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Southwest Airlines still flying high

The airline industry is in full retreat against overpowering fuel prices — slashing flights, raising fares and slapping consumers with new fees for everything from checked bags to a packet of peanuts.

All the airlines, that is, except Southwest Airlines. The Dallas-based low-fare carrier still allows passengers to check luggage, munch on snacks and sit where they like without doling out extra cash. And while it has raised fares this year, the airline continues to set the lowest prices in the industry on most routes.

It’s all part of a very different strategy for dealing with the run-up in fuel prices. Rather than sharply raising fares across the board, Southwest is trying to attract more higher-paying business travelers. Instead of hitting customers with multiple new charges, the airline is trying to draw more travelers by marketing itself as the “no-fee airline.” And while others are shrinking, Southwest is continuing to grow and take advantage of opportunities on routes vacated by competitors.

“Southwest is perfectly positioned competitively with the network airlines in full retreat,” said Michael Derchin, an airline analyst with FTN Midwest Securities, in a recent report on the airline.

The carrier has “a unique ability to generate strong revenue growth in a weak economic setting, while maintaining the lowest cost structure in the industry, despite a high fuel-cost environment,” he said.

The strategy’s architect, Gary Kelly, recently solidified his position at Southwest by assuming the position of chairman as well as chief executive officer. In July, he will become the company’s president as well.

He takes those titles from two of the industry’s titans — Herb Kelleher, Southwest’s legendary co-founder and chairman, and Colleen Barret, who rose to the president’s job by helping to build the airline’s employee- and customer-centric corporate culture.

“It’s obviously a very challenging time for the industry,” Kelly said. “We’ve got a lot of work ahead of us.”

The airline’s biggest advantage right now is its hedging program, which allows it to purchase much of its jet fuel at lower prices. While Southwest still feels the sting of the spike in prices, it is far more muted than at competitors such as American and United.

Analyst Kevin Crissey of UBS predicts that Southwest will be the only large airline to turn a profit this year, largely because of its fuel hedges.

That partial shield has allowed Southwest the breathing room to plan a long-term strategy rather than making desperate moves to stem the bleeding. Indeed, some of Kelly’s plans to bring in more money, such as in-flight Internet service and partnering with another airline to offer international flights, won’t be rolled out until next year at the earliest.

And there are no guarantees that the carrier’s course will mean a smoother flight.

“We’re in a transformational phase,” he said. “We have great enthusiasm that [our plans] are going to work, but there’s still a risk.”

No frills, no fees

American recently announced plans to begin charging $15 each way to check the first piece of baggage, and other airlines are considering similar changes. American also increased fees for a host of services, including flying with pets, having overweight luggage and unaccompanied minors.

U.S. Airways said Thursday that it will no longer provide free snacks in coach. Northwest has begun to charge passengers extra to sit in the exit row, while AirTran Airways charges to reserve a seat in advance.

But Kelly is skeptical that so-called unbundling of charges is the answer.

“Customers hate all that stuff,” he said. The airline has a 37-year history of providing low-price service, he said, “and we’re going to live up to that and deliver what our customers have come to expect.”

Instead, Southwest has been using its refusal to levy extra charges as a marketing weapon. A commercial features a flight attendant from an unnamed rival reading a long list of fees and says customers with questions can press the attendant call button “for a minimum fee of $1.”

“We want to differentiate and celebrate those differences,” Kelly said.

Focus on business

But Kelly said he is more interested in drawing passengers, typically business travelers, who tend to pay more for fares because they’re purchased at the last minute. Earlier this year, the airline unveiled its new “Business Select” fare, which is generally about 10 percent higher than its average prices.

The business fare includes priority boarding and a free alcoholic drink, and it is fully refundable.

About 5 percent of travelers are buying the new fare, Kelly said, and it generated about $15 million in additional revenue during the first quarter. He expects that number to rise as Southwest increases its marketing to business fliers.

Southwest is also upgrading its frequent-flier plan, typically a major draw for business travelers.

“When you go into a new market against an entrenched carrier, it can be challenging to get those business travelers who are wedded to that frequent-flier plan,” he said. “It can be tough to get them to jump to the good guys.”

Kelly said he was developing “some interesting techniques” to improve Southwest’s “Rapid Rewards” plan, but he wouldn’t disclose specifics. He added, “We’ll have a lot to talk about on that by next year.”

The airline is also planning on drawing more passengers by offering flights to international destinations as early as next year. Southwest won’t fly directly to foreign cities but will partner with another airline to provide the international segment of a trip. The two airlines would split the revenue from each shared passenger.

Kelly sees Southwest offering fares to Mexico, Canada, the Caribbean and Hawaii with one or more partners.

Continued growth

The airline is adding 13 planes to its fleet this year and is tweaking its schedule to take advantage of pullbacks at other airlines.

For example, the airline recently said it would launch six new daily flights from Denver, including two new destinations from that city — San Francisco and Omaha.

“It’s a tough decision in this environment to continue to grow,” Kelly said. “So there’s a limit to how much we’re willing to do.”Still, he said, his planners are watching other airlines cut back and are looking for opportunities.

“We have to have the airport facilities, planes and flight crews, so we can’t always react quickly,” he said. “But we’re making some educated guesses.”

He said the Denver expansion was “a no-brainer,” given growth in the market and United Airlines’ loss of market share.

He added that growth can be successful only if costs stay in check and revenue expands as well.

“Otherwise, it makes no sense to grow the fleet,” he said.

Kelleher, the Southwest co-founder who handed the reins to Kelly on May 21, said he’s confident that Kelly is the right man to steer Southwest on its new course.

“He has done one heck of a job, and I can’t imagine anyone who would be better,” he said. “I feel like Southwest is in very good hands.”