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You have to give Southwest Airlines CEO Gary Kelly credit. Analysts are constantly prodding him to embrace tried-and-true approaches for generating ancillary revenue. For the most part, he resists. He doesn't want to mess with the airline's secret sauce.

With higher fuel prices likely to stick around for the foreseeable future, U.S. airlines know they must increase revenue, both from fares and ancillary opportunities like bag fees and premium seats.

Even airlines like Alaska Airlines and JetBlue Airways, which historically have avoided nickel-and-diming their customers, have been adding fees in an effort to raise ancillary sales.

Not Southwest Airlines, though. Yes, in recent years, it has has been more aggressive with products like Early-Bird check-in, allowing customers to secure a better boarding position — and with that a better seat — by paying a fee. On Thursday, during Southwest’s second quarter earnings call, executives said that product is selling better than ever.

Most of Southwest’s core value proposition remains intact, and on Thursday CEO Gary Kelly reiterated the carrier has no plans to alter it despite higher fuel prices. That means the airline is unlikely to assess bag fees, assign seats in advance, or add premium economy sections in the near-term.

“I don’t think we need to change the essence of what Southwest Airlines is to find opportunities to drive revenues,” Kelly said.

Southwest is more insulated from higher fuel prices than most airlines because it hedges more of its fuel, but it is not immune. For the second quarter, it said its fuel cost was up roughly 17 percent-year-over year, less than the roughly 40 percent it would have been without hedges yet still a considerable increase. (Next year it is 64 percent hedged and if fuel moves above $80 per barrel the airline will benefit significantly, CFO Tammy Romo said.)

While Southwest is in a strong position, the higher fuel prices were a slight drag on earnings. The company reported net income of $733 million, down 1.3 percent year-over-year despite Flight 1380 in April, when a woman was killed after being pulled from a Boeing 737 after an engine failed. After that incident, Southwest executives said, passengers briefly booked away from the airline, and it needed to introduce a rare summer fare sale to make up for it.

Southwest’s unit revenue was down partially because of that event. Its revenue per available set mile, which measures how much an airline makes for each seat flown one mile, decreased 3 percent, year-over year.

Assigned Seating Not Needed

One easy revenue opportunity, analysts often remind Kelly, is assigned seating.

While many Southwest loyalists like the carrier’s open seating policy, some potential customers might be turned off by the boarding process, which requires most customers to check in 24 hours in advance and line up at the gate if they want a good seat.

On the call, analyst Duane Pfennigwerth at Evercore ISI asked Kelly if the airline would reconsider, noting that Ryanair — often considered a Southwest clone — generates considerable revenue selling seats in advance. Kelly said he couldn’t guarantee Southwest would never assign or charge for seats in advance, but said it has no plans to and is not evaluating it.

“Let me be very blunt, we are not looking at assigning seats right now,” Kelly said. “We are not talking about assigning seats now, and we’re not talking about looking at it sometime in the future.”

Kelly assured investors Southwest has more ideas for short-term revenue generation, though he declined to name them.

“Fortunately, I think there are a lot more opportunities,” Kelly said. “And when they’re ready for prime time, we’ll share them. … We’re not sitting idly by.”

Asked if Southwest might consider premium seating, such as a first class or extra legroom section, Kelly also said it’s unlikely.

“That’s not in the basket of things that I was alluding to,” he said. “Now having said that, we can always think about the opportunity. I would kind of lump that in with assigned seating, and that’s something that we could always do.”

He also said Southwest will keep free checked bags as they are. All Southwest customers get two free bags. Most carriers charge for bags, though airline-branded credit card holders usually get at least one for free.

“We try to avoid the complexity, make it really easy,” Kelly said. “You don’t have to jump through any hoops to have free bags on Southwest Airlines. And that works very well for us, and we get tremendous brand loyalty as a consequence of that.”

A long-time Southwest executive, Kelly appears to be more immune to the pressures of Wall Street than most airline CEOs. He reminded analysts Southwest is consistently profitable even though it rarely copies revenue-generating ideas from other airlines.

“We’ve been the largest airline in the country for 15 years,” he said. “I don’t like the saying if it ain’t broke, don’t fix it, but there’s certainly no evidence that it’s broken.”

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Tags: airline earnings, airline innovation, southwest airlines, U.S. airlines

Photo credit: Southwest Airlines CEO Gary Kelly said Thursday the airline has no plans to assign seats or add premium seats. 273475

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