The Secret of Southwest's Success: Free Whisky, Hot Pants and Low, Low Fares

24:27So saving a few minutes on every turn is huge. This means they have a very large cost advantage relative to the other airlines, right? They've just reduced their fleet by 25%, right? They've gone from four to three. And they can still do the same number of flights, right? Same amount of revenue, less capital costs. And the next year, 1973, with all these changes, Southwest turns a profit. Sort of amazing from what we know about the 1970s, right? Yeah, true. I mean, seriously, right? We have an oil embargo in 1973. We've got stagflation, huge inflation later in the 70s. This is not an era when every company is profiting.

25:14And when you want to be starting an airline. I mean, there is a theory that starting and growing during hard times makes you make better choices. Well, it is the case that Southwest, from 1973 on, is going to be profitable every year for the next 47 years. Stunning. Well, because think of the oil prices during this time. Think of the inflation during this time. You know, problems with unions. You're thinking about financial crashes, recessions. Yeah. Yeah. So we're going to take a break. And when we come back, we're going to do Southwest's big expansion, right? And Southwest is going to conquer America.

25:52From Texas to the country.

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28:19All right, Robert, we're back with more Southwest. It's the mid-70s. Southwest is there in Texas, starting to make a profit. These airlines that are flying cheap and making a profit are weird outliers, right? Because remember, any airline that's flying an interstate route is forbidden by law from lowering its prices. And like, why would you want to lower your prices, right? Like, you're a business. You just want to go to the government and say, hey, our costs have gone up. Can we charge more? And the government's like, yeah. People talk a lot about the competitive spirit. But like most people, if you've got a pretty sweet gig and you own an airline, right?

28:58You run an airline, life is good. It's a nice life. Yeah. And you're not like a crazy billionaire, but like you're rich. You have a pleasant life. You get to wear uniforms sometimes. Whatever. You get to fly wherever you want. So that's the way it worked for a long time. But then around this time, things start changing for a few reasons. One reason is the 747, the Boeing 747, the wide body. And of course, the airlines love it, right? Because it's the big, shiny new thing. You got to have the big plane. With the little hump on the top. Yeah, I love that bump. I love that, I know. More wild, over-the-top services you can provide.

29:33Air Canada puts a disco in its 747, almost two on the nose for the 70s airline. So good. Disco ball. You lower the lights and then people smoke a town. Smoking is what I go to for the 70s. So the airlines love 747s, in fact, too much. They buy too many of them. And so now there is a glut of seats flying around America. Airlines are flying all these planes largely empty. And then they notice over there, oh, look, Southwest. Southwest is making a profit by selling just cheap tickets, no disco. So the big national airlines start going to the government asking to do this unheard of thing. cut prices.

30:11And for the first time in like decades, the government says, well, okay, you can cut your prices. And surprise, when the airlines cut their prices a lot, they get more customers. People fly more. Those empty seats start to fill up. But there's another kind of big sweep of history thing happening. And that is a change in the way people think about business and government and regulation. And, you know, we talked before about this kind of mid-century world where the government was just much more involved in the economy in lots of ways and how that worked for people. But, you know, now we're in the 70s, and the 70s are a bad economic time, right?

30:55You have kind of the rust belt is starting, and inflation is coming and the oil crisis is there. And a huge distinction because when an economy is growing, you can actually be a kind of a bad business, you know, with heavy regulations. And every year, oh, you grow four or 5%. Everybody's happy. The government's happy. You're happy. Your customers are happy. But when an economy starts to shrink, this is where the problems happen because you're not used to it. And people start to rethink regulation. It's happening kind of popularly. and academically, scholarly, right? So the scholarly piece comes out of the University of Chicago, of course.

31:33This economist named George Stigler in the early 70s, actually right around the time Southwest is just getting its first flight off the ground, Stigler publishes a paper called A Theory of Economic Regulation. It winds up being a hugely influential paper, helps him get the Nobel Prize later on. And he lays out the key idea on the first page. He writes this. He writes, as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit. So what he's saying is you like to think government regulation is cracking down on those evil businesses in order to protect the public.

32:10Yeah, yeah, yeah. But in fact, what he's saying is that industries, especially incumbent players, want the regulation to keep out scrappy independents trying to come up and take your business. Yes. He is saying regulation exists for the benefit of the regulated businesses. And there is an economic term associated with this. It's regulatory capture, which means the regulators are captured by the industry they're regulating. So the FAA at the time might include people who worked at all the big airlines. Yes. And after you work at the FAA, where are you going to get a job? Yes. Oh, I don't know. How about American Airlines?

32:50Yeah. Yes. And in Stigler's theory, and I think it's fair to say, in fact, they were captured by the airlines they were regulating. And, you know, there's a case that when the airlines were just getting going back in the 30s, maybe it was reasonable for the government to regulate them, right? Maybe they would have priced each other out of business. Maybe they would have cut corners in a way that made it dangerous because of competition. But 40 years later, to still be blocking new airlines on the grounds that they'd be too cheap, like, that's regulatory capture. And it resonated not just as an academic idea, but as a popular idea.

33:28And it's interesting, the timing of this and the politics of this, because, you know, the sort of standard story of this is it happened in the 80s under Ronald Reagan. Right. Ronald Reagan brought this conservative revolution where he and the federal government deregulated the economy. But that's not true in the case of airlines. This started in the 70s. Ted Kennedy was a big proponent of deregulating the airlines. And Jimmy Carter, the Democratic president in the late 70s, appointed this skeptic of regulation to run the federal airline regulator. The CAB, was it the Civilian Aviation Board, I believe?

34:04That was this board that did all the pricing and stuff. And in 1978, Congress passed a law to deregulate the airlines. Bipartisan, Carter signed it into law. So now, all of these rules about who can fly where and what they can charge that have guided almost the entire industry, but not Southwest, are gone. And remember, at this time, people thought there was something very broken about America and American capitalism. Because in the 1970s, we're also seeing this sudden influx of Japanese cars, which they feel are cheaper and built better. And there was this overwhelming sense, I mean, I guess President Carter said it as this malaise, that like, we're a country that doesn't innovate.

34:46And part of the problem is the government at this point. Yes. And so now, airlines are deregulated. You would think this would allow for a wave of innovation, right? Southwest is like prime to start flying. You're telling the story like it's about to change everything. It's really interesting what happens because they can go wild, but they don't really. They don't. And I think it really shows sort of the difference between their kind of public persona, the corporate brand on the one end, and their behavior as a company on the other. Like, think about it, right? Like, their reputation is the goofy Mavericks, you know, the flight attendants making dad jokes during the safety announcements.

35:30And, like, there was this famous basically publicity stunt one time where there was a trademark dispute with some other company, Plane Smart, P-L-A-N-E Smart, right? And they decide they're going to settle it by Herb Teller having an arm wrestling match with a guy from the other company. And they do this like pro wrestling match and Herb loses and gets carried out of the room on a stretcher with an IV bag of wild turkey. Right. And he rides a Harley Davidson and whatever. This is the brand. But from a business standpoint, from an efficiency standpoint, Southwest is nothing like that. They are, in fact, incredibly disciplined.

36:06And so what you see is in the decades after deregulation, it's the other airlines that are going wild, transforming themselves, spending tons of money, going bankrupt. And Southwest is the one that is cautious and disciplined. If they were like maverick outliers in any way, it was that. It was by being like cautious and efficient. Which is amazing, right? All that cigarettes and whiskey. And the moment the market goes free, what you realize is maybe what I was talking about, about what Warren Buffett said, which is, in a business like this, the way you're going to win is to just be ruthless about your bottom line.

36:45Yeah. About your costs. Yeah. There's no advantage of one airline over another. You can try all the discos you want, but it's essentially a commodity product. And in a commodity product, you have to watch every cent. Robert, I've prepared for you a list. I love a list. Five ways in which other airlines went wild and Southwest didn't. in these years after deregulation. Number five, super premium comfort economy class plus. So you know, right? So there was first class and there was whatever, business class and premium economy comfort plus, more leg room, even more leg room. And you know, there is a logic to this, right?

37:23Which is, oh, different people will pay different prices. You know, if people want to pay for more, for more, let's do that. Southwest is like, you know what? We got one kind of seat. It's just a regular seat. We'll fly you from one place to another in that seat. Number four. Selling tickets everywhere. Oh, interesting. Travel agents were still big in the 80s. And then, you know, in the 90s, the internet comes along, and you get your Orbitz and your Expedias coming along, you know, online travel sites. I'm a kayak man. Southwest didn't care that much about travel agents and was not even on Orbitz or Expedia or Kayak actually until like last year, forever basically.

38:04I don't know if you ever noticed that. If you did a kayak search, they didn't come up. I did. You'd have to do separate searches for Southwest. And so there's a straightforward reason for this. When you buy a plane ticket through a travel agent or through Expedia or kayak, the intermediary gets some of that money. And Southwest wants to get all of that money. And so they're just like, no, we're not going to sell through those intermediaries. So funny, right? Airlines are this glamour business, or they were for decades. And like the airline CEOs at Delta and American, they don't want to be trying to save what is a half a percent, one percent.

38:38They want to sell more tickets that not Southwest. OK, number three, hubs, hubs. So after deregulation, now remember, airlines can fly wherever they want. They're not constrained by the government. And they're like, we're going to fly everywhere. And the way we're going to do that is the hub and spoke model. Right. So we're going to pick a city and tons of flights are going to go in and out of that city. And that way people can go wherever they want. They just got to go through, you know, Atlanta if you're flying Delta or Dallas if you're flying American. Southwest? No. No. Southwest is like, you know what?

39:12We're just going to fly people from Phoenix to L.A. And we're going to fly 10 flights a day and it's going to be cheaper and it's going to be great. We're not in the business of flying people wherever they want to go. We're in the business of flying profitable routes where we can sell cheap, reliable tickets. They've done the research. They know that people are paying a lot of money. They know that they can undercut the current fares and that there'll be enough people to fill the planes. Yes. And by the way, when they go into a new city, they typically go into not the main airport, right? Have you flown Southwest?

39:42Oh, yes. I've seen a lot of the country in strange small airports. Yeah. I used to fly San Diego to Oakland all the time. So, you know, in San Francisco, San Francisco is the big airport. I've done Oakland to Burbank. That's San Francisco to L.A. to other people. But to me, it is Oakland to Burbank. And there is a reason for this, right? It's those airports tend to have cheaper gates, right? Airlines have to pay for gate space. Southwest, you know, their passengers are not flying onto Tokyo or whatever. If you're American Airlines, you've got to go to JFK or LAX or SFO. Southwest is that they're not in that business.

40:21And also, those airports tend to be less crowded, which makes it easier to do a fast turn, right? They get jammed up less. Oh, interesting, right? Because you can get right on the runway. Number two. Yes, that's where we are. Planes. After deregulation, the airline's like, we can fly anywhere. And for little routes, we're going to get little planes. And for medium-sized routes, we're going to get medium planes. And for big routes, we're going to get big planes. Southwest does not. With one very brief exception, they have flown one kind of plane the whole time, the Boeing 737, which in keeping with the Southwest vibe is not a tiny plane.

40:56It's not a giant plane. It's just a plane. It's so funny, right? Boring is their competitive advantage. Yeah. And like, just think about the efficiencies on this one, right? I mean, from small ones and big ones, you only got to print one seat back card. Yeah, the pilots can fly any plane if you have to move. Yeah, yeah, yeah. Will you need a pilot get sick? You know, is this pilot certified on this plane? Yes. The answer is always yes for Southwest. Even, you know, the things like getting the baggage in and all the logistics, it's always the same. If they need to swap in a new plane, they always got the right plane.

41:26It creates this incredible efficiency of standardization. This would be enough for any business. But you're telling me there's one more, the number one reason. Yes. And it's kind of a meta reason. It kind of flows through all of these. The number one reason that Southwest was able to stay efficient and profitable when all the other airlines went wild, they never tried to be number one. Think about this. I actually think this is really an important one and useful to think about. Airlines tend to attract big ego CEOs, right? I mean, most big company CEOs have big egos. But the airline business, as we've been discussing, is a bad business.

42:05You're not getting into it because you want to be rich. You're getting into it because, like, you want to fly the big planes. You want to beat everybody else. You want to be the most glamorous airline in the sky. You're right. And they're kind of obsessed with this in the same way that broadcast TV used to be like, ABC's number one this week, NBC's number one the next week. And they want to be the number one airline in the world. In fact, when they are, don't they put that on their ads? Like, oh, more people fly so-and-so than any other airline. And you really see this. Like, when you read histories of the period, they're like, personally, the CEOs are personally obsessed with beating their rival.

42:37And Southwest is not. There's this really simple but great quote from Herb Keller, market share has nothing to do with profitability. Oh. No, it's so true. We don't want to fly more people than anybody else. We just want to make more money than we spend flying people. This whole story is like an indictment of the way Americans do business, at least for a certain period of time, right? That they want the regulations, they don't want to compete. They want to be number one, even if it means it costs their investors money. But not Southwest. And this is why I think this is at the core of Southwest success, right?

43:22Like every other major airline that still exists that was around at deregulation has gone bankrupt at least once, some more than once. Southwest has not. They have been profitable every year for 50 years, with the exception of the pandemic of 2020. But as we will discuss after the break, a lot of those things from that list of what made Southwest great are about to cause it some real trouble.

44:03Did you ever notice how you spend hours shopping online only to pause right before you hit buy now? That tiny hesitation, the one where you wonder if it's trustworthy, can make or break the sale. Now, with AI changing the way we discover and compare things, that split-second trust question matters more than ever. That's where PayPal comes in. For more than 25 years, PayPal has been a leader in online payments. And now they're at the forefront of agentic commerce, making it work for businesses, letting them maintain control of their brand and their customer relationships. So even as the way we shop changes, the moment that matters most still feels familiar and deeply dependable.

44:46Built for payments, growth, and agentic. PayPal Open. Built for all business. Visit paypalopen.com to get started. If your best finance people are doing expense reports, chasing receipts, or spending time on month-end close, it's time to get Brex AF, a gentic finance that eliminates that work before it starts. Learn more at brex.com slash AF. Hey, it's Jacob Goldstein from Business History. In our new series, American Genius, we tell the stories of three great writers who changed the way business works in America. Our first episode is about Benjamin Franklin, who, among many other things, was a best-selling business writer.

45:28Take a listen. He's writing this much later in his life, consciously creating this image of himself. And I do want to emphasize how unusual this model is at the time, this self-made man myth, because you don't want to be self-made. It's low class to be self-made. You know, this idea that we have today is the opposite. Right. And it comes from Franklin. Today, there is the derisive term nepo-baity. Well, exactly right. And these days, if you are a billionaire, you had better have a Benjamin Franklin story about starting in a garage, coming up with the idea from nothing. And here is Benjamin Franklin inventing it right before our eyes.

46:11This has been brought to you by Odoo. To listen to more of our American Genius series, listen to business history. New episodes release every Wednesday on the iHeartRadio app or wherever you get your podcasts.

46:38Okay, so we're back with the Southwest story. Southwest has this amazing run, not just year after year, but decade after decade. And by the time Herb Keller dies in 2019, Southwest is carrying more passengers than any U.S. airline. Not that they care. That's amazing. They're big and successful, but trouble is coming. They're about to hit this run of trouble. And in a lot of ways, the same things that made them successful for all those years are going to be key causes of their problems. The first thing that goes wrong, it starts in like late 2018, early 2019, when there are two separate plane crashes.

47:22One is in Indonesia, one is in Ethiopia, they're different airlines, but both are Boeing 737s. 737s. This is a huge news deal. It was a big deal because it was the newest version of the 737, the 737 MAX. And in March of 2019, the FAA grounds all 737 MAXs in the U.S. So these are 737s. Remember, Southwest is the airline that only flies 737s, which has been great until now. But now, unsurprisingly, they have more 737 Maxes than any other airline. And they get hammered, right? Like, they now have to cut back on their service. To be clear, they don't have to shut down. They're not flying solely 737 Maxes, some of the older 737s.

48:11But they lose something like a billion dollars in revenue because of this. This is the classic tradeoff between efficiency and resilience. Yeah. Right? And we saw this a lot in the pandemic with shipping, you know? Yeah, like supply chain stuff and just-in-time delivery. Yeah, if you had a really efficient supply chain, you were also the one most at risk for something going wrong because you didn't have a lot of other sources for your materials. Yeah. So in this analogy, Southwest was super efficient. Very efficient. But they had this huge risk just sitting there. So they lose a billion in revenue.

48:42They cost some of that back from Boeing. But, you know, it's a blow. Not a death blow, but a blow. And then 2020, of course, you get the pandemic. Terrible for all airlines. only year since 73 that Southwest didn't turn a profit. Bad, but again, not devastating. It's after the pandemic that things keep going wrong and get worse for Southwest. 2022, the big legacy airlines, Delta, United, American, they are doing great. There was this rebound travel, right? Everybody had saved up their money, and they were like, I'm going to Europe. I'm taking the big planes. I'm going. Stimulus checks. Government sends you a check.

49:19You just sign it over to Delta and go to Europe. And, you know, this is a moment when a lot of people are feeling rich, right? Like when you look at people's bank balances at this time, it's wild. Like people, in fact, got richer. And so this is a moment when you will pay for premium economy comfort plus, right? This is a moment when you will fly to Europe. And all of those behaviors are not Southwest behaviors, right? This is not a simple plane. This is not Phoenix to LA. This is not weird little airports, right? So this is a moment when everybody else is coming back and Southwest is kind of muddling along.

49:53And then really the big blow, the big blow comes in December of 2022. Not long before Christmas, this giant winter storm hits the East Coast and upper Midwest. Airports shut down. Lots of airlines cancel flights, you know, up and down. Luckily, there's not news crews who would, like, go out to the airports and stand there for 48 hours straight. Luckily, it's not Christmas time when there's no news and they're so happy to go to the airport with people sleeping on the ground. I could verify this was a big deal. This was a big deal. And for most airlines, it's like, yes, there's a storm. And now a day, two days later, we're back up and running and everything's fine.

50:36But Southwest at this moment has this epic, epic collapse. They cannot get things going. And the storm has passed, but Southwest is still largely grounded. They cancel more than 16 ,000 flights. They leave something like 2 million people stranded. And when they figure out what went wrong, it turns out it was this one internal software system that was supposed to reassign Southwest crew members when a flight got canceled or rescheduled. And it just completely failed and they couldn't get it back up. So think of this, right? Like the company doesn't even know where their flight crews are and the crews themselves, like they want to work, they want to get things going in.

51:21The crews themselves have to actually, like, call on the phone, like, ordinary schmuck passengers to find out where to go to work. They have to wait, you know, hours on hold. When they get through, people don't even know because, like, some poor person at headquarters is trying to figure all this out on a piece of paper or something. It's a disaster for Southwest. Was it because of Southwest's cost-cutting? Was this one of the ways they cheaped out by having, like, a 1970s internal system? So the CEO perhaps predictably said, no, no, this was just like an unfortunate, you know, he actually I think used the phrase perfect storm.

51:56But the union leaders at the company, the people, you know, who had been negotiating with the CEO for years said, no, no, we have been telling you for years that this system is out of date and it's going to fail. So maybe it was because they were too cheap. You know, what is efficient and what is too cheap? In any case, this is a disaster for Southwest, right? Days and days of news coverage. So Southwest winds up paying something like$750 million in reimbursements and penalties. And now things are bad for the company, right? Their profits are stagnant even as the industry is coming back. Their stock price falls by more than 50 % between 2021 and 2023.

52:39By 2024, the stock is still below where it was before the pandemic. I feel like if Herb Kelleher were still around, he would say, go with the plan. Like, this is what our company does. Stay the course. And yes, there will be disasters that happen. But like, we have the better business model. Go, go, go. I mean, it's interesting to think about him having died like just before Southwest ran into so much trouble. Is that correlated? I don't know. In any case, that is basically what Southwest was trying to do, just keep being Southwest. But if you're a publicly traded company with still a pretty good brand and your stock price is way down, what happens to you?

53:24You get a call from Wall Street. You get a call from Wall Street, right. And in this case, it was an activist hedge fund called Elliott that bought something like 10 percent, more than 10 percent of the company's stock. And what Elliott does is this kind of thing. They buy up stock and try and turn companies around. Yeah, you accumulate until you have to announce how much you own of the company. And then you write a strongly worded letter. To the board. To the board. So in its letter to the board in 2024, Elliott writes, quote, While Southwest has a proud history, that history is not an argument for supporting poor leadership and sticking with the strategy that no longer succeeds in the modern airline industry.

54:05This is what they do. And they're hoping, they're taking the bet that they can make dramatic changes, maybe not long-term changes, but maybe some short-term changes to increase the value of the company and then get out of the business. And they're saying, like their idea is Southwest, you should become more like everybody else, right? That is the subtext of a strategy that no longer succeeds in the modern airline industry. Oh, and also they want him to fire the CEO, of course, because they always want him to fire the CEO. But what's interesting to me is that other part, right? Their strategy no longer succeeds in the modern airline industry.

54:36Because in a lot of ways, if you think about Southwest at the time of deregulation and the rest of the industry, or in the 80s when they're all going wild, in some ways, it's the rest of the industry that has become more like Southwest. What made Southwest different was really cheap prices. But now, there are ultra-low-cost carriers with really cheap prices. There are also, you can fly basic economy on Delta. As I do every time. I'm wearing extra sweaters because I can't fit in my luggage. I'm sitting across from you in the row, just one from the back of the plane. You paid less. Close to the bathroom.

55:12You know, even in terms of vibes, right? Think about vibes. When Southwest launched, they were like the friendly, hey, we're your pal airline. And the others were like the more formal kind of corporate airline. Now, like every company is your pal, right? I tell the jokes, yes. And when you fly now, right, when you fly now and you see college students flying for the weekend, you see ordinary people who are not business people flying. When you see people flying who aren't rich, frankly, who aren't, you know, upper middle class, like that is Southwest. This is fascinating. So I'm right in a way that sticking with the plan is the most efficient way to go.

55:50But what I didn't include is that other airlines are also doing the same plan. Your competitive advantage was that you were cheaper, more nimble, able to make these decisions better than other airlines. And once everyone does it, what do you got? So what has Southwest done under this pressure? Well, they didn't fire the CEO, but they are changing, right? There were still those things about Southwest that were different. You know, they still had one kind of seat. You still didn't get a seat assignment. No longer. Starting on January 27th, 2026, Southwest passengers will have the choice of standard, preferred, or extra legroom.

56:31I'm a little sad. Yeah. End of an era. I mean, yeah. End of an era. Yeah, it was a good run. It was a pain in the ass era, but end of an era. I mean, it was a good run. It was a great run. For the airline industry, like, I'd take 48 years. For the first time in the history of Southwest, everybody's going to buy an assigned seat. Not me. I'm going Herb Kelleher style. I'm going to just walk on the plane and sit wherever I want to. I love it. That's the end of the show. We'll put a list of sources in the show nuts. That's the end of the show. You said show nuts. because we're in the airline. That's the end of the show.

57:12We'll put a list of the sources in the show notes. I do want to mention one book that I found particularly useful. It's called Hard Landing. It's by Thomas Petzenger Jr. And it's an old book. It's the story of what happened right around deregulation, kind of before, during, and after. And it's a very good nonfiction book. Our showrunner is Ryan Dilley. Our producer is Gabriel Hunter Chang. And our engineer is Sarah Bruguer. I'm Jacob Goldstein. I'm Robert Smith. We'll be back next week with another episode of Business History, a show about the history of business. Robert Smith, as you know, there is nowhere in Pushkin's office to make a video, to make a video podcast, which is unfortunate.

57:51We tried and it was described as two gray men in a gray box. And reasonably so. Fortunately for us, in an amazing coincidence, literally down the hall from Pushkin's office, there is the showroom of a company called Buzzy Space. This is a company. It's where we're sitting right now. And what they do is they design furniture and acoustic solutions that make, I'm reading here, workplaces more comfortable, more creative, and more fun. I would even say cozy. Their furniture is like sort of curved and interesting colors and I guess keeps things quiet. Yes. Honestly, I wish our office was this showroom.

58:30You can find more at Buzzy.space. That's B-U-Z-Z-I dot space. Did you ever notice how you spend hours shopping online only to pause at checkout because you wonder if you trusted enough to hit buy now? Agentic Commerce is testing that moment more than ever. That's where PayPal comes in. With 25 years of checkouts, 400 million consumer accounts globally, and the benefit of fraud protection. So no matter where a purchase starts, it ends with trust. Built for payments, growth, and agentic. PayPal Open. Built for all business. Visit paypalopen.com. If your best finance people are doing expense reports, chasing receipts, or spending time on month-end close, it's time to get Brex AF.

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