If you’re a fan of Warren Buffett you’re probably aware that for the last forty years or so, he’s admonished the merits of investing in airlines. It’s little wonder, as the industry is notoriously cyclical, is capital, fuel and labour intensive, has powerful unions and a history of attracting fresh capital. Given that history, its no surprise that most US airlines have been bankrupted numerous times over, and have left a trail of capital destruction in their wake for investors.
In a 2002 interview with the London newspaper, The Telegraph, Buffett stated:
“If a capitalist had been present at Kitty Hawk back in the early 1900’s, he should have shot Orville Wright. He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You've got huge fixed costs, you've got strong labor unions and you've got commodity pricing. That is not a great recipe for success. I have an 800 (free call) number now that I call if I get the urge to buy an airline stock. I call at two in the morning and I say: 'My name is Warren and I'm an aeroholic.' And then they talk me down.”
On the basis of the above, you’d probably be surprised to learn that an airline stock was actually the best performing stock in the S&P500 in the thirty years since it went public. That airline stock turned $10,000 at it’s IPO into $10.2m thirty years later. That same airline stock became more valuable than all it’s rival competitors combined. That airline stock never had a money-losing year. And that airline stock never laid-off an employee.
Source: Bloomberg
These incredible statistics lay at the feet of business maverick, pioneer and innovator, Herb Kelleher, the co-founder, later CEO, and chairman emeritus of Southwest Airlines. Mr Kelleher passed away in early 2019, leaving a legacy of business insights we can all learn from. Over the years I’ve read a lot about Southwest Airlines and Herb Kelleher and thought it time to dig a little deeper into what made him such a success. As Charlie Munger likes to say, when you find something that’s an anomaly, ask why? why? why?
“The idea of picking some extreme example and asking my favorite question, which is 'what in hell is going on here?'; that is the way to wisdom in this world.” Charlie Munger
Like Cornelius Vanderbilt had seen the opportunity to bring steamships to the masses on New York’s harbour one hundred years before him, Kelleher recognised the opportunity to ‘democratise the skies’ and make air travel a quicker, convenient and affordable alternative to travel than via cars, buses and trains for the masses.
Kelleher kept the company’s strategy simple and his unconventional approach helped keep costs low so he could offer 50%-60% discounts on competitor’s fares.
“To support the strategy, the company determined to fly only one type of airplane, the Boeing 737, and to substitute linear flying for the hub-and-spoke model that has prevailed in the industry. But at the center of Southwest’s success are its culture and employees.” Chuck Lucier
The key to Kelleher’s success was leveraging the human trait of ‘reciprocation’ to the maximum extent possible. He built a cultural flywheel that his competitors couldn’t match. He shared the spoils with his employees and in the process built America’s most successful airline.
The more I dug into the roots of Southwest Airlines success, the more I found those same characteristics that have defined the other extreme business successes we’ve covered; Walmart, Nucor, In-N-Out Burger, Home Depot, Panera Bread, McDonalds, Starbucks etc.
I’ve drawn on many historic interviews with Herb Kelleher to piece together the ingredients of Southwest’s success. You’ll notice 90% of the sub-headings below are common to the previous posts on the CEO Masters. Just as there are common threads that link the Investment Masters, there are also many commonalities that permeate the ranks of the world’s greatest companies and their CEO’s. And that should be no surprise, either. If you’ll recall, Warren has always said, “to be a great businessman, you need to understand investing, and to be a great investor you need to understand business.”
It’s About People
"The business of business is people."
“I think the values of Southwest are humanism, number one. I think simplicity, number two. Humor, number three. Service, altruism, number four. I think that pretty well sums it up.”
“We have a People Department. That's what it deals with, so don't call it Human Resources - that sounds like something from a Stalin five-year plan. You know, how much coal you can mine.”
Value People / Leverage Reciprocation
"If you don't treat your own people well, they won't treat other people well."
“I always felt that our people came first. Some of the business schools regarded that as a conundrum. They would say: Which comes first, your people, your customers, or your shareholders? And I would say, it's not a conundrum. Your people come first, and if you treat them right, they'll treat the customers right, and the customers will come back, and that'll make the shareholders happy.”
“We focused on our employees as people. We want them to know that they’re important to us not just because they’re at work uh, like they were cogs in a machine. So we pay a lot of attention to their personal lives. The grieves, the joys that their experience. We recognize those if they’re seriously ill. We communicate with them, we send them care packages. We want them to know that we value them as individuals, not as part of a workplace.”
“At Southwest Airlines, you can't have a baby without being recognized - getting communication from the general office. You can't have a death in your family without hearing from us. If you're out with a serious illness, we're in touch with you once every two weeks to see how you're doing. We have people who have been retired for 10 years, and we keep in touch with them. We want them to know that we value them as individuals, not just as workers. So that's part of the esprit de corps.”
“We used to have a corporate day. Companies would come in from around the world and they were interested in how we hired, trained, that sort of thing. Then we’d say, “Treat your people well and they’ll treat you well,” and then they’d go home disappointed. It was too simple.”
“We did have a different take [to competitors] as a matter of fact and that was the employees came first. Employees first, customers second, shareholders third. If the employees serve the customer well, the customer comes back, and that makes the shareholders happy. It’s simple, it’s not a conflict, it’s a chain. If you treated the employees well, if you cared for them, if you value them as people, if you gave them psychic satisfaction in their jobs uh, that they would really do a great job for the customers and the customers would come back, which would be good for the shareholders. Most companies didn’t operate that way. So we turned the pyramid upside down, in effect, and said the employees come first and they always have. Not just in our minds but in our hearts as well.”
“We’re perfectly happy with having, generally speaking, the highest pay for employees in the domestic industry. They reward us with tremendous productivity, which lessens the effect. And the other airlines disadvantaged their people. I’m not saying they didn’t have to, in the sense of “either we do this or we fail,” so it’s not a criticism. I’m just talking about the economic effects of it.”
“We teach each of our managers to sit down at least once a week with all of the people who work for them, so if they have any suggestions, they can make them in person.”
Promote Ownership
“We put in the first profit-sharing plan in the airline industry. Our people were very cognizant that they were owners. And there are two stories that I just love. Western Airlines asked to borrow a stapler in Los Angeles, and our customer-service agent went over with the stapler to their counter, and the Western ticket agent said: Why are you [waiting]? He said: Because I want the stapler back. That affects our profit sharing. Another classic was down in San Antonio, when one of our customers was railing at one of our customer-service agents and said: Don't you know I'm a shareholder of Southwest Airlines? And the customer-service agent looked at her and said: Lady, we all are.”
Empower People
“If you create an environment where the people truly participate, you don’t need control. They know what needs to be done and they do it. And the more that people will devote themselves to your cause on a voluntary basis, a willing basis, the fewer hierarchies and control mechanisms you need.”
“Provide guidelines only, not rules. Give your employees the flexibility to make decisions on the spot.”
Culture is Key
“We don’t just have a central culture committee; we have one at each facility across the country. I think we’ve been pretty successful in going from 198 people to 35,000 and keeping the esprit de corps alive. At many other companies, they give up as they get bigger. They say, “We’re so big now that we can’t keep this joie de vivre, this effervescence, in our company.” We’ve always said, “It’s the most important thing we have, and we’re going to do everything that’s needed to maintain it.”
“We were a little concerned as we got bigger that maybe some of our early culture might be lost, so we set up a culture committee, whose only purpose is to keep the Southwest Airlines culture alive. Before people knew how to make fire, there was a fire watcher. Cave dwellers may have found a tree hit by lightning and brought fire back to the cave. Somebody had to make sure it kept going because if it went out, there was no telling when another tree would be hit by lightning. And so, the fire watcher was the most important person in the tribe. I said to our culture committee, “You are our fire watchers, who make sure the fire does not go out. I think you’re our most important committee at Southwest.”
“We decided that we had to institute another limitation on expansion, one which is cultural in nature. We simply cannot increase our staff by 10% per year and expect to maintain the same kind of environment and culture we have, and that is important to us.”
Culture is a Competitive Advantage
“I think the difficulty for them [competitors] is the cultural aspect of it. That cannot be duplicated. One of the things that demonstrates the power of people is when the United Shuttle took out after us in Oakland. They had all the advantages. I mean, they had first-class seats for those who don’t want to fly anything but first class. They had a global frequent flyer program, which we did not have. They probably spent $25 million or $30 million on their advertising campaign. I probably have something like a thousand letters at my office that tell you why they finally receded from Oakland. Those letters say, “Herb, I tried them, but I just like your people more, so I’m back.” Don’t ever doubt, in the customer service business, the importance of people and their attitudes.”
“One thing I tell our people is that the intangibles are much more important than the tangibles because anybody can buy the tangibles, but nobody can replicate the intangibles very easily. And I'm talking about the joie de vivre -- the spirit of our people.”
“The intangibles are far more important than the tangibles in the competitive world because, obviously, you can replicate the tangibles. You can get the same airplane. You can get the same ticket counters. You can get the same computers. But the hardest thing for a competitor to match is your culture and the spirit of your people and their focus on customer service because that isn’t something you can do overnight and it isn’t something that you can do without a great deal of attention every day in a thousand different ways. This is why I can say our employees are our competitive protection.”
“We basically said to our people, there are three things that we’re interested in. The lowest costs in the industry — that can’t hurt you, having the lowest costs. The best customer service — that’s a very important element of value. We said beyond that we’re interested in intangibles — a spiritual infusion — because they are the hardest things for your competitors to replicate. The tangible things your competitors can go out and buy. But they can’t buy your spirit. So it’s the most powerful thing of all.”
No Master Plan
“We’ve never done the long-range planning that is customary in many businesses. When planning became big in the airline community, one of the analysts came up to me and said, “Herb, I understand you don’t have a plan.” I said that we have the most unusual plan in the industry: Doing things. That’s our plan. What we do by way of strategic planning is we define ourselves and then we redefine ourselves.”
Innovate / Change
"We tell our people all the time, 'You have to be ready for change.' In fact, sometimes only in change is there security"
“I don’t want our people to be afraid of change. I want them to welcome change—substantive change for good reasons. Change is something that has always transpired at Southwest. You don’t change your principles or your philosophy, but tactically you adjust to outside competition and forces.”
“I really attribute [our success] to historicity, a sense of futurity, and innovative thinking.”
“I think some of the critical elements are to remain outward looking, to preserve alacrity, and to stay loose.”
Encourage Ideas for Innovation
“Foster a fluid exchange of ideas, whereby everyone feels free to get the information they need without having to dig through multiple layers. Ideas should be able to easily circulate up, down, and around. I think that is extremely important. In this scenario, paperwork is the enemy. Yes, you need it, but you constantly have to fight to keep the volume down and simplify the information so that people can understand it readily. I also believe you need to exalt the people who come up with new ideas; they must be thanked and toasted and lionized for the ideas they’ve provided, and which have been productive and constructive.”
“We have a rule at Southwest Airlines: An employee can send an idea to anyone at any time. They can convey it orally, put it in writing; it does not matter who it is. Responses are sent within 1 week. We want to show respect for the fact that they cared enough to submit that idea. In addition, a simple ‘‘no’’ is unacceptable; that is just an exercise of power and can be invoked very irrationally. If we say ‘‘no’’ to your idea, you are likely to receive a page and a half explaining exactly why we don’t think it will work at that point in time. This process keeps ideas coming from people, because they do not feel as if they have been spurned as a consequence of being ignored or just being told ‘‘no.’’ If you consistently turn down ideas, you won’t get any more. A venture capitalist can entertain twenty ideas for every one that eventuates into something worthwhile, so within the company we try to do the same thing: keep the ideas coming. Otherwise, you end up curtailing innovation.”
“You have to welcome new ideas and creativity, and you have to entertain a thousand ideas for every good one that you get. But if you start turning them down just to turn them down, because you can’t be bothered and don’t have time, you never get a great one.”
“I think you have to listen to [people’s] ideas and you don’t credential them because you can get a great idea from anyone, anywhere, no matter what they do or how much education they’ve had or what their background is. Because people’s minds usually are working furiously. So it’s important to listen to everyone that has an idea. And even if the idea is not perfect, it may be the kernel of a great development in it. So I’d say, when it comes to ideas, keep your ears open.”
Hire Right
“We spend a lot of time trying to hire employees who have a customer service focus and are altruistic.”
“At Southwest Airlines, we value education and experience, but we would rather have some-body with less education and experience but with a great attitude. If it comes down to a choice between the two, we’ll take the attitude over the education and experience and provide those ourselves.”
“We devote an enormous amount of time to making sure we get people who are other-oriented, who have a servant’s heart, who enjoy working as part of the team.”
“Bad attitudes metastasize throughout your organisation, no matter where they are located.”
Keep it Simple
“We have been successful because we’ve had a simple strategy. Our people have bought into it. Our people fully understand it. We have had to have extreme discipline in not departing from the strategy.”
“What we try to do is establish a clear and simple set of values that we understand. That simplifies things; that expedites things. It enables the extreme discipline I mentioned in describing our strategy. When an issue comes up, we don’t say we’re going to study it for two and a half years. We just say, “Southwest Airlines doesn’t do that. Maybe somebody else does, but we don’t.” It greatly facilitates the operation of the company.”
Corporate Debt
"Our job is to never lose focus on keeping our costs low and to never suffer an excess of hubris so we take on too much debt."
“We decided that no matter how attractive expansion looked, we were going to maintain the strongest balance sheet, the most liquidity, and the only investment grade rating in the airline industry. That measure was taken to hedge our bets against the inevitable bad times.”
“We're the strongest airline in the industry financially. So if somebody wants to charge the same fares as we do with higher costs and lose money, that's fine. If they want to fight a war, we're ready to go 2 years or 5 years or 10 years -- whatever it takes -- in order to be successful.”
Humility
“I constantly have warned our people over the years that, as we became bigger and more successful, our primary potential enemy was ourselves, not our competitors. Getting cocky, getting complacent, thinking that the world was our oyster, disregarding our competitors, both new and old. I think humility is very important in keeping your eye on the carrot, keeping focused outwardly instead of inwardly, and knowing when you have to change. An investor in the airline industry some years ago that I was talking to said, “Southwest Airlines is the most humble and disciplined airline that I deal with.” I said, “The two go together.”
"When you think you've got it all figured out, then you're probably already heading downhill."
Success Factors
“[You] have to focus intently upon what’s important and what’s unimportant, not be trapped in bureaucracy and hierarchy. Be results- and mission-oriented. “
Fight Bureaucracy
“Fight hierarchy and bureaucracy as hard as you possibly can. Don’t ever let it become the master; always remember it’s the servant.”
Don’t Always Maximise Short-term Profit
“Since I’ve been in the industry, I think there have probably been over a million layoffs around the world. Southwest has never had an involuntarily layoff in its thirty-five year history. Many times we have sacrificed profitability during the bad times in order to provide our people with job security because that’s another aspect of how we value them. I think it provides a reciprocal trust in what our focus is. So, we’ve never had an involuntary furlough in the whole history of Southwest Airlines.”
“We’ve never had a furlough. We could have made more money if we’d furloughed people during numerous events over the last 40 years, but we never have. We didn’t think it was the right thing to do. And you know, one of the disciplines is not furloughing. I didn’t realize this at first, by the way, so it came as somewhat of an insight to me. You know, suddenly a little synapse clicked, and I said, “You know, not furloughing is really a great discipline with respect to hiring.”
Head Office
“I’ve always said that the general office is at the bottom of the pyramid, not the top. Our job at the general office is to supply the resources that our front-line fighters need in order to be successful. They’re not there to glorify us or make us look good, which would be impossible, anyhow. So, the focus is on the people in the field actually doing the job.”
“One of our vice presidents came to me and said, “Herb, it’s easier for a mechanic or a flight attendant or a provisioner to get in to to see you than it is for me.” I said, “Bill, I want you to understand why that is. They’re more important than you are.”
“We really do believe, as Sam Walton said, that the best leaders have to be the best servants and we try to make our company that way.”
Spend Time in The Field
“We think that our management ought to spend time with customers in the field, sampling what our employees and customers experience every day. So we have a requirement that each of our officers each quarter goes out into the field to act as a reservations agent, to load baggage, to dispatch airplanes, or whatever is required, and report back to me on what they did, what they found out, and what they did to improve the job.”
Tone at The Top
“I also think leadership by example is very important. Southwest has never had any disputes over our executives’ being paid too much. Because, quite frankly, we’ve always made sure they were underpaid. We’re not afraid to show our people that we’re not in it for ourselves. Let me give you an example: We negotiated a contract with our pilots in which they took a five-year pay freeze in return for getting stock options. Well, it wasn’t part of the deal, but I immediately took a five-year pay freeze.”
“I have turned down many, many millions of dollars in salary and options because it didn’t set a good example. Our officers have never received a salary increase that is larger on average than our non-contract employees have gotten. In other words, if they get a 3.5 percent increase, our officers get a 3.5 percent increase. We’ve always done that.”
Maintain Smallness
"Think small and act small, and we'll get bigger. Think big and act big, and we'll get smaller."
Think Differently / Grow the Market
“We don’t apply labels to things because they prevent you from thinking expansively.”
“The cost advantage is very important because we started out with a philosophy that we were going to charge low fares, come hell or high water. We were going to enable more people to fly. It didn’t matter whether we had competition or not. In other words, we just said we’re a different type of cat. When we get a load factor that gets into the 70 or 75 percent range over an appreciable period of time, we don’t increase fares. We add flights and put additional seats in. So if you come from that basic position, that this is what you are, then of course you have to have low costs.
Now, how do you get low costs? Through a lot of things, including the inspiration that you give your people, their productivity, the fact that they feel that they’re doing something that is really significant and that they enjoy. If you take all of Southwest’s compensation together — wage rates, profit sharing, the full 401(k) match, the stock options that our people have — Southwest employees are the most highly compensated people in the airline industry. One of our pilots just retired with $8 million in his profit-sharing account. Now, you have to do well to produce that.”
“If you go into a new city pair market and let’s say there are about 125 thousand people a year flying between the two cities when you enter it, and at the end of one year with Southwest Airlines’ great customer service, low fares, and high frequency which equals convenience there are a million people flying, what does that tell you? What that tells you is that you have just liberated a tremendous number of people who for business and personal reasons are now able to fly much more than they ever were before. And that’s very important to them. And that’s why we’re a symbol of freedom.”
“There’s no opposition between the two: offering low fares provides the largest return to our shareholders. Fortunately, we were sufficiently innovative–—or intoxicated!–—to realize that before we started Southwest Airlines. We charged the lowest fares in the airline industry; just look at the Department of Transportation (DOT) fare report. In its 30th anniversary issue, Money magazine featured an article that said our business model belongs in the Ripley’s Believe it or Not category, because the company which has produced the highest return to shareholders over the last 30 years is an airline: Southwest Airlines. Charge low fares, get more people to fly, get them to fly more often, and you will produce the best return to shareholders. Low fares and high shareholder returns are not in conflict with one another in any way, shape, or form. You just have to keep your costs low.”
Focus on Your Core Competency
“Another thing we decided as a matter of policy years ago was that we wouldn’t do anything that wasn’t connected with the airline business. I guess what we were saying in kind of a humble way was, “We don’t know everything about everything. We know about one thing.” I have seen other airlines make mistakes, buying radio stations, hotel chains, rental car businesses, and so forth and so on. And I thought, We don’t want to get into thinking that we’re almighty because we’ve done pretty well. And that’s still the policy today.”
Mission Statement
“I want to tell you with respect to a mission statement is that a lot of people hire outside people to prepare their mission statements. My suggestion is that if you need someone outside your company to prepare a mission statement for you, then you really don’t know what your mission is and you probably don’t have one.”
“People always are writing and calling and saying we want to help you revise your mission statement, you know, they say, “Things have changed greatly in the American economy.” And I’ve said, ours is eternal. It has nothing to do with the American economy. It simply has to do with the way you treat people — the respect that you give them and the opportunity that you give them whether they are employees or customers. So it’s basically focused on people and how they should relate to one another and that’s eternal. So we don’t need to revise it to take into account new developments in corporate America.”
Win-Win
“We’re the most unionised airline in the industry, and we’ve never treated the labor unions as adversaries, we’ve always treated them as partners. Because if the canoe goes down we are going to go down with it. I don’t mean that in a perfunctory, superficial way'; we hold company events and we invite all the labor union leaders to come to them as they are part of the company, too. If they have an issue we take care of it as quickly as we can. Being very cognisant of their needs, and they reciprocate. They respond to that very very well.”
"Our relationship with Southwest is about more than just delivering great airplanes. It's about understanding their business, trusting each other and working together to achieve solutions. We know that while they have a lot of fun and play hard, they also run a business model that the entire industry emulates and admires. We are delighted and honored to have such a wonderful partner." Carolyn Corvi, Vice President/General Manager, Boeing 737/757
Summary
Ripley’s Believe It Or Not, indeed.
Who would have thought that was possible, given what we know about airlines and their destruction of capital over the years? One thing that is apparent to me, however, is that it doesn’t seem to matter what industry we look at, there are successful business stories to be found, regardless of what the greater competitive landscape looks like. And Southwest is just another example of a business that has succeeded in an industry where success doesn’t come about too often.
And how did they do it? In the same way that all the other success stories we have reviewed did. Walmart, Panera, McDonalds, Nucor, etc - they all used things like culture, people, innovation, humility and reward in the right way.
One other thing strikes me in all this - many of the business and investment masters we have reviewed have all talked openly about the secrets of their success. They have been remarkably transparent and at times brutally honest about it. And when it comes down to it, what they say isn’t really rocket science; the principals are actually quite simple. So if that’s the case, and it is, why have so many of their competitors (in all the industries) failed when they have tried to emulate that success?
I believe it’s because they don’t have the same outlook on things. And never will.
They don’t put people first or act with humility. They don’t lead by the right example. They don’t build winning cultures. They’re all foreign concepts to them, and even though they understand that those measures lead to success, they are unable to apply them because of their own personality biases. They discount them and treat them with scorn: “If I gave my people profit sharing, it would mean less for me!” Or, “If I allowed my people all the power, they’d never do anything and I would end up being my own janitor.”
Herb even mentions that business schools have looked scornfully on his premise of ‘people first, customers second and shareholders third.’ “That would make the shareholders unhappy!” would be their obvious reply. The funny thing is, the company’s job is not to make the shareholders happy, its to make them money. And Herb’s belief that if you treat your people right, they will treat the customers right, which will mean that the shareholders do make money. His track record over the last thirty years proves that theory correct, I would think.
Further Reading/Sources
‘How I Built This’ - Herb Kelleher Interview with Guy Raz. NPR.
‘The Legacy of Herb Kelleher’ - Bill Taylor - Harvard Business Review 2019
‘Herb Kelleher: The Thought Leader Interview’ - Chuck Lucier. Strategy+Business 2004
‘Herb Kelleher on the Record’ - Business Week’ - 2003
‘Corporate innovation at Southwest Airlines: An interview with Herb Kelleher’ Kelley School of Business. 2009.
‘Customer Service - It Starts at Home’ - Herb Kelleher. JLCRM. 1998
‘The High Priest of Ha Ha. Obituary: Herb Kelleher’ The Economist 2019.
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