had forty-five aircraft with $32 million in revenues by
1973. How Southwest achieved the company’s first year of profitability
demonstrated clearly that Lamar Muse, Herb Kelleher, and other early
Southwest managers and board members had the iconoclastic characteristics of intelligent fanatics, which foreshadowed what was to come
for the business.
Prior to February 1973, Southwest was struggling with lower load
factors on the San Antonio to Dallas route. To combat this, Lamar
Muse, then CEO of Southwest and longtime, experienced executive
at Universal Airlines, and Herb Kelleher developed a strategy to lower
prices by half (from $26 to $13) to improve the load factor on that
route. There were no restrictions on the discount. The tactic subsequently worked, improving the load factor.
Unfortunately, Braniff, the largest airline operator in Texas, which
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had tried hard to prevent Southwest from flying in the first place,
reacted to Southwest’s price move by lowering its own Houston to
Dallas route fare to $13, encouraging customers to “get acquainted”
with the airline. This was a tremendous blow to Southwest. At the
time, this route was relatively small for Braniff and the cheaper fare
could have been sustained by its other operations. Southwest, on the
other hand, could easily have gone bankrupt; the Houston to Dallas
route was its only profitable route, and accounted for more than 70%
of its revenues.
Muse and Kelleher quickly reacted and devised a marketing strategy that not only allowed them to win but also led Braniff to exit the
route two years later. Following Braniff’s announcement, Southwest
put a two-page advertisement in Houston and Dallas newspapers, with
the caption “Nobody’s going to shoot Southwest Airlines out of the sky
for a lousy $13.” The ad went on to describe that Southwest was giving
customers a choice: customers could choose to pay the reduced $13
fare, or they could pay the normal fare of $26 and receive a complimentary fifth of Chivas Regal scotch, Crown Royal Canadian whisky,
or Smirnoff vodka. Nondrinkers would receive a complimentary
leather bucket.
For the duration of the deal, roughly 76% of passengers chose the
normal fare price and gift. Southwest was the largest liquor distributor in Texas for a few months. Business travelers loved the deal—they
charged the higher-cost fare to their expense accounts and took the
alcohol as a gift. Southwest had outsmarted the established competitor
and displayed the creativity to compete successfully in one of the worst
industries known to capitalism.
If that stroke of marketing genius had not perked your interest in
1973, you might also have observed, through significant due diligence,
that Southwest Airlines was trying to change the commercial airline
industry by doing more than just lowering airfares. The company had
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to dispose of a newly acquired Boeing 737, for a tidy $500,000 profit,
after the federal court ruled that Southwest could not fly out of state,
which was the main reason for the purchase of the plane. The company
also needed the cash to stay in business.
With only three planes and many scheduled flights, peers in
the industry thought it would be impossible to maintain the schedule. Fortunately, Southwest’s ground operations guru, Bill Franklin,
stepped up to the plate and said that it was possible to maintain the
schedule if the company kept the three planes en route and minimized
plane turnarounds to ten minutes or less. A turnaround means pulling
a plane up to a gate, unloading passengers, loading new passengers, and
pushing back from the gate.
Neither the FAA, Braniff, nor the manufacturer of the Boeing
737 thought a ten-minute turn could be accomplished. Average turnaround times for airlines were forty-five minutes to an hour. Bill, on
the other hand, had experience with older DC-3 airplanes regularly
turning quickly at Trans-Texas. He believed that a Boeing 737 could
be turned in ten minutes or less, and the workers at Southwest were
too new and inexperienced to know any different. Southwest was able
to pull it off, and the ten-minute turn became one of the hallmarks of
the company.
Southwest was tapping into a market with great possibilities.
Southwest’s management was determined to bring air travel to the
masses. Prior to 1971, air travel was restricted to the elite, who could
afford the high prices regulated by the government. Southwest was at
the forefront of deregulation of the airline industry with its low fares. If
successful with their model, there was plenty of runway for Southwest
to grow at abnormally high rates for a long time.
Many competitors shrugged Southwest off as an afterthought,
and few U.S. competitors cared to clone Southwest’s zany model.
Companies that did care to clone Southwest, like People Express or
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American West, did not possess the iron discipline Southwest possessed
and ended up failing. Those companies lost focus by stepping outside of their niche and losing control of their spending, and so forth.
Southwest was able to maintain its focus on being profitable and providing job security for its employees.
It took twenty years for someone in the airline industry to steal
Southwest’s ideas and maintain focus. Twenty-six-year-old Michael
O’Leary was the first. O’Leary was the accountant of Tony Ryan, CEO
of a poorly performing Ryanair, and was charged with getting the company to profitability. He took a trip to Dallas in early 1991 to learn all
of Herb Kelleher’s secrets and went on to create a fairly true clone of
Southwest in Europe, albeit with some differences. Michael O’Leary
had this to say about the trip:
We went to look at Southwest Airlines in the U.S. It was like
the road to Damascus. This was the way to make Ryanair work.
I met with Herb Kelleher. I passed out about midnight, and
when I woke up again at about 3 a.m., Kelleher was still there,
the *********, pouring himself another bourbon. I thought I’d
pick his brains and come away with the Holy Grail.1
Since Ryanair’s initial public offering in 1997, the stock is up more
than 2,000%, a return of 19.4% compounded annually. Compare that
with the S&P 500’s total return of 6.4% over the same period. So, if
you were not able to identify Herb Kelleher and other Southwest managers as intelligent fanatics in the early 1970s or the 1980s, an investor
could have been redeemed by following another intelligent fanatic into
a Southwest clone in Europe twenty years later.
Michael O’Leary was not the only individual to borrow heavily
from Herb Kelleher and succeed. Kip Tindell borrowed many ideas
from Southwest Airlines’ corporate culture, in a totally different
industry, when he founded The Container Store in Dallas, in 1978.
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According to Tindell, The Container Store believed “in the vision of
Herb Kelleher, the legendary cofounder of Southwest Airlines, who
said ‘a company is stronger if it is bound by love rather than by fear.’ I
was completely taken by it.”2 The Container Store has fostered employees who have been, and continue to be, more productive than average
employees, and this has led to better customer relations. Tindell says
he pays anywhere from 50% to 100% more for every employee and
gets about two to three times more productivity out of them. Tindell
also says that The Container Store has a 10% employee turnover rate,
compared to the retail industry average of 100%.
***
Herbert Kelleher was born on March 12, 1931, in Haddon Heights,
New Jersey. He grew up during the Great Depression; however, he
did not experience the Depression as many other kids in his neighborhood or other parts the United States experienced it. His father
provided the family with financial stability as a general manager at the
Campbell’s Soup plant and benefited from the recession-proof nature
of the business.
Herb was a hard worker in school, in sports, and outside of school.
He excelled in all of his activities and had a knack for leadership. Herb
not only learned at school but also was interested in reading stories of
heroes and adventure; later, he continued to be a voracious reader and
learner. When Herb was eleven or twelve years old, he experienced
a change in his family dynamic that shaped him. His brothers and
sisters, all older, had by that time all moved out of the house, and his
older brother Richard died in World War II, in 1942. Not long after
that, his ill father died.
Herb was left with his mother, who had a great influence on how
he was to look at the world, in terms of ethics, morals, and how to treat
others. Herb said:
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She used to sit up talking to me till three, four in the morning. She talked a lot about how you should treat people with
respect. She said that positions and titles signify absolutely
nothing. They’re just adornments; they don’t represent the
substance of anybody . . . She taught me that that every person and every job is worth as much as any other person or any
other job.3
Many of these lessons would later be infused in Southwest Airlines,
and the idea of a company treating employees as it treats its customers
turned out to be a very powerful competitive weapon.
After working six summers at Campbell’s, doing various jobs—as
a soup chef, a warehouse foreman, and a part-time analyst—Kelleher
went to and graduated from Wesleyan University. Like the other CEOs
profiled in this book, Herb did not graduate with a degree in business
but with a bachelor’s degree in English and philosophy. He had an eye
on becoming a journalist. Luckily, a mentor at the college steered Herb
into law, which became his conduit into the business world and ultimately into Southwest Airlines.
Herb Kelleher graduated with a law degree in 1956, and after working for a few years as a clerk in New Jersey, then as a partner at a law
firm, he moved with his wife to San Antonio, Texas, in 1961. As Sol
Price had done in San Diego, twenty years prior, Herb Kelleher gained
immense business experience by representing many different types of
businessmen at the law firm Matthews, Nolin, MacFarlane & Barrett.
It was also at the firm that Herb met client Rollin King, an entrepreneur who had been running a third-level charter airline doing
short-haul routes out of Twin Beaches since 1964. By 1967, King had
observed and studied the success of Pacific Southwest Airlines, which
was the first large discount airline operating within California. Rollin
King met with Herb Kelleher soon after at a bar, where King sketched
the triangle diagram of the three-city route on the back of a cocktail
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napkin. After some thought, Kelleher was on board with a $10,000
investment and to provide legal services.
Southwest was going to need a lawyer with a warrior spirit to overcome the challenges the company was about to face. After two rounds of
financing, the company was able to raise $543,000. Soon, Southwest’s
application to fly between Dallas, Houston, and San Antonio had been
approved by the aeronautics commission. However, it was not until
1971 that Southwest was able to make its first flight.
As already described, the competitive landscape for airlines in
Texas was substantial. Incumbents were benefiting from a regulated
monopoly established by the government. Southwest was entering the
market as a discount airline, which worried competitors. With their
large resources, competitors did everything in their power to prevent
Southwest from getting off the ground, and they were successful in
temporarily delaying Southwest’s first flight. The incumbents filed a
temporary restraining order that prohibited the aeronautics commission from issuing Southwest a certificate to fly. The case went to trial in
the Austin state court, which did not support another carrier entering
the market.
Southwest proceeded to appeal the lower court decision that the
market could not support another carrier. The intermediate appellate
court sided with the lower court and upheld the ruling. In the meantime, Southwest had yet to make a single dollar in revenues and had
already spent a vast majority of the money it had raised.
Like any other investor in such a situation, board members were
getting frustrated and nervous about the future prospects of Southwest
Airlines. Herb Kelleher proposed to the board one last shot at overturning the ruling, saying, “I will continue to represent the company
in court, and I’ll postpone any legal fees and pay every cent of the court
costs out of my own pocket.”4 With little left to lose, everyone agreed
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to give Herb one last chance and allow him to argue in front of the
Supreme Court of Texas.
The only problem was that the company needed highly experienced operators and cash. Southwest had only $142 left in the bank
and roughly $80,000 in overdue bills. These problems were resolved
after King and Kelleher hired the qualified Lamar Muse as CEO, in
January 1971. Muse had many years of experience managing operations at a number of airlines and was the iconoclastic entrepreneur to
get the company up and running. Acting quickly, Muse was able to
raise a significant amount of cash to buy aircraft from his expansive
network of contacts, and he was able to enlist a group of highly qualified operators to help him.
How was Southwest able to acquire talent? This is where luck
came into play. The recession had impacted the airline industry to the
point that there were many talented individuals available—individuals who were open to thinking differently about the airline industry.
Bill Franklin later dubbed this early group of talented managers at
Southwest “The Over-the-Hill Gang.”
Southwest’s competitors continued to fight. Braniff and Texas
International filed complaints with the U.S. Civil Aeronautics Board
and also put pressure on Southwest’s initial public offering underwriters to withdraw the offering. Fortunately, Southwest was able to retain
another brokerage firm to underwrite the offering, and shares began
trading publicly on June 8, 1971.
The aeronautics board also threw out the complaint from Braniff and
Texas International, just two days before Southwest’s inaugural flight.
Kelleher was able to convince the supreme court to rule in Southwest’s
favor and to order the lower courts not to enforce the injunction. Only
ten days after its initial public offering, Southwest was able make its
inaugural flight. Through the public offering, Southwest was able to
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raise $7 million to purchase aircraft and to execute its strategy, and it
has been fighting with a warrior spirit ever since.
Lamar Muse did have a large impact on building Southwest Airlines
from scratch to fourteen airplanes, $81 million in revenues, and 1,325
employees in 1978, which is the year Muse resigned and Herb Kelleher
became chairman. More than a year later, in 1980, Lamar and his son
founded Muse Air. Lamar came out of retirement to run the operation, which competed with Southwest. However, Muse Air could not
compete successfully and was subsequently purchased by Southwest,
in 1985.
Howard Putnam became CEO after Lamar Muses’s departure,
but his tenure only lasted until 1981, when he decided to become
the president and chief operating officer of Braniff International. But
Braniff was too big and too late. As Howard Putnam said, “They liked
what Southwest was doing, and their sense was that the only way
Braniff would be saved was to simplify and make it a transcontinental
Southwest Airlines. Unfortunately, there wasn’t enough cash to do it.”5
Herb Kelleher was appointed CEO in 1982 and ran Southwest
until 2001. He led Southwest from $270 million to $5.7 billion in
revenues, every year being profitable. This is a significant feat, and no
other airline has been able to match that kind of record in the United
States. No one could match the iron discipline that Herb Kelleher
instilled in Southwest Airlines from the first day and maintained so
steadfastly throughout the years.
***
If you ever hear the words conventional and wisdom conjoined,
reject them. Because if it is conventional, it isn’t wisdom. And if
it’s wisdom, it isn’t conventional.
—Herb Kelleher
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How has Southwest been able to attain uncommon results in the worst
industry in capitalism? The company has succeeded by being unconventional. Herb likes to tell the story of how a Washington think tank
told the company that it would not be able to survive without six of
the “keys to success” that other carriers have used. Southwest followed
none of those keys to success. At every point of Southwest’s history, the
company has successfully challenged industry norms.
Southwest differed from the competition because of its lowcost fares. In the 1970s, before deregulation, flying was expensive,
because the government controlled the prices. Rollin King and Herb
Kelleher’s idea was to provide lower fares and enable a greater number
of Americans to fly. Southwest would not be competing with other
airlines but with other forms of transportation.
To lower its fares, Southwest did four things. First, the company
operated out of less-costly and less-congested airports, such as Dallas’s
Love Field and Hobby Airport in Houston. Direct flights between
these small airports allowed the company to utilize its aircraft most
efficiently and to get passengers directly to their locations; smaller
airports are generally situated closer to downtown locations, making
them more attractive to customers who are time sensitive, such as businessmen. Love Field, for instance, is only a fourteen-minute drive from
the heart of downtown Dallas. Compare that with the distance from
Dallas/Fort Worth International Airport, which is twenty-five to thirty
minutes from downtown Dallas by car.
Second, Southwest focused on operating only one type of aircraft,
the Boeing 737, which gave the company bargaining power in new airplane purchases and the power to make suggestions in the manufacture
of those planes, to improve plane efficiency. Additionally, operating
one type of aircraft lowered the labor hours necessary to train pilots,
mechanics, and other workers.
Third, Southwest understood that planes are only good if they are
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in the air. The company reduced the amount of time planes were on the
ground by 90%, to ten minutes, and has maintained quicker turn times
throughout the years than its competitors. Southwest has been able to
get the most efficiency from a smaller number of planes and employees.
Finally, Southwest focuses first on its employees. Southwest is able
to retain highly qualified, hardworking employees by providing an
atmosphere that reinforces individual responsibility and offers opportunities for advancement. As a result, employee turnover at Southwest
has been well below the industry average. Lower turnover cuts down
on costs and maximizes investment in employees.
There were other ways that Southwest was able to lower prices
without affecting the customer experience. In the late 1970s, the company was considering whether to install a multimillion-dollar ticketing
system to automate tickets. Instead of parting ways with millions of
dollars for such a system, an employee suggested that Southwest get a
machine that produced a ticket that simply stated, “This is a ticket,”
and nothing else. The ticketing system was simple and highly cost
effective, because if a customer’s dog ate the ticket or the customer lost
it, the customer could easily obtain another ticket. This reduced costs
with respect to labor hours and materials.
Southwest could get clever, simple, cost-effective solutions from
its employees because those employees thought and acted like owners.
Employees also possessed copious amounts of curiosity, a characteristic sought by Southwest’s hiring team. Learning the lessons from his
mother, Herb Kelleher built an egalitarian culture at Southwest. Each
employee was treated the same as every other employee. Management
was open to listening to all workers and to trying new, often unconventional ideas.
To get employees to think and act like owners, management aligned
employees with Southwest’s actual owners, both fiscally and intellectually. On the financial side, Southwest Airlines was the progenitor
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of profit sharing within the airline industry. Each employee had the
opportunity to participate in the profit-sharing program and to contribute to a 401(k) retirement account, with a hefty employer match.
Intellectually, employees at Southwest are given autonomy to make
their own decisions. Giving such power to employees enables them to
act quickly to resolve a customer’s problems, as an owner would do.
Planning and corporate layers dilute customer service, increasing the
time needed to find a solution. Not every decision will be perfect, so
Kelleher has been a big proponent of the motto “Ready, fire, aim.” It’s
much better to clean up a mess and learn from the experience than to
continually prepare but never act on an opportunity.
A great example of how quickly Southwest Airlines capitalized on
opportunities occurred in 1990. Midway Airlines announced that the
company was out of cash and was closing its doors in Chicago, providing any airline an opportunity to swoop in and take over. Southwest
was already prepared, with a team in Chicago before Midway’s
announcement was made. The next day, Southwest’s team of lawyers
was negotiating with Chicago city officials, trying to get the use of
gates at Midway Airport, while a team of service personnel was already
at Midway, on standby. By early afternoon, Southwest had agreed to
spend $20 million on Midway Airport.
Shortly after, the mayor had a press conference announcing the
deal, during which a reporter asked Southwest’s vice president and
general counsel when the public could see a sign of Southwest’s commitment. The VP replied, “Go out to the airport; you’ll see it right
now.”6 This speed allowed Southwest to capitalize on eighteen gates at
Midway Airport and gain a more than 50% market share.
By this time, Southwest had $1.19 billion in revenues and $45
million in profits. Thinking small and acting small was not lip service.
Southwest Airlines acted with nimble precision, whether it was generating $5 million in revenues or $5 billion in revenues.
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Additionally, each employee had a set of guidelines on how to manage their affairs within the company. Southwest Airlines has a crystal
clear mission that all employees can understand. Herb Kelleher has
gone so far as to state that if an individual were to ask any employee
the company’s mission, the employee would be able to describe it more
eloquently then Kelleher himself, because employees are on the front
lines. This mission and management philosophy had been embedded
in the culture from day one, and as the company grew larger, the company stuck to its principles with laser focus.
The first principle was to maintain a start-up-like corporate culture.
As other CEOs profiled here have demonstrated, a can-do, action-oriented work environment is much more efficient than a bureaucracy.
And as Southwest grew, Herb promoted the idea to continue simplifying. He has said on many occasions, “If we think small, we’ll grow big,
but if we think like we’re big, we’ll grow smaller.”7
Although Kelleher said “Think small,” this didn’t include simplifying by eliminating large numbers of employees. Southwest Airlines is
the only airline—and one of the few corporations in any industry—
that has been able to run for decades without ever imposing a furlough.
Cost reductions are found elsewhere, and that has promoted a healthy
morale within the Southwest Airlines corporate culture. Employees
have job security. A happy, well-trained labor force that only needs to
be trained on one aircraft promotes more-efficient and safer flights.
Southwest is the only airline that has a nearly perfect safety record.
***
There is a clear path of teaching from our first intelligent fanatic,
John H. Patterson, indirectly to Herb Kelleher. As we saw in chapter
1, many men who worked under Patterson at National Cash Register
went on to become successful on their own, using many of Patterson’s
principles. One of the more famous examples was Thomas Watson,
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who went on to mentor many others at IBM. In an interview, Herb
Kelleher told the following story about where he originally learned the
culture of risk taking and how to apply it at a company:
What I remember is a story about Thomas Watson. This is what
we have followed at Southwest Airlines. A vice president of
IBM came in and said, “Mr. Watson, I’ve got a tremendous
idea.” (Of course, this was long ago; the original Mr. Watson.)
“And I want to set up this little division to work on it. And I
need ten million dollars to get it started.” Well, it turned out
to be a total failure. And the guy came back to Mr. Watson and
he said that this was the original proposal, it cost ten million,
and that it was a failure. “Here is my letter of resignation.”
Mr. Watson said, “Hell, no! I just spent ten million on your
education. I ain’t gonna let you leave.” That is what we do at
Southwest Airlines.8
There are many examples at Southwest Airlines that demonstrate
exactly this type of risk-taking culture. One notable example, highlighted in the book Nuts!, by Kevin and Jackie Freiberg, is of Matt
Buckley, a manager of cargo in 1985. After working at Southwest for
three years, Buckley thought of a great idea: a same-day door-to-door
cargo service. The service would compete with Federal Express, which
Southwest had been using. Buckley drew up a detailed plan for his service, called Rush Plus, and presented it to Herb Kelleher and Colleen
Barrett. Both managers agreed to give the idea a chance and urged
Southwest to use Rush Plus exclusively.
It quickly turned out to be a mistake, but Kelleher and Barrett
did not think it was an absolute failure. Management had given an
employee the chance to try something out and to learn something,
even if it was unsuccessful. Buckley, on the other hand, reacted as most
employees would, with shame and embarrassment. The support of the
company helped Buckley learn from the situation:
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The more I was exposed to the jokes and jabs, the better I felt.
I finally realized that people were actually trying to help me
heal. Despite my overpromising and underproducing, people
showed support and continued to reiterate, “It’s okay to make
mistakes; that’s how you learn.” In most companies, I’d probably have been fired, written off, and sent out to pasture. But,
in this lifetime, I’d be hard-pressed to find the kind of love and
forgiveness bestowed upon me by so many to allow me to
save face.9
To Herb Kelleher, “anything worth doing always requires some
risk, and with risk comes failure.”10 Instead of thinking of risk in terms
of gambling and payoffs, Herb thought of risk-taking more like a scientist. The scientist sees whether something works, and if it doesn’t, he
quickly changes course, with little hesitation. The quicker an organization, management, and employees cut their losses, the quicker the
company can find a solution.
Herb Kelleher wanted employees to take risks; however, Southwest
as a whole never took big financial risks. It grew conservatively. The
company took its time when expanding outside of Texas, and only
expanded into areas that made financial sense. Expansion was done
mainly with internally generated funds, whereas other airlines were
piling on debt and growing for market share rather than for profits.
Southwest was preparing for a rainy day, and for opportunities.
Take, for instance, the Iraqi invasion of Kuwait, in 1990. Jet fuel
costs surged along with an economic recession—possibly the worst
combination of events for the airline industry. The lower traffic and
high fuel costs led two major U.S. carriers to file for bankruptcy and
one to liquidate. The remaining eight major airlines and two mediumsized national carriers were having significant difficulties, due to high
debt and being unprepared for the worst. Debt defaults, employee
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layoffs, and towering reported operating losses were common among
all of them, except one.
Southwest reported only a $4.6 million loss for the fourth quarter
and ended the year with more than $40 million in profits. Southwest
went on to have one more unprofitable quarter, in the first quarter of
1991. However, the company quickly turned the corner in the second
quarter and maintained profitability for the year.
There is another clear connection between Herb Kelleher and
other intelligent fanatic CEOs in this book: he created a culture that
focused on communication within Southwest and with the outside
world. Kelleher was able to distill complex ideas into comprehensible
information that every employee, regardless of position or intelligence,
could understand.
Southwest employees were encouraged to create the same type
of simple, effective communication. The employee communications
department produces the corporate newsletter LUV Lines, which clearly
communicates complex issues, such as how valuable each customer
interaction is to the company as a whole and how important every
employee’s efforts are to the company. An excerpt from Southwest’s
LUV Lines in 1995 shows how clear internal communication with
employees was:
How important is every Customer to our future? Our Finance
Department reports that our break-even Customers per flight
in 1994 was 74.5, which means that, on average, only when
Customer #75 came on board did a flight become profitable!
Aside from that statistical data, let me share with you a
down-to-earth formula devised by our Dallas chief pilot, Ken
Gile. It utilizes our annual profit and total flights flown to
clearly illustrate how vital each Customer is to our profitability
and our very existence.
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When you divide our 1994 annual profit by total flights
flown, you get profit per flight:
Then, divide profit per flight by Southwest’s systemwide
average one-way fare of $58:
The bottom line, only five Customers per flight accounted
for our total 1994 profit! In other words, just five Customers
per flight—only 3 million of the 40 million Customers we carried—meant the difference between profit and loss for our
airline in 1994. To take it a step further, to have lost the business of only one of those Customers would have meant a 20
percent reduction in profit on that flight. That’s how valuable
each Customer is to Southwest and you!11
Such clear communication helped employees understand their
significance in a large, multibillion-dollar organization. It also shows
how important each customer interaction is for the company’s wellbeing. As a result, employee morale continued to be as strong while
the company grew as it would have been if the company had never
grown at all. Communication with employees at Southwest is not
much different from the clear communication Warren Buffett has had
with shareholders and with his owned operations, through Berkshire
Hathaway’s annual shareholder letters. Intelligent fanatics are teachers
to every stakeholder.
***
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100 | Chapter 5
Herb Kelleher and other early Southwest Airline managers could have
been identified as intelligent fanatics early. So, what would be the
reward for investing with such special individuals, in such a horrible
industry? Investing in Southwest Airlines in June of 1971 and holding
until Herb Kelleher stepped down as CEO in 2001 would have produced life-changing returns, turning $10,000 into $7.4 million dollars, excluding dividends. This would be a 25% CAGR, compared to
the S&P 500’s return of 8.5% over the same period (see figure 5.1).
Figure 5.1
$10,000 Investment in Southwest Airlines Compared to S&P 500
(1971–2001)
Source: Compustat data
Interestingly, if one waited to invest until Southwest Airlines was
nearly profitable, in 1972, and held it until the end of 2015, then
that $10,000 investment would have turned into $52.4 million dollars.
That would be a 21.49% compounded annual return. The S&P 500
grew $10,000 into $184,500 during the same time period, or a 6.85%
compounded annual growth rate, which is barely visible in figure 5.2.
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Low-Cost Airline Wizard: Herb Kelleher
| 101
Figure 5.2
$10,000 Investment in Southwest Airlines Compared to S&P 500
(1972–2015)
Source: Compustat data
A true sign of an intelligent fanatic–led organization is that the
business continues to outperform even after the intelligent fanatic has
fully exited the business. Herb Kelleher stepped down as chairman of
Southwest Airlines in 2008, yet the company has been able to maintain
its culture and performance. Sales have grown from $11 billion in revenues and $178 million in profits, in 2008, to $20 billion in revenues
and profits of $2.2 billion in fiscal year 2015. The stock has continued
to outperform the S&P 500 (see figure 5.3).
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102 | Chapter 5
Figure 5.3
$10,000 Investment in Southwest Airlines Compared to S&P 500
(2008–2015)
Source: Compustat data
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