Southwest Cuts Capacity Plan

It will also seek $1 billion in new revenue by 2010.
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Buffered by rising fuel costs and decreasing yields,

Southwest

(LUV) - Get Report

says it will reduce capacity growth and seek $1 billion in new revenue by 2010.

Changing the airline industry's most successful business model may seem counterintuitive, but Southwest CEO Gary Kelly says it's necessary.

"For 26 years, we relied on a very conservative focus," he said Wednesday, on a conference call with analysts. "There's been a real beauty in that simplicity.

But this decade has presented us with the imperative to make some adjustments.

"Our model isn't broken -- it's just a little bent," added Kelly, who announced a broad array of new initiatives. Southwest shares rose 1.3% to $14.83.

In the fourth quarter, Southwest will slow capacity growth to 6%, down from a planned 8%. Service to Denver and New Orleans will grow, but the airline will reduce less profitable flying, particularly transcontinental flights. In 2008, capacity will also grow by 6% instead of 8%, as Southwest takes delivery of 19 aircraft instead of a planned 34.

Starting in the fourth quarter, Southwest will try to stimulate revenue by enhancing its fare structure, frequent-flyer program, advertising and boarding procedures. A goal will be to attract business travelers. "We're getting all the leisure travelers going on vacation that we want," Kelly said. The airline wants to "speak to the road warriors," who pay higher fares.

Kelly said the most common problems Southwest encounters in new markets are an aversion to its boarding process -- seats are not assigned -- and difficulty in weaning passengers from competitors' frequent-flyer programs. Both will change, he said, although he did not explicitly say that Southwest will add assigned seating.

Putting more passengers on each flight is certainly a goal. Last year, Southwest's load factor of 73% was 5 points below the industry average. The carrier will be equipped to code-share with an international partner, a move that would likely improve load factors, in 2009.

On the expense side, unit costs have risen 20% since 2003, primarily because of pricier fuel. To compensate, Kelly said, "We will have to manage salary, wage and benefit costs even better." Pilots are currently in negotiations, and other contracts will be open for negotiation in 2008.