When Southwest Airlines evaluates routes, it researches at all the data you expect, including how many travelers fly on existing flights, and the average fares they pay. But for leisure opportunities, it often examines something else — potential credit card applications.
For U.S carriers, credit card partnerships are big business, with banks locking up airlines in multi-year deals worth billions. Companies like Chase and American Express buy points and miles from airlines and use them to reward their big-spenders, allowing travelers with the right cards to fly “free.” It complements the traditional free ticket approach in which Southwest rewards its flying customers with points. But credit card deals are so lucrative some airlines are ambivalent about whether a customer pays with points or cash.
“The credit card is core to the airline business,” Andrew Watterson, Southwest’s chief revenue officer, said in an interview.
Southwest has long known its highest-value customers — both frequent flyers and consumers who have its Chase credit card — want free flights to Hawaii. Until recently, it didn’t have an airplane that could make it year-round with a full payload, but now that it has the 737Max, Southwest soon will add Hawaii from the West Coast, though it hasn’t said from where. (Southwest will start Hawaii flights with older 737-800s, but those aren’t viable aircraft for the routes long-term, Watterson said.)
The Hawaii new routes could help increase credit card sign-ups in San Diego, Sacramento, the Los Angeles basin and the Bay Area — markets where the carrier already has a strong presence.
“It’s not just for credit cards, but it is part and parcel of it,” Watterson said. “We view Hawaii expansion as something that will ignite credit card applications.”
The Hawaii expansion is not the first exotic destination where Southwest has considered credit card sign-ups. Watterson said Southwest has expanded into Mexico and the Caribbean in part for similar reasons. Yes, customers might be happy about redeeming a free flight from Chicago to Omaha for Thanksgiving, but what what gets them excited about applying for a new card is the chance to visit Cancun during spring break. “You have that kind of sexy place for the credit card,” Watterson said.
How did Southwest survive for all those years without any “sexy” destinations?
Its core business has performed well, with the carrier leveraging its cost advantage against legacy rivals. But Watterson said it’s also because this credit card phenomenon is relatively new. While customers have always carried airline-branded cards, profits didn’t pop until recently. At its 2017 investor day, Southwest said revenue from the Rapid Rewards program increased by $1.7 billion between 2011 and 2016.
“It’s a post-Great Recession thing,” Watterson said. “Even before then, it was interesting, but I think as the economy strengthened and the airlines went through the re-negotiations with the banks, it got to the point of critical mass.”
In a research note in February, Joseph DeNardi, an analyst with Stifel, estimated Southwest earned roughly $2.8 billion last year from selling miles to Chase, an increase of roughly $544 million, compared to the prior year. In the note, he said all carriers are benefiting as “high margin, less cyclical revenue continues to be transferred, en masse, from credit card issuers to airlines.”
In all, Southwest customers redeemed 9.6 million reward tickets in 2017, accounting for about 13.8 percent of the airline’s capacity, according to an SEC filing. That’s about twice as much capacity as other airlines permit for award travel, DeNardi said.
This doesn’t mean Southwest will start otherwise money-losing route just to spur credit card applications. The new Hawaii flying — Southwest said it will start selling tickets later this year, but hasn’t said when flights will begin— should help the airline improve its competitive position on the West Coast.
Southwest seeks to be the preferred airline in California, and it wants to have at least as much breadth and depth in North America as its competitors, including Alaska Airlines and United Airlines. Watterson said travelers in Oakland, Los Angeles and San Diego expect their favorite airline to carry them to Hawaii, just as JetBlue loyalists in New York count on it to fly them to Florida and the Caribbean.
The good news is Hawaii is generally a stronger market than many East Coast leisure destinations. Though many carriers, including United and Hawaiian Airlines, have been adding capacity to the islands, fares remain relatively high. And, unlike the Caribbean, Hawaii is a place tourists want go year-round.
“You can offer $0 leisure fairs and you can’t fill your airplane to the Caribbean in September,” Watterson said.
Here are some other takeaways from our recent discussion with Watterson.
Europe Not on the Table
The Boeing 737 Max is also capable of flying to Europe from the Eastern United States. But for now, Southwest isn’t keen on the opportunity, Watterson said.
“Europe is not ruled out,” he said. “It’s just that the priority is so low so there is no working going on to study it. It all comes back to what our customers are demanding. Right now, we find that we can be the hometown airline in many cities and not provide transoceanic service.”
In the near-future, other than Hawaii, many of Southwest’s new routes probably won’t be so exciting. Most of them fall into the “connect the dots” category, or adding service in markets where the airline is already strong. On March 8, as part of this strategy, Southwest announced new daily routes from Houston Hobby to Columbus, Ohio and Louisville, Kentucky, and from Denver to Memphis.
“Almost anyplace where we are the hometown carrier we are far from finished,” Watterson said.
The “connect the dots” mantra works for international flights, too. Southwest likely won’t open new markets in Latin America and the Caribbean, but it could add new routes at airports it already serves. An airport where Southwest is strong might get a new route to Cancun, for example.
Little Interest in Smaller Markets
In recent months, United and American Airlines have showed new interest in smaller airports, such as Wilmington, North Carolina, South Bend, Indiana and Kalispell, Montana. Fares are higher in those markets, and major carriers like using 50-to 76-seat regional jets to fly small-town passengers into their hubs.
Southwest doesn’t have much interest in smaller markets, Watterson said, preferring larger cities where it can fill its smallest plane, the 143-seat Boeing 737-700. When it does consider smaller airports, it prefers secondary airports near major cities, such as Long Beach and Burbank near Los Angeles.
Still, Southwest is watching its competitors, particularly since United said it plans to grow 4-6 percent in 2018, 2019 and 2020, with much of it coming in three markets where Southwest has a big presence — Chicago, Denver and Houston.
“When a competitor grows in our focus cities we certainly pay attention to it,” Watterson said.
No Basic Economy
Four of the five largest airlines in North America — all except Southwest — now have a no-frills Basic Economy product.
And two others, Alaska Airlines and JetBlue Airways, have said they’re considering it for competitive reasons. Executives at Alaska and JetBlue say it’s tough when an airline like United undercuts it on price for a fare that doesn’t include a free carry-on bag. But passengers may buy the United because it shows up first on Kayak.com.
But Southwest, which sells its tickets directly to consumers, still does not want a no-frills fare, Watterson said.
“We encourage all the other airlines to have Basic Economy,” he said. “We love competing against substandard products.”