Air Herb's secret weapon.

No, it's not fancy stealth technology - that's our flight of fancy behind Herb Kelleher - but it's every bit as formidable. The question is, how long can Southwest Airlines maintain its flight path when the time comes for him to leave the CEO 

Low costs; high spirits. This aspect of Southwest Airlines has been well documented. But the company's true innovation is that its short haul, high frequency, low-fare strategy is aimed not just at other airlines but at surface transportation. Southwest occupies the nexus between two market spaces, the flying passenger who doesn't wish to pay for things that are not important, such as meals or reserved seating, and people who might otherwise consider driving to their destination. In doing this, the company has forged a unique culture, one that is inseparable from its folkloric CEO, Herb Kelleher, and uses it as a clever competitive weapon to establish dominance in a new market.

In their chronicle of Southwest Airlines, Nuts!, Kevin and Jackie Freiberg write: "The idea of corporate culture is too important to the effective functioning of today's corporations to be dismissed as a 'fleeting craze. Culture is the glue that holds an organization together." As he relates in the

following interview, Herb Kelleher credits Southwest's culture for achieving financial results and maintains that it's the one task on which he works the most.

If Joseph Campbell, author of The Hero with 1,000 Faces and celebrated Princeton scholar of the world's mythologies, were alive today, no doubt he would find Southwest Airlines worthy of closer study. (Heaven knows everyone else has; on "corporate culture" day held twice a year, the company charges some 150 outsiders $100 each to attend.) The bedrock values of the company are evident in what Campbell would call its foundation myth. After graduating from NYU Law School in 1956, Herb Kelleher clerked for a New Jersey Supreme Court justice for several years before joining a Newark law firm.

Becoming increasingly restless, he was attracted by the opportunities in Texas, from whence his wife hails. Soon the Haddon Heights, NJ, native, whose first paying job was as a branch manager for the Philadelphia Bulletin earning $2.50 a week, was working for a Texas law firm. In 1966, a Texas businessman, Rollin King, who was planning to launch an intrastate airline, hired him as an outside counsel. (The business plan was drawn up between the two men on a cocktail napkin in a local bar.)

From the outset, the fledgling company was almost shot down by legal challenges from rival carriers Texas International, Braniff, and Continental, which tried to persuade Texas courts that the state couldn't support another contender. Kelleher, by now a partner in the venture, argued the case all the way to the U.S. Supreme Court and won. Since then the company has always thought of itself as an underdog, its employees wearing that moniker as a badge of pride.

When Southwest finally received permission to operate in 1971, it had four Boeings and less than 70 employees, barely enough to operate. When it could not meet payroll, the company had to make a choice: sell one of its planes or lay off people. It decided to do the former and asked its employees to cut turnaround time at the gate from 55 to 15 minutes. The tradition of Southwest employees, from pilots to ramp agents, pitching in to do what's necessary in order to help the company was born.

Kelleher himself tries to set an example: A Dallas teacher once wrote to him saying none of her students had ever flown on any airline. He sent the class on a free round trip to Austin and threw in a tour of the capital. When it was pointed out to him that mechanics on the graveyard shift found it difficult to participate in company picnics, he held a 2 A.M.. bar-b-q with himself and the pilots as chefs. At company gatherings he arrives on a motorcycle in jeans and a T-shirt. He sings rap songs with lyrics that make fun of himself.

When Stevens Aviation, a South Carolina charter company, used "plane smart," a Southwest slogan, in its TV ads, Kelleher contacted Stevens' CEO Kurt Herwald, and suggested that they settle the dispute, not with lawyers, but with a CEO-to-CEO arm wrestling match. (Southwest got to keep the slogan.)

Halloween is practically a national holiday at Southwest, with people going to great lengths in costume creation. Last year the women in the communications department dressed up as "Herb's killer tomatoes." Yes, it's true Kelleher once showed up dressed as Elvis, but folklore notwithstanding, he never dressed up as the Easter Bunny. "Hey, I've got a corporate image to maintain here," he jokes.

Part of the fun is reserved for passengers who might find a flight attendant greeting them from the overhead cargo bin or singing the flight safety instruction to a C&W tune. Others find entertainment in watching the frenzied crews turnaround planes in less than 20 minutes, less than half the industry average. (Total operating costs are about half the industry average.)

Passengers also like the low fares. Southwest's average one-way airfare is $75 with an average trip length of 441 miles. The carrier is among the most generous in the industry in compensation and benefits. Through its profit-sharing plan begun in 1974, the first in the industry, employees now own 13 percent of Southwest's common stock. (Paradoxically, it is also the most heavily unionized, with 85 percent belonging to organized labor.)

Passengers, who have found themselves victims of random acts of kindness, tell stories that strain credulity in an age when the glamour of flying is on par with bus travel:

* An elderly woman making a reservation to fly to Phoenix for cancer treatment broke down crying because she had no friends to be at her side. The Phoenix-based agent told her she now had a friend, and came to her aid by driving her around Phoenix for two weeks and was there for the woman when she needed help.

* On a Southwest flight to Oklahoma City for a court hearing before a military judge, a passenger discovered that he had left his one and only tie in his office. When flight attendant Jennifer Smith asked, "What would you like this evening?" he replied, "I would like a necktie; could I possibly borrow the captain's?" Ms. Smith said, "I can't lend you the captain's tie because it's part of his uniform, but I will look into a resolution to your problem." Minutes later, she returned with a drink and a tie belonging to another customer - along with his address so the needy passenger could mail it back to him.

Under Kelleher's guidance Southwest has become the fourth-largest U.S. carrier in terms of originating customers boarded. From 1992 through 1996, the company earned the Department of Transportation's "triple crown" for best on-time performance, best baggage handling, and fewest customer complaints among all major carriers. It has cinched the on-time performance record through 1998. Since 1973, it has also reported 26 consecutive annual profits despite two major industry downturns. Today the airline operates more than 2,400 flights a day with 27,000 employees carrying 52.6 million passengers, with $4.2 billion in total operating revenue and $433.4 million in profits. From three planes in 1972, it now operates 284 Boeing 737s - having one aircraft type allows for greater efficiency and easier turnarounds. Last year it received 141,710 resumes, but hired only 4,115 people. It received requests for service from 171 destinations, but operates in only 54 cities in 28 states. The company also has 821 married couples on its payroll - that is, 1,642 employees have spouses who work for the company.

Its business strategy of operating direct short-haul routes, eliminating the costs associated with hub routes, has been imitated by United, Continental, and Delta. In Europe, Southwest wannabes have sprung up in the form of Easyjet in the U.K and Ryanair in Ireland. Virgin Express is another, and Richard Branson would like Congress to allow him to take his act to the U.S.

Imitating the strategy is one thing, but duplicating the culture is quite another. Colleen Barrett, EVP for customers and corporate secretary, is the second-ranking officer in the company, and is often described as Herb's alter ego. She worked for Kelleher as his legal secretary and through the early years at Southwest interpreted his vision into day-to-day policy. Birth, deaths, marriages, and promotions are acknowledged with personal notes from Colleen or Herb. Every square inch of wall space in its five-story Love Field headquarters is covered with photos and mementos of employee gatherings and celebrations. (The "scrapbook" is taken down and rotated every so often to new locations so employees will be exposed to different exhibits.) It's not for nothing that most employees consider Barrett the den mother of Southwest's culture. "Southwest is a cause, not a career," she says. "We offer people a chance to be themselves, not to be robots. When you trust people until they show they shouldn't be trusted, people respond."

Barrett, who grew up in Bellows Falls, VT - and is the airline industry's highest ranking female executive - attributes the Southwest style to common sense, the Golden Rule, and something both she and Kelleher had in common - working middle-class Irish mothers who insisted that their children treat people with dignity and respect, something Barrett says tends to be omitted at the MBA level.

In every story about the company, it's reported that Southwest "hires attitude." But doesn't every company? "We look for a sense of humor, a sense of service, and we screen out bad attitude," says Barrett. "We don't care if you're the best pilot in the USAF, but if you condescend to a secretary, you won't get hired." CFO Gary Kelly also points out that the company tolerates mistakes particularly when the customer is well served. "One can feel the enthusiasm for people," says Kelly, who was promoted to his current position by Kelleher at the tender age of 34 in 1989. "He had confidence that I could do it and coached me through the rough patches."

Historically, being small gave Southwest a psychological edge. But at $4 billion in annual revenues Southwest is no longer the junkyard dog of the airline industry. Having experimented with daily nonstop flights from Baltimore to Phoenix (the longest scheduled flight in its history), the company is flirting with being transcontinental. Last March, it announced scheduled service to MacArthur Airport in Islip, NY, 40 miles east of Manhattan, allowing people to travel across the country for $299 each way. Two other East Coast cities will follow.

Is there still room to grow, without departing from its core strategy? Kelleher is convinced there is. And the 68-year-old chain-smoking chief, who is fond of his Wild Turkey bourbon, doesn't see himself slowing down or stepping aside anytime soon. Wall Street adores Herb almost as much as his killer tomatoes. Merrill Lynch's Candace Browning observes that the company's first quarter operating margin of 15.5 percent was the highest of any large carrier and the highest Southwest has achieved since 1981. CIBC Oppenheimer's Julius Maldutis reckons the market has given the stock a 20 to 30 percent premium relative to the S&P 500 owing to [TABULAR DATA OMITTED] Southwest's predictable growth profile.

Then there's the question of what becomes of Southwest without the extrovert-in-chief? "There's no question Herb's an institution," says Jim Parker, Southwest's general counsel, who lawyered with Kelleher before the airline was formed, "but we have a whole cadre of leaders here. They may not wear funny hats or drink Wild Turkey, but they're here just the same."

- J.P. Donlon

FINDING A LASTING ESPRIT DE CORPS 

Much of Southwest's continued success seems to derive from its unusually intimate labor-management relations. What's your take on why that works and the process you used to sustain this bend over time?

Well, first of all, we don't talk about labor-management relationships at Southwest Airlines. We eschew the words "labor" and "management" as much as possible because the very utilization of those words, in my estimation, sets up two different groups within the company with two different labels. So we simply talk about the people at Southwest Airlines. The titles and positions are somewhat incidental to the fact that they are people.

Some years ago, one of our vice presidents said, "Herb, it's easier for a ramp agent, a flight attendant, a pilot, or a mechanic to get in to see you than it is for me." I said, "Let me explain the reason for that. They're more important than you are."

We try to value each person individually at Southwest and to be cognizant of them as human beings - not just people who work for our company. We try to memorialize and celebrate and sympathize with and commemorate the things that happen to them in their personal lives. What we're really trying to say is, "We value you as people apart from the fact that you work here." That approach has been very helpful to Southwest. We have not been prescriptive as to how people can or should behave when they're on the job. Fundamentally, they can behave the way that their basic natures influence them to behave. If they want to tell jokes, they can tell jokes. If they want to play practical jokes, they can play practical jokes, and they can, in effect, be a liberated spirit within a working environment. We've never thought that you should have to come to work and assume a mask, be different from who you really are, look like you're a bunch of little lead soldiers stamped out of a mold, and I think it makes people feel good about themselves and good about what they do, and it also gives vent to their creative energies, their imaginations.

I've frequently made the statement to our people: The intangibles are more important than the tangibles. Another airline can go out and get airplanes. They can acquire ticket counter space at the terminal. They can buy baggage conveyors and tugs. But the hardest thing for a competitor to imitate - in the customer service business, at least - is attitude; esprit de corps is the way that you treat customers and the way that you feel about people. And it's very difficult to emulate that, because you can't do it mechanically, and you can't do it programmatically, and you can't do it according to a formula.

When you and Rollin King first got together, did you set out to do it this way?

Rollin and I worked on getting the airline started, which was basically litigation with the incumbent airlines of that time. After we got started, several of the other carriers tried as hard as they could to put us out of business as quickly as they could. I think there was a root there of a survivalist sort of mentality - one for all or all for one, or together we perish, in effect. And later on, basically starting in the early '80s, we really started focusing on people as people and identifying that as the appropriate value for Southwest Airlines.

SOUTHWEST'S LONG-TERM PERFORMANCE

Total Annual Average        5 Years      10 Years
Return to Shareholders       16.0%         13.5%
Net Income CAGR              23.0%         22.0%
EPS CAGR                     21.0%         21.0%

It's interesting because people would say to me continually, "Herb, this works fine. You have great esprit when you have 200 people; wait till you get to 500." And we've gone through 1,000 and 1,200 and 1,500 and each time people say that, and now we're up to 27,000 and I think we still have tremendous motivation and esprit de corps. But I'm still asked that question.

Suppose you decided to help start another airline or a semiconductor firm or maybe an investment banking firm, would the culture of that firm be similar to this - or is this a one-of-a-kind phenomenon?

From what I've seen, it's possible to do it in any kind of business, and it doesn't really matter whether it's a customer service business or production or manufacturing business.

I would say the majority of our readers would love to understand better how they can create this kind of motivation or connection to people in their businesses.

Yes. We're not afraid, we're not abashed to talk to our people about important philosophical things - things that are perhaps inspirational in nature. Our current signature line is that Southwest Airlines is the symbol of freedom. It's not just for the outside world. It's directed towards telling our people, "Hey, what you're doing every day is important to millions of people across the U.S. who otherwise would not be able to fly. So you're doing a great amount of good for society." It's an uplifting thing.

I analogize it to a story I heard years ago: If a mason is working on a wall and you ask him what he's doing and he says, "I'm laying bricks," you're not going to get the same kind of work as you would if he said, "I'm building a house." So we want our people to understand that they're in effect building a house, that they're doing well by doing good for other people. So you need that kind of thing.

Another thing is that it's not as heretical today as it was many years ago when I first announced our hierarchy of rankings. At that time, it was supposed to be a conundrum: who comes first, your employees, your shareholders, or your customers? And people would ask you that as if it were some great mystery that only Pascal could solve. I just frankly said, "Your employees come first. There's no question about that. And if your employees are satisfied and happy and dedicated and inspired by what they're doing, then they make your customers happy and they come back and that makes your shareholders happy." So it's not a mystery. Most things are very simple. Einstein said that. The simpler it is, the more likely it's true, in effect. We tell our people, "Don't worry about profit. Think about customer service." Profit is a by-product of customer service. It's not an end, in and of itself. It's something that's produced by your efforts and the way that you treat each other and the way you treat the outside world.

Every anniversary of a Southwest Airlines employee is recognized. All the holidays are recognized; all the marriages; all the deaths in the family; that sort of thing, which is very, very personal.

Do you have banners and cakes every month? You must be doing this every day.

We have a lot of celebrations of different things, but I'm talking about personal communications in terms of cards, in terms of notes - "sorry to hear about the death of your grandfather" - that sort of thing. And that is a prodigious process for 27,000 people. But I would estimate, and this is just off the top of my head, that everybody at Southwest Airlines - all 27,000 - hear from us in one way or another, probably five times a year.

You've been quoted as saying, "We hire attitude." That's nice. But everybody claims that, don't they?

But they don't value it. They don't pay all that much attention to it. They don't make it a priority. I've been with companies where they have an opening, and you know what they consider the function of their personnel department? To plug that hole as quickly as they possibly can. That's quite different from what we do in many cases. Some years ago our vice president of the people department told me the department had interviewed 34 people for a ramp agent position in Amarillo, TX, and she was a little embarrassed about the amount of time it was taking and the implied cost of it, and my answer was, "If you have to interview 134 people to get the right attitude on the ramp in Amarillo, TX, do it."

Can you talk about what the attitude is?

First of all, it's an attitude of humility, one of modesty. Secondly, it's an attitude of selflessness, altruism, where perhaps doing things for other people is the way you ennoble yourself instead of doing things for yourself, concentrating on you. We're trying to find out what people are really like at the center of their being - whether they have a sense of humor, whether they have the servant leadership attitude and mentality, whether they have the capability of being leaders too. You hire somebody for one job, but we're looking for the capability and the leadership qualities that will enable them to rise through the ranks.

You use words like selflessness, humility - are these employees or an order of monks?

It's kind of funny that you would say that. I was talking at the Yale Graduate School of Business some years ago. In the Q&A session, one of the students stood up and said, "It seems to me you're talking more about a religion than a business." And I said, "If you feel that way about your business, I think that's good. That's a plus."

ON FOREIGN SKIES AND COMPETITION

In its current policy, the U.S. seeks to open international markets to its "open skies" initiative on keeping the U.S. domestic market closed to foreign competition. Do you favor changing the current system?

When you're looking at the largest market in the world, you have to ask yourself, how do we get a comparable return? You don't get a comparable return if you open the largest market in the world, for instance, to one of the smallest markets in the world. You're only deceiving yourself if you think you could effect a deal whereby in return for open skies and foreign ownership in America, America received the right to have open skies and own European airlines in the European Union. That wouldn't be a fair exchange. But you know, you have to deal with blocks of countries in order to get a fair quid pro quo for what you're giving up.

Assuming the European Union as a whole opens itself up, Southwest could fly from Frankfurt with the same ease that you fly from Dallas to St. Louis.

Correct. And the fact that the Union has been formed breeds thoughts that finally you might have an entity that was large enough 'and had enough passenger traffic itself to justify opening up the U.S., but I don't think you'll see the results by and large that some people anticipate in the U.S., because the main reason the rest of the world doesn't want to open itself up to U.S. carriers is because United and American and Northwest and Delta have much lower costs. You remember when they opened skies with Canada. Canada said, "How about if you give us three years to come across the border before you're allowed to come across our border," for fear that their carriers, Air Canada and Canadian International, would just disappear from the face of the earth. So from the standpoint of other countries and other carriers, some are not particularly desirous of having their own countries open up to U.S. competition.

You've flown transcontinental at least once.

Yes, once. It was an experiment.

What's your take on that experiment?

It's something that taught us that there are a few things we have to adjust - for instance, where you put the trash on a longer haul flight like that. But it was basically to see what it was like and how it would work out. We don't intend to do it on a regular basis, but as a consequence of the change in the tax law, we're flying much longer flights than we ever flew before, like Nashville to San Diego because obviously the segment fee doesn't affect you as much when you're flying a longer haul. That's been very successful for us, but it doesn't portend any transcontinental service. We have no such plan and no such intention as of the present time.

There seems to be a rough analogy between Southwest and Wal-Mart; just as Wal-Mart has gone to a semi-rural area to set up its mega-stores, you've gone to secondary airports to create your point-to-point system.

We have and we haven't. Where we have the opportunity, we do. Where it looks as if it would be a promising opportunity, we do, but we serve Los Angeles International, Phoenix International, Las Vegas - the same airports that everybody else does. So, there again, it's not a rule. It's just something that you take advantage of if you have the opportunity.

So you're being tactical?

To do so, right.

We've got airlines like United doing its shuttle in California and USAir doing its Metro-jet. Are they trying to go head-to-head with you?

Yes.

So, their tactic is to meet you on the ground?

Yes. But it hasn't hurt our earnings any, has it?

Not so far. But...

It's been going on since '94.

So you think you can hold out because you will still have the cost advantage?

I think we have the cost advantage and we have the customer service advantage, and when we collide with one another in a city like Manchester, NH, what happens is that the market expands exponentially so that there are plenty of passengers on Metrojet and plenty of passengers on Southwest Airlines. Southwest's costs are far lower. We're making a profit. I don't know whether Metrojet is.

There's also a lot of discussion on predatory pricing. Presumably big carriers can come in and underprice or undercut you, and just see who bleeds most. Is there truth to that?

Well, I'll tell you - there is truth to that. I mean, it's possible, at least, and that's why we have always said that it's not important just to have low cost. It's important to have a very strong balance sheet and lots of equity so that you can fight those wars of attrition on an ongoing basis. Southwest Airlines is clearly capable of doing that. You can't get any quick hits against us. You can't get any startling victories within a very short period of time. You know we're powerful enough financially to fight a war for decades if need be in these markets.

I'm not suggesting this falls into the category of predatory pricing - don't misunderstand me - but it is funny because somebody from one of the newer carriers said to me, "The other airlines price differently against Southwest Airlines than they do against us." I said, "That's right. Against us, they just set up whole divisions of their companies." The United Shuttle, Continental Light, Delta Express, and Metrojet - that's all they do with respect to us. They deploy hundreds of airplanes against us.

The whole experience of air travel started out as an elegant experience 30 years ego. People got dressed up with their furs and brought their own food.

My mother would have slaughtered me had I gone to the airport without at least a sport coat on and a tie.

Today it's a bus with wings. Is this what we're faced with?

In the days of elegance that you were talking about, air transportation was only for 15 percent of the people in America. We deregulated so that air transportation would become available to the other 85 percent who have taken advantage now of the opportunity to fly for the first time in their lives. You have to make a philosophical judgment as to whether that's good or not. I happen to think it's good. I mean, I'd hate to go back to the old days of elegance and say 85 percent of the people who are now flying can't fly anymore.

TAKING FLIGHT ON THE INTERNET

Regarding your Internet strategy: Up to 70 percent of your customers now fly ticket-less; what's the future of your Internet or info-tech strategy going forward?

Ticketless is not necessarily connected with the Internet, but, of course, ticketless does make it possible to complete the whole transaction using the Internet. We obviously think that there's a great future in Internet sales, and it's coming along very rapidly. I think one of the gurus of the Internet said five years ago that it's going to be half as large as you think it is by 2000, and it's going to be twice as large as you think it is by 2005. I think, essentially, that was correct. So, our site has been very effective - selected as the best site by Transport World, for instance - and we continue to work on honing and refining and developing it because we feel that in the future, the volume is going to be tremendous.

I heard you've got something called Net-Res. Do you have any other new projects?

Yes, we have a number of ongoing projects at Southwest Airlines at any given time. Some of them, I think, are pretty innovative. Ticketless, in and of itself, by the way, was a reaction, a tactical response to being thrown out of three of the computer reservation systems. I said, "Instead of having travel agents have to hand write tickets, we're going ticketless." Then I said to our people, "How do we do it?" They had it up and running on a systemwide basis in four or five months, but I think you'll see more and more of that. I think you'll see an expansion of it in the airports. Gerry Greenwald in an interview the other day said - and I don't quarrel with this at all; I think he's right - there will come a day when you'll have a smart card, which will do everything. It'll check you in, admit you through the turnstile to get into the passenger holding area, etc. That kind of thing is coming, but we've been very, very careful, and very repetitive about telling all of our people that this does not mean any sacrifice of jobs in Southwest Airlines. That technology is not going to cause anybody to lose a job at Southwest.

What's your general philosophy about the application of technology to business strategy?

Well, first of all, it should be a servant, not a master.

And you have your Aunt Maude technique - what's that again?

Yes, the Aunt Maude technique. Basically that means it should be something that's very user-friendly. The criterion being - and it used to be Kodak's criterion - an your Aunt Maude operate this camera? Well, can your Aunt Maude operate this interface? Whatever that might be. I think the whole industry is headed that way, and frankly, for years, I held us back a little because there was so much change. I was afraid to make huge investments at the beginning of the 1980s, for instance, or even the middle of the '80s, for fear they'd be outmoded in three or four years. It's kind of interesting how that has worked out because, of course, the power and the expense is gone. Power's gone way up; expense has gone way down. We had less of a Y2K problem because our systems were so new, we didn't have to remediate nearly as many systems because they're already Y2K complaint. So, it worked in our favor in that respect.

Basically, I've always been concerned about the company being run by a computer. I'll give you a specific example to pull it down to earth. Years ago, I wanted to put in a competitive fare against another carrier in a very special and difficult situation. The answer I got was: "We can't do it, because the computer won't do it." I said, "I guess I have a choice. Either I can leave or the computer can." So the computer got fired. Good-bye computer. I've seen companies that are run by their computers, and that is their answer: The computer won't do it. I don't believe in that.

What's your big challenge going forward?

Low costs and high spirits are the two things that I concern myself with, and they're related. One's related to the other because to occupy our niche, we have to be able to charge lower fares. That is self-evident. One of the ways you achieve lower fares is through high employee productivity - people being really dedicated to what they're doing and being proud of doing it well. So, the two relate to one another in that way, but they also relate to customer service in terms of the price you pay, and the quality of service you receive. So keeping costs low and spirits high are the two things I focus on.