Sunday, January 6, 2019

Herb Kelleher: The Man Who Democratized Air Travel

Click here to read the original Cautious Optimism Facebook post with comments

4 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff’s career began nearly three decades ago at a major airline that competed head-to-head with low-fare upstart Southwest Airlines. Former Chairman and CEO Herb Kelleher’s recent death has revived the story of his fight against not only entrenched competition, but heavy-handed government regulation that nearly crushed Southwest in its infancy.

Kelleher and Fort Worth-based American Airlines CEO Robert Crandall
Southwest Airlines co-founder Herb Kelleher died this week at age 87. While most Americans today are acquainted with Southwest Airlines’ no-frills and fun anything-goes service, they may be less familiar with its tumultuous beginnings. Before Southwest’s first flight left the ground it was nearly killed by endless legal challenges and restraining orders filed by incumbent competitors.

Younger Americans may not remember that when the idea for Southwest was reportedly drawn on the back of a San Antonio bar cocktail napkin in the late 1960’s the U.S. airline industry was completely regulated by the federal Civil Aeronautics Board (CAB). 

If an airline wanted to raise a fare it needed permission from the CAB. To lower a fare it waited for permission from the CAB. Adding or removing a flight had to clear with the CAB. To start service to another city or on another route it had to apply with the CAB. To end service or close a route, to change a flight schedule, to add or reduce frequency of routes in markets, to offer new in-cabin service, and yes, to start a new airline; it all had to be approved by the CAB first.

The well-established legacy carriers also fostered a nice exclusive club with their cozy CAB relationships. Cooperating with the incumbents the federal government effectively cartelized the industry and maintained very high fares with its price policing power—much the same way OPEC operates today only that, unlike OPEC, the airlines were legally required to comply with the CAB’s mandates whereas OPEC member nations can and often “cheat” with little or no consequences.

(By the way, there is plenty of precedent for this arrangement going back to the Interstate Commerce Commission's cartelization of railroads to enforce higher-than-market rates in the 1880's and FDR’s National Industrial Recovery Act that cartelized nearly every big business in America and mandated collusion to raise prices)

Some fruits of the CAB cartel include Pan Am’s famous government-granted monopoly on U.S. commercial service to Europe, the duopoly granted to Pan Am and Northwest to fly to Asia (later absorbed by United and Delta respectively), and a legacy of very high fares that confined air travel to only wealthy Americans. As Kelleher notes in the attached article “a couple of years ago [approx. 2008] 85 percent of [Americans] had flown at least one commercial flight as opposed to 15 percent in 1966."

Along came Southwest in the late 1960’s with a new idea: offer frequent, rapid turnaround, no-frills, low fare service between three Texas cities: Dallas, Houston, and San Antonio. Kelleher was the co-founding attorney who was to become Chairman and Rollin King a pilot and businessman who would be a managing director.

No sooner than Kelleher had secured financing and was ready to launch his first flight did Southwest's three primary Texas intrastate competitors—Continental, Texas International, and Braniff—file suit to ground the new airline (see attached Reason article).

Southwest fought over four years of litigation battles with the CAB-connected cronies before its first plane ever wheeled up. Unable to fly and earn revenue its finances were drained by legal fees which reflected the strategy of the legacy carriers: If they couldn’t shut down Southwest completely in court, they planned to hobble and eventually bankrupt it with a long-drawn out legal battle during which they were allowed to keep flying and finance themselves but Southwest could not.

Kelleher promised Southwest’s investors he would personally incur all legal costs if they lost their Texas Supreme Court appeal. Famously (and thankfully) Southwest won, the ruling being that service between three Texas cities represented intrastate service and therefore was outside the interstate commerce domain and price-control authority of the CAB.

The rest is history. Southwest started low fare service and undercut its competitors. Braniff attempted to predatory-price Southwest out of the skies with an even lower $13 moneylosing oneway Houston-Dallas fare and Southwest responded by matching but also offering an alternative $26 fare that included a free bottle of Chivas, Crown Royal, or Smirnoff. Two months later Southwest was the largest distributor of premium liquor in Texas and the tactic worked. Braniff called off its campaign to “break” Kelleher and Southwest grew rapidly and democratized the skies—its low cost model and fun-loving culture luring customers from competitors and creating new customers who previously couldn’t afford to fly.

In another market-friendly turn of events, the CAB was dissolved as part of federal partial airline deregulation beginning in 1978 and Southwest was freed to extend its model outside of the Texas market right as it had reached its intrastate limits. After a short period of chaotic adjustment in the industry, airlines settled into their current hub-and-spoke model which, while unpopular with passengers who have to make connections, is so economically efficient that it has simultaneously expanded service to hundreds of previously unserved smaller cities, increased the frequency of flights, and reduced average airfares by nearly 60% adjusted for inflation.

While Southwest started with a point-to-point model that eschewed hubs, it quickly ran out of profitable point-to-point markets and adopted hub-and-spoke itself as anyone who has connected through Phoenix, Las Vegas, Chicago Midway, or Baltimore can attest.

Southwest and partial airline deregulation truly “democratized the skies” and air travel is considered a common everyday commodity today as opposed to the exclusive domain of the rich before 1978.

And in the end Southwest won more than just the legal battle. It’s now the largest domestic airline measured by passenger boardings, has managed an incredible streak of forty-plus years of profitability in an industry beset by bankruptcies (every other major U.S. airline filed for bankruptcy during the 2002-2011 period), has paid above average compensation in exchange for higher employee productivity, has consistently ranked among the top American companies to work for, and during a 25-year period from the early-1970’s to mid-1990’s its stock price rose by over 40,000%. 

Most ironically Southwest is still around and larger than ever while crony antagonists Continental, Braniff, and Texas International all eventually filed for bankruptcy and either ceased operations or were absorbed into other airlines. As is often the case, the firms that receive the most government protection or subsidies fail while those that operate as private, for-profit enterprises and have all the cards seemingly stacked against them succeed.

Southwest’s low-fare model has also inspired countless startup copycats in Europe and Asia, democratizing air travel for hundreds of millions more around the world.

And it all hinged on a single court ruling that placed limits on the reach of the autocratic regulatory CAB which had fostered industrywide inefficiency and cronyism, and broke the CAB-enforced cartel that tried to project government power against the little guy to prevent him from offering the consuming public his better mousetrap.

RIP Herb Kelleher (1931-2019)

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