Pushkin.

Hey listeners, Malcolm.

Here today we're doing things a little differently and sharing a new podcast from Pushkin Industries that we think you'll enjoy.

It's called Business History a very Own.

Jacob Goldstein and former Planet Money host Robert Smith examine the surprising stories of businesses big and small, bringing to life the greatest innovations, the boldest entrepreneurs, and the craziest mavericks in the archives of commerce and finance.

You already know that.

Here on Revisionist History, we reevaluate the most interesting and compelling stories you think you've heard through a new lens.

Business History does the same thing, but focusing on how companies and founders of the past have led us to this current moment.

Business History shares why some company stocks soar while other business ideas crash, and what the businesses of the past can teach us about commerce today.

And speaking of soaring, the episode you're about to hear is all about how Southwest Airlines developed a winning formula involving hotpants and whiskey that forced its competitors to change how they did business.

Southwest revolutionized flying and was profitable every year for nearly five decades until their model fell apart.

Okay.

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Sign up on the Business History show page on Apple Podcasts, or at pushkin dot fm, slash plus.

Robert Smith, I'm gonna give you a classic business origin story.

Do be a favorite, Jacob and just set the scene.

I went Atmospherics.

It's nineteen sixty six, San Antonio, Texas, and a lawyer named Herb tellerher is drinking wild turkey bourbon and smoking.

Cigarettes as everyone did in nineteen sixty six at the Sane Anthony Club, great bar name in Texas.

And so Herb.

He's from New Jersey.

His dad died when he was twelve.

He worked at the Campbell soup factory in high school and college in the summers, grows up to be a lawyer, eventually moves to Texas, and on this particular night, he's drinking with a client of his named Rolin King, and Rawlin's a Harvard MBA amateur pilot and In fact, right around this time, Herb is helping Rolin wind down this failed charter air business he'd had called Wild Goose Flying Service, basically like like flew rich guys to go hunt in the in Texas, in the country whatever.

So far as the most Texas story I've ever hed Verry Texas.

And ron says to Herb something like, you know, look, I know you're working on this failed air charter business that I have, but I think you and me we should actually start a real airline.

And Ronin takes a cocktail napkin there at the bar and he draws a triangle.

The top he read to Dallas.

The bottom left, he writes, San Antonio.

What's he right on the bottom right?

Houston, Texas, Houston right good.

You know, Rollin says, Look, these cities are hundreds of miles away from each other.

Takes a long time to drive from one to the other hours and you know, at the time you could fly between them, but basically nobody did.

It was inconvenient, it was really expensive.

Flying is what you did when you need to go New York to La on business.

Yeah, yeah, exactly.

And so Herbs like, this is a crazy idea, and I want to do it.

Turns out the napkin might be apocrypual, but the triangle is real.

Well, those cities are in fact in a triangle.

And on the strength of the triangle and the Bourbon and the cigarettes, they launched Southwest.

And I'm going to argue in the show today that Southwest is the most successful airline in the history of America.

Let's do it.

I'm Jacob Goldstein and I'm Robert Smith.

And this is Business History, a show about the history of business, so it's called Business History.

Today on the show, we're talking about Southwest, which is scrappy, which is fun, and which completely changed what it means to fly in America.

Southwest eventually got into trouble, but it had this decades long run of incredible consistent profitability.

That may sound simple, right, A business is profitable, But in the airline industry, this is amazing.

The airline industry is notoriously one of the worst businesses in the world.

If you think about it, all those great airlines say their names on buildings have disappeared, right twa Eastern PanAm Aloha went to Hawaii, right, And even the big ones that are still around your Delta's, United's Americans.

They've declared bankruptcy at least once.

At least once.

It's just a regular thing.

The investor Warren Buffett notoriously said.

Don't say the investor Warren Buffett.

People know who Warren Buffett is, the singer Beyonce.

United An airline.

Warren Buffett always talked about how much he hated investing in the airline industry, even though he said he was somewhat addicted to it.

He famously said, if a far sighted capitalist had been President Kitty Hawk for the very first airplane flight, he would have done his successor is a huge favor by shooting Orville down.

It's rough.

Uncle Warren's kind of a hard mess.

He's like no airplines.

Ever, It's okay, let's do this Southwest story, the Triangle.

The Triangle.

We're going to start with the Triangle.

One obvious but very important fact about the triangle.

All three of those cities, San Antonio, Houston, they're all in Texas.

And this is really important.

In nineteen sixty six, the late sixties, when they're coming up with this idea because at the time, interstate air travel was regulated by the federal government.

Right, if you want to fly from state to state, the federal government is going to have a lot to say about it.

And so Herbin Rowlins figure, you know what, we're not gonna have to deal with that.

We're just going to stay inside of Texas.

And they've started in this place that it's actually pretty rare in the United States to have a big state with three population centers that far apart.

It's optimal.

Yeah, And the way airline regulation worked at that time in the late sixties feels wild, feels unimaginable today, Like the federal government decided which airlines could fly which routes, and by the way, at this time, they basically kept saying no when people asked to fly new routes, like no, no, we're not going to let you do that.

We're not going to let any more competition there.

And again, you're a major airline.

You want to fly from Denver to Seattle and you go to Washington, DC, and you're like, I.

Think this is my be a good route, Like, no, we've decided there's enough competition there.

We don't think there should be more.

And the airlines who do fly there, the government tells them down to the penny what they can charge for a ticket.

This is amazing to me.

It's it's like they're treating airlines and maybe they thought of it this way as a.

Public utility, like this power company.

Yeah, this thing that well, everybody needs it, and it's important to our national security and such.

So we're going to regulate this down to the penny you can charge.

And so this regulatory regime had some really striking effects.

Right, So the airlines are not competing on price.

The government's telling them the price, and so they wind up competing on service.

When people talk about how great air travel used to be, this is the era they're talking about, you know, and like it does seem like it was cool.

Like American airlines put a piano bar in first class, Like there was a piano player there on the plane.

Oh so good, and you could like mingle and like smoke, you could smoke, have a martiniz.

Even in coach.

Coach was good.

Like pan Am would roll a cart down the aisle with a with a roast on it and they'd like carve your slice of beef for you.

Seats were wider, there was more leg room, but like this came at a price, right, and not just a metaphorical price, an actual dollars price.

So here's here's one example.

I found in nineteen seventy, a round trip ticket from New York to LA cost two hundred and eighty four dollars Robert Smith.

If you adjust that for inflation, nineteen seventy, two hundred and eighty four dollars.

I got the DLSCPI inflation calculator right here.

Nine hundred nine fifty no more.

Two hundred and eighty four dollars in nineteen seventy is the same as two thousand, four hundred and thirty four dollars.

I'm not paying five.

I'm not paying one thousand, four hundred dollars.

That's what it cost a fly round trip New York LA.

So it was like first classes today.

But this is like all the tickets.

Yes, and so to anyone compla about how much better air travel used to be, I say, just fly for his class, because it's exactly it's still rad Yeah, apparently you walk past it at those big seats do look cool.

So you know, when businesses aren't competing on price, this is what happens, right, You get very nice things and they cost a lot of money.

Right, this is the world Herb and Rolin are getting into with Southwest and really ends up being mostly Herb.

Herb is the key figure at the airline for a long time.

He trains his personal savings to launch the airline.

He's still working his day job as a lawyer.

You know.

They do still have to get regulatory approval, not from the federal government but from the state of Texas.

Freedom loving Texas, Freedom loving Texas.

They get a certificate saying they can go into business serve in that triangle, and then the next day, the very next day, three legacy airlines that flew those triangle routes already sued to prevent Southwest from flying.

Saying what we don't want competitors, saying we don't need more airlines, saying the market does not need more airlines, And they immediately got an.

Injunction, even in Texas, even in Texas, Land of the Free, remember the Almo whatever.

It's so funny to think of, right, this is the way I think of the UK or Europe working, right, I forget that in the United States of America, you would just be like, I don't feel like having a new competitor.

Yeah, I mean well, if you think about like mid century America, right, which this still is, right, Like, you have this history where in the thirties, if we go back a few decades, right, you have the Depression and then you have the New Deal, which is this moment when the government really steps in to regulate the economy.

Banks were much more highly regulated, trucking was much more highly regulated.

Yeah, and there was a distrust of business even at this point, far from the depression.

Yeah.

So that's the context, and that's why Southwest has to fight this legal battle just to fly, and it actually takes a year.

For years, Southwest is blocked from flying.

They're spending all their capital on legal fees.

And after a while, the board says this, enough, we're just losing money in court.

We're not a real company.

Let's give up.

And Herb says, look, I'll represent the company for free.

There's more legal fees.

I'll pay him out of my own pocket.

And he keeps fighting.

Was he stubborn or was he like, this is an actual business opportunity on one hundred percent convinced of it.

I think he was stubborn.

Okay, went through a lot of cigarettes, so many cigarettes that'll load it up like half of their startup capital.

But he's doing well in court.

He's winning in court.

Eventually, by June of nineteen seventy one, so this is years into it, things are looking good.

Southwest schedules its first flights for June eighteenth, and on the sixteenth, the rival airlines get wait for it, an they're in junction to block Southwest, and Herb goes to Austin where the State Supreme Court is, pulls an all nighter in the law library, goes before a special session of the State Supreme Court on the seventeenth and gets the court to block the injunction.

And he picks up the phone and he calls this guy, Lamar Mews, who he's hired to, you know, run operations at Southwest, tell him the good news, says, you know, we're good to go, and Lamar's like, are we you know?

Like I feel like at this point, surely there's gonna be another injunction and tomorrow we'll be about to go and the Sheriff's going to show up and say you can't fly.

What do I do if that happens?

And Herb says, if that happens, And this part's a quote he says, roll right over the son of a bitch and leave our tire tracks on his uniform.

Oh, Herb.

So the next day comes and in fact, Southwest does not have to drive over the sheriff.

There were no more injunctions, and they started flying, offering cheaper fares that were like twenty percent lower than their competitors, and basically nobody cared.

So I know, back in these days, if you were flying, you were probably a business person and you probably had your company pay for it, your secretary book the tickets.

You're just like, I gotta get from sand tony Ell to Houston.

I got to be there by nine to fifteen.

Yeah, exactly, Like nobody in that universe has an incentive to save twenty percent to fly on some airline nobody's ever heard of, Like, why would you do that?

And so Southwest is doing badly, and there's this amazing moment a few months later where Herb's sister in law calls him and is like, Herb, I got to tell you I just flew on Southwest and it was the most amazing flight, incredible service, And HER's like, oh, that's so good to hear, and his sister in law is like, yeah, on the plane, it was just me, the pilots and the flight attendants.

I was the only passenger.

It was incredible crushing.

But the way they turn it around is actually interesting and delightful.

And there's there's really two key things they figure out, two key things they do to turn it around.

The first one happens just later that year, and it's that same guy Lamar used, the guy tell her hired to run operations.

He's thinking about the fact that every night Southwest flies an empty plane back from San Antonio to Dallas to get a maintenance that's where their maintenance center is, and it's like too late for businessmen.

Nobody's gonna fly at that point.

They'll just stay in a hotel on the company dime.

Right, But Lamar thinks, like, well, the plane's flying anyway, we gotta have a pilot on it.

What if we sell tickets really cheap and just see if anybody buys them?

So they offer tickets for ten bucks.

Oh crazy late night fair, right, other you know, adjusted for inflation, that's like eighty But at that time, in that regulated expensive world, it was crazy cheap.

It was less than half of what tickets usually cost, and they do like one radio ad or something.

It's just like a cheap experiment.

And the first night they have one of these flights, they are swamped.

People are lined up to get on it, and crucially, crucially, the people who are there look nothing like the people who usually fly.

Remember this is like the carved roast businessman, I want to say business person, the reallyest businessman.

Sure.

Era of flying.

Flying is you know, refined expensive.

The majority of Americans at this point have never been on a plane nineteen seventy one.

And so with this new ten dollars late night fair, Southwest is not playing that game, right, Like they're not competing with the twenty six dollars midday businessman fair.

It's a whole different product almost.

It's a whole different customer base.

These are people who maybe they would have driven a few hours, taken the boss, you know, the greyhound, and they see a price that's like close ish to what they might have paid anyway, and they're like, I'm getting on a plane.

Yeah, it's positive some right, Like they're they're not cannibalizing some other fair.

They're bringing new people into flying, and so quickly they're like, oh, this is working, and they create two fair classes, the regular weekday business person fair and this cheap nights and weekends fair for the masses.

And it works.

They have competitors, right, because it's Texas, it's easier for people to change their prices.

And so one of the old school competitors, Branif.

Bran If really they were an airline, they cut their regular daytime fare to thirteen dollars, half of what it had been before.

It was money loser for them.

But like Classic, they're a big airline.

They can lose money on this little fare and they figure, you know, Classic, big player move will just bleed Southwest dry.

And so Southwest has this, I have to say, delightful response.

When Branif does that, they say, okay, we'll give you a choice, public customer.

You can pay thirteen dollars to fly midday, or you can pay the usual twenty six dollars fare and get the flight and a fifth of shivis regal fifth of whiskey.

Well you just get that when you get on the planet.

Yes, yes, and a glass.

I've just come to the I think, isn't that that comes to the little valeure purple?

Yeah, I mean it's only an hour flight.

What could go wrong?

The people buying these tickets, these are the mid day weekday ticket.

They're not paying, right, the company is paying, and so why wouldn't they be like, Yeah, I'm paying twenty six dollars for my ticket, company, please pay me back.

And then they get the whiskey.

Are you telling me they didn't report the whiskey to their employer.

They just took it home.

Seems plausible, Yes, they just took it home.

I think it meets the deminimus exemption.

And so there's this moment when Southwest is the biggest shivis regal distributor in Texas.

So what I love about this story so far is Southwest And maybe this is just you know, Herb's craziness really is that they're really innovating and responding to what's going on.

They're able to change on a dime, really and come up with these ideas in this staid industry where are sort of by government definition, they didn't want anything to change.

Yes, and there's a weird way in which that regulation is like their friend, right, you know, like the Bezos line, your margin is my opportunity.

It's sort of that vibe.

Yeah, yeah, yeah, So I do want to say one more thing about sort of the vibe and the shivis regal and the whole kind of Southwest positioning of itself in the marketplace on what their brand was.

Their brand was like we are the wild Mavericks.

We love whiskey.

And there was another piece of this that has aged less well, which is the flight attendant uniforms that they came up with.

And they were these like extremely extremely short shorts.

And you've shown me a picture of this.

We've all seen the short skirts that stewardesses would wear at airlines.

These are way short.

They are way shorter.

So this was an era where there was like rampant sexism toward flight attendants in the airline industry, and Southwest was definitely a part of that.

So, okay, it's nineteen seventy two, right.

Southwest has been up and running for about a year.

Those off peak fares are popular, but the company is still losing money.

Their daytime flights are still running largely empty.

Businessmen are still flying brandish whatever.

And by the spring of nineteen seventy two, companies, I guess, checking account whatever, their current account bank account is down to one hundred and forty three dollars, not one hundred and forty three.

One hundred and forty three dollars.

They're about to run out of money.

In a warehouse full of whiskey.

Don't get me rod whiskey.

They got the wa we got the short shorts of the whiskey.

But one hundred and forty three dollars.

You don't have to have airplanes.

They have four airplanes, right, that's their big asset.

And so they decide they're gonna sell one of the planes.

That's the way you get money, ouch ouch, Right, So it means they're gonna have to cut back on flights.

They're gonna have to lay people off.

And this, by the way, is the classic beginning of a death spiral, when you start to cut essential parts of your business, and that means you make less money, which means you have to sell another plane.

And this is like the way fewer flights means it's less convenient to fly them.

Right.

So there's this guy, Bill Franklin, who's in charge of ground operations, and he says, okay, we just went from four planes to three.

I know a way we can keep the same number of flights, same staff.

We just have to keep the planes we have in the air more often, and the way to do that is spend less time on the ground.

And I think it was actually weirdly hard for me to find this number, but my sense is that the turnaround time at the gate for Southwest at this point was something like twenty five minutes.

Which is amazing by today's standards.

But they were small planes, right, Yeah, So just to be.

Clear what this means, Right, the plane comes into the gate, passengers get off, the plane gets cleaned, other passengers get on, whatever has to happen outside the plane, fuel, luggage, bug, pushback from the gate.

All of that twenty five minutes.

And Bill Franklin is like, okay, we can keep our current schedule with three planes instead of four.

We just have to go from twenty five minutes to ten.

It does not seem possible.

What they said to him, That is what they said to Bill Franklin.

And here's Bill Frankuilin's quote when they said it.

He said, we're gonna do ten minute turns with this airplane.

And if you can't do a ten minute turn, you're gonna get five, and we'll bring somebody else in and if he can't do a ten minute turn, we'll fire him to and we'll just keep firing until we can find someone who can do it.

I feel like, you know how now they say stay seated until we're at the gate.

I feel like at this point at Southwest, they're like, as soon as the plane touches.

Down, they're like, don't get up, get up, get your stuff.

That is the bottle, that is the bot.

So you have like, you know, people from the from the back office helping out.

You have flight attendants cleaning the plane from the back as the passengers they're getting off.

Is it a deep clean?

I am guessing that.

I'm guessing they were not worried about how clean the plane was.

That's not why you were flying Southwest for ten dollars, right, you know.

Then you have the gate crew like hustle in the passengers on for the next flight.

And then once everybody's on the plane, just in the door, they close the door and the pilot pushes back from the gate.

Are they waiting for passengers to sit down?

No, they are not.

If they didn't make that rule until the eighties, I don't know it's because of Southwest, but maybe by the way I just wanted.

There's a very very interesting thing to talk about right here, about the getting on everybody standing up.

When you fly Southwest, as you may know if you have flown some I asked, you don't reserve a specific seat.

You just get on the plane and you sit in the order that you've arrived.

Yes, the person who gets their first gets to get on first.

Person who gets their last gets to get on last.

There is no seat number, and even when you get there, they don't give you a seat number.

And much like the subway, you if you see an open seat.

You hustle for it.

Well, so let's talk about this, right, Let's talk about what's the fastest way to get on a plane.

This, on one level, doesn't feel like the fastest.

I feel like I know one hundred slowest ways to get on the plane.

Every time I'm lining up, I'm like, really really yagers I know, And then it's just like, are you going from the back?

You're going from the front.

Are you're going for People have studied this.

There is a literature of a lane boarding back to front, one of the classics.

Quite slow in fact, because there's a lot of waiting.

There's a lot of standing and waiting.

People have come up with other ways, like window middle aisle.

There's actually an astrophysicist who came up with this very elaborate system of like alternating rows, and I think window middle aisle.

But a problem with window middleisle is you don't get on with like your spouse or your kid family you're sitting next to, and you have to explain the whole thing, and then you're just fighting with someone handing on the study this get on and sit down wherever is either the fastest or the fastest among any reasonable way to get on a plane.

It is shockingly fast.

Well, I have read that when computers look at when people leave something like leave a sports stadium, it is remarkably efficient because everyone is optimized for finding the best way out and the shortest way out.

And so you have sixty thousand people all simultaneously optimizing.

And you can understand that.

I know, so Southwest didn't need an astrophysicist to figure out that sit down wherever you are is fast.

Right, there's this sense of like, oh, I'd better sit out.

It's like the musical chairs version of getting out of plan.

Right.

They just did it, and it helped them with their super fast turns.

You know, they don't hit ten minutes every time, it's sort of the dream, but they hit it sometimes, and when they miss, it's still a lot faster than twenty five minutes.

Right, And you know, remember these plays are going back and forth, back and forth on these short hops all day long, so saving a few minutes on every turn is huge.

This means they have a very large cost advantage relative to the other airlines.

Right, They've just reduced their fleet by twenty five percent, Right, They've gone from four to three, and they can still do the same number of flights, right, same amount of revenue, less capital costs.

And the next year, nineteen seventy three, with all these changes, Southwest turns a profit.

Sort of amazing from what we know about the nineteen seventies, Yes, right, I mean, I mean seriously, right, we have oil embargo in nineteen seventy three, We've got stagflation, huge inflation later in the seventies, Like this is not an era when every company is.

Probably you don't want to be starting an airline.

I mean, there is a theory that starting and growing during hard times makes you make better choices.

Well, it is the case that Southwest from nineteen seventy three on is going to be profitable every year for the next forty seven years.

Stunning well, because think of the oil prices during this time, think of the inflation during this time.

You know, problems with unions, You're thinking about financial crashes, recessions.

Yeah.

Yeah, So we're going to take a break and when we come back, we're going to do Southwest big expansion, right, and Southwest is going to conquer America from.

Texas to the country.

All right, Robert, we're back with more Southwest.

It's the mid seventies.

Southwest is there in Texas starting to make a profit.

These airlines that are flying cheap and making a profit are weird outliers, right because remember any airline that's flying an interstate route is forbidden by law from lowering its prices, And like, why would you want to lower your prices?

Right, Like, you're a business.

You just want to go to the government and say, hey, our costs have gone up, can we charge more in the government's Like yeah.

People talk a lot about the competitive spirit, but like most people, if you've got a pretty sweet gig and you own an airline, right, you run an airline.

Life is good, nice life.

Yeah, and you're not like a crazy billionaire, but like you're rich.

You have a pleasant life.

You get to wear a uniform sometimes whatever, You get to ride wherever you want.

So that's the way it worked for a long time.

But then around this time things start changing for a few reasons.

One reason is the seven forty seven, the Boeing seven forty seven, the wide body, and of course the airlines love it right because it's the big, shiny new thing.

You gotta have the big plane with a little hump on the top.

Yeah, I love that.

I love that.

More wild over the top services you can provide.

Air Canada puts a disco in its seven forty seven almost two on the nose for the seventies airlines, So good disco ball.

You'll lower the lights and then people smoking.

Smoking is what I go to for the seventies.

So the airlines love seven forty sevens, in fact too much.

They buy too many of them.

And so now there is a glot of seats flying around America.

Airlines are flying all these planes largely empty.

And then they notice over there, oh look, Southwest.

Southwest is making a profit by selling just cheap tickets, no disco.

So the big national airlines start going to the government asking to do this unheard of thing, cut prices, and for the first time in like decades, the government says, well, okay, you can cut your prices.

And surprise, when the airlines cut their prices a lot, they get more customers.

Yeah, people fly more, those empty seats start to fill up.

But there's another kind of big sweep of history thing happening, and that is a change in the way people think about business and government and regulation.

And you know, we talked before about this kind of mid century world where the government was just much more involved in the economy in lots of ways and how that works for people.

But you know, now we're in the seventies and the seventies are a bad economic time, right.

You have kind of the rust belt is starting, and inflation is coming, and the oil crisis is there.

And a huge distinction because when an economy is growing, you can actually be a kind of a bad business, you know, with heavy regulations and every year, oh you grow four or five percent.

Everybody's happy, the government's happy, you're happy, your customers are happy.

But when an economy starts to shrink.

This is where the problems happened because you're not used to it.

And people start to rethink regulation.

It's happening kind of popularly and academically scholarly, right, So the scholarly piece comes out of the University of Chicago.

Of course, this economist named George Stigler.

In the early seventies, actually right around the time Southwest is just getting its first flight off the ground, Stigler publishes a paper called A Theory of Economic Regulation winds up being a hugely influential paper helps him get the Nobel Prize later on, and he lays out the key idea on the first page he writes this.

He writes, as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit.

So what he's saying is you like to think government regulation is cracking down on those e businesses in order protect guy.

Yeah, yeah, yeah.

But in fact, what he's saying is that industries, especially incumbent players, want the regulation to keep out scrappy independence trying to come up and take your business.

Yes, he is saying regulation exists for the benefit of the regulated businesses, and there is an economic term associated with this, it's regulatory capture, which means the regulators are captured by the industry they're regulating.

So the FAA at the time might include people who worked at all the big airlines.

And after you work at the FAA, where are you going to get a job?

Yes, oh, I don't know.

How about American airlines?

Yeah?

Yes, And in Stigler's theory, and I think it's fair to say, in fact, yes, they were captured by the airlines they were regulating.

And you know, there's a case that when the airlines were just getting going back in the thirties, maybe it was reasonable for the government to regulate them, right, Maybe they would have priced each other out of business, maybe they would have cut corners in a way that made it dangerous because of competition.

But forty years later to still be blocking new airlines on the grounds that they'd be too cheap, Like, that's regulatory capture.

And it resonated not just as an academic idea, but as a popular idea.

And it's interesting the timing of this and the politics of this, because you know, the sort of standard story of this is it happened in the eighties under Ronald Reagan, right, Ronald Reagan brought this Conservative revolution where he and the federal government deregulated the economy.

But that's not true in the case of airlines.

This started in the seventies.

Ted Kennedy was a big proponent of deregulating the airlines, and Jimmy Carter, the Democratic President in the late seventies, appointed this skeptic of regulation to run the federal airline regulator.

The CAAB was at the Civilian Aviation Board.

I believe that that was this board that did all the pricing and stuff.

And in nineteen seventy eight, Congress passed a law to deregulate the airlines, bipartisan.

Carter signed it into law.

So now all of these rules about who can fly, wear and what they can charge that have guided almost the entire industry but not Southwest, are gone.

And remember, at this time, people thought there was something very broken about America and American capitalism because in the nineteen seventies we're also seeing this sudden influx of Japanese cars, which they feel are cheaper and know better, and there was this overwhelming sense I mean, I guess President Carter said it as this malaise that like we're a country that doesn't innovate that and part of the problem is the government at this point.

Yes, and so now airlines are deregulated.

You would think this would allow for a wave of innovation.

Right Southwest is like prime to.

You're told the story like it's about to change everything.

It's really interesting what happens because they can go wild, but they don't.

Really they don't.

And I think it really shows sort of the difference between their kind of public persona the corporate brand on the one and their behavior as a company on the other.

Like think about it, right, Like their reputation is the goofy mavericks, you know, the flight attendants making dad jokes during the safety announcements, and like there's this famous basically publicity stunt one time where there was a trademark dispute with some other company plane Smart Pla and he smart right, and they decide they're going to settle it by Herb tell her having an arm wrestling match with the guy from the other company, and they do this like pro wrestling match, and Herb loses and gets carried out of the room on a stretcher with an IV bag of wild turkey.

Right and he rides a Harley Davidson and whatever.

This is the brand.

But from a business standpoint, from an efficiency standpoint, Southwest is nothing like that.

They are, in fact, incredibly disciplined.

And so what you see is in the decades after deregulation, it's the other airlines that are going wild, transforming themselves, spending tons of money, going bankrupt, and Southwest is the one that is cautious and disciplined.

If they were like Maverick outliers in any way, it was that it was by being like cautious and efficient, which is.

Amazing, right, all that cigarettes and whiskey and the moment, the moment the market goes free.

What you realize is maybe what I was talking about about what Warren Buffett said, which is in a business like this, the way you're going to win is to just be ruthless about your bottom line, yeah, about your costs.

There's no advantage of one airline over another.

You can try all the discos you want, but it's essentially a commodity product, and in a commodity product, you have to watch every cent.

Robert.

I've prepared for you a list, a level list, five ways in which other airlines went wild and Southwest didn't.

We's still FEO years after deregulation number five super Premium Comfort, Economy class plus.

So you know, right, so there was first class, and there was whatever business class and premium economy comfort plus, more leg room, even more leg room.

And you know there is a logic to this, right, which is, oh, different people will pay different prices.

You know, if people want to pay for more for more, let's do that.

Southwest is like, you know what, we got one kind of seat.

It's just a regular seat.

We'll fly you from one place to another in that seat.

Number four, selling tickets everywhere.

Oh so, travel agents were still big in the eighties, and then you know, in the nineties, the Internet comes along and you get your orbits and your expedias coming along, you know, online travel sites.

I'm a kayak man.

Southwest didn't care that much about travel agents and was not even on orbits or Expedia or kayak actually until like last year, for forever.

Basically, I don't know if you ever noticed that if.

You did a concation they did, you'd have to do separate searches for Southwest.

And so there's a straightforward reason for this.

When you buy a plane ticket through a travel agent or through expediaor Kayak, the intermediary gets some of that money, and Southwest wants to get all of that money.

And so they're just like, no, we're not going to sell through those intermediaries.

It's so funny, right, airlines are this glamor business, or they were for decades, and like the airline CEOs at Delta and American, they don't want to be trying to save what is half.

A percent one percent?

Right, they want to sell more tickets that not Southwest Okay, number three hubs hubs.

So after deregulation, now remember airlines can fly wherever they want.

They're not constrained by the government, and they're like, we're going to fly everywhere.

And the way we're going to do that is the hub and spoke model.

Right, So we're going to pick a city and tons of flights are going to go in and out of that city, and that way people can go wherever they want.

They just got to go through you know, Atlanta if you're flying Delta or Dallas if you're flying American.

Southwest.

No, No, Southwest is like, you know what, We're just going to fly people from Phoenix to LA and we're gonna fly ten flights a day, and it's going to be cheaper, and it's going to be great.

We're not in the business of flying people wherever they want to go.

We're in the business of flying profitable routes where we can sell cheap, reliable tickets.

They've done the research.

They know that people are paying a lot of money.

They know that they can undercut the current fairs and that there will be enough people to fill the planes.

Yes, and and by the way, when they go into a new city, they typically go into not the main airport.

Right.

Have you flown Southwest?

Oh?

Yes, I've seen a lot of the country in strange small airports.

Yeah.

I used to fly San Diego to Oakland all the time, so you know in San Francisco, San Francisco's the big Airport's done.

Oakland to Burbank, that's San Francisco to LA to other people, But to me, it is Oakland.

And there there is a reason for this, right, it's those airports tend to have cheaper gates, right, airlines have to pay for gatespace Southwest.

You know, their passengers are not flying onto Tokyo or whatever.

If your American airlines, you've got to go to JFK or LAX or SFO.

Southwest is that they're not in that business.

And also those airports tend to be less crowded, which makes it easier to do a fast turn right, they get jammed up less.

Oh interesting, right, because you can get right on the right on the runway number two.

Yes, that's where we are planes.

After deregulation, airlines like we can fly anywhere, and for little routes, we're gonna get little planes, and for medium sized routes, we're gonna get medium planes, and for big routes, we're gonna get big planes.

Southwest does not, with one very brief exception, they have flown one kind of plane the whole time.

The Boeing seven thirty seven, which, in keeping with the Southwest vibe, is not a tiny plane.

It's not a giant plane.

It's just a plane.

It's so funny, right, Boring is their competitive advantage.

Yeah, and like just think about the efficiencies on this one, right, I mean from the small ones at Bigwah, you only got to print one seatback card.

Yeah.

The pilots can fly any plane, any flame.

Yeah, yeah, yeah, yeah, well, you need a pilot get sick.

You know, is this pilot certified on this plane?

Yes?

The answer is always yes for Southwest, even you know the things like getting the baggage and all the logistics, it's always the same.

If they need to swap in a new plane, they always got the right plane.

It creates this incredible efficiency of standardization.

This would be enough for any business.

But you're telling me there's one more.

The number one reason.

Yes, and it's kind of a meta reason.

It's kind of it kind of flows through all of these The number one reason that Southwest was able to stay efficient and profitable when all the other airlines went wild.

They never tried to be number one.

Nice think about this.

I actually think this is really an important one and useful to think about.

Airlines tend to attract big ego CEOs, right, I mean, most big company CEOs have big egos.

But the airline business, as we've been discussing, is a bad business.

You're not getting into it because you want to be rich.

You're getting into it because you want to fly the big planes.

You want to beat everybody else.

You want to be the most glamorous airline in the sky.

You're right, and they're kind of obsessed with this in the same way that broadcast TV used to be, Like ABC's number one this week, NBC's number one the next week.

And they want to be the number one airline in the world.

In fact, when they are, don't they put that on their ads, like, oh, more people fly so and SO than any other airline.

And you really see this, like when you read histories of the period, they're like personally, the CEOs are personally obsessed with beating their rival, and Southwest is not.

There's this really simple but great quote from Herbteller, market share has nothing to do with profitability.

Oh no, it's so.

It's so true.

We don't want to fly more people than anybody else.

We just want to make more money than we spend flying people.

This is such a This whole story is like an indictment of the way Americans do business, at least for a certain period of time.

Right that they want the regulars.

They don't want to compete.

They want to be number one, even if it means it costs their investors' money.

But not Southwest.

And this is why I think this is at the core of Southwest success, Right, Like every other major airline that still exists that was around at deregulation has gone bankrupt at least once, some more than once.

Southwest has not.

They have been profitable every year for fifty years, with the exception of the pandemic of twenty twenty.

But as we will discuss after the break, a lot of those things from that list of what made Southwest great are about to cause it some real trouble.

Okay, so we're back with the Southwest story.

Southwest has this amazing run, not just a year after year, but decade after decade, and by the time Herbkellerer dies in twenty nineteen, Southwest is carrying more passengers than any US airline, Not that they care, but that's amazing.

They're big and successful.

But trouble is coming.

They're about to hit this run of trouble, and in a lot of ways, the same things that made them successful for all those years are going to be key causes of their of their problems.

The first thing that goes wrong, it starts in like late twenty eighteen early twenty nineteen, when there are two separate plane crashes.

One is in Indonesia, one is in Ethiopia, they're different airlines, but both are Boeing seven thirty seven specific huge news deal.

It was a big deal because it was the newest version of the seven thirty seven, the seven thirty seven Max.

And in March of twenty nineteen, the FAA grounds all seven thirty seven Maxes in the US.

So these are seven thirty sevens.

Remember, Southwest is the airline that only flies seven thirty sevens, which has been great until now, but now, unsurprisingly they have more seven thirty seven Maxes than any other airline and they get hammered right like, they now have to cut back on their service.

To be clear, they don't have to shut down.

They're not flying solely seven thirty seven Maxes, some of the older seven thirty sevens, but they lose something like a billion dollars in revenue because of this.

This is the classic trade off between efficiency and resilience.

Yeah, right, And we saw this a lot in the pandemic with with shipping.

You know, you've chain stuff you just in time delivery, a really efficient supply chain.

You were also the one most at risk for something going wrong because you didn't have a lot of other sources for your materials.

Yes, so in this analogy, Southwest was super efficient, but it has this huge risk just sitting there, so they lose a billion revenue.

They cost some of that back from Boeing, but you know it's a blow, not a death blow, but a blow.

And then twenty twenty, of course you get the pandemic all airlines only you're since seventy three that Southwest didn't turn a profit.

Bad, but again not devastating.

It's after the pandemic that things keep going wrong and get worse for Southwest.

Twenty twenty two, the big legacy airlines, Delta, United American, they are doing great.

There was this rebound travel, right, Everybody had saved up their money and they were like, I'm going to Europe, I'm taking the big planes, I'm going stimulus checks.

Government sends you a check, you just sign it over to Delta and go to Europe.

And you know, this is a moment when a lot of people are feeling rich, right, Like when you look at people's bank balances at this time, it's wild like people in fact not richer.

Yeah, and so this is a moment when you will pay for premium economy comfort plus, right, This is a moment when you will fly to Europe, and all of those behaviors are not Southwest behaviors.

Right.

This is not a simple plane, This is not Phoenix to La, this is not weird little airports.

Right.

So this is a moment when everybody else is coming back and Southwest is kind of muddling along.

And then really the big blow, The big blow comes in December of twenty twenty two, not long before Christmas.

This giant Wiener storm hits the East coast and upper Midwest.

Airports shut down, lots of airlines cancel flights, you know, up and down.

Luckily there's not news crews who would like go out to the airports and stand there for forty eight hours straight.

Luckily it's not Christmas time when there's no news that they're so happy to go to the airport with people sleeping on the ground.

I could verify this was a big deal.

This was a big deal.

And for most airlines it's like, yes, there's a storm, and now a day two days later, we're back up and running and everything's fine.

But Southwest at this moment has this epic epic collapse.

They cannot get things going.

And the storm has passed, but Southwest is still largely grounded.

They cancel more than sixteen thousand flights, They leave something like two million people stranded, and when they figure out what went wrong, it turns out it was this one internal software system that was supposed to reassign Southwest crew members when a flight got canceled or rescheduled, and it just completely failed and they couldn't get it back up.

So think of this, right, like the company doesn't even know where their flight crews are, and the crews themselves, like they want to work, they want to get things going in Yeah, the crews themselves have to actually like call on the phone like ordinary schmuck passengers to find out where to go to work.

They have to wait, you know, hours on hold.

When they get through, people don't even know because like some poor person at headquarters is trying to figure all this out on a piece of paper or something.

It's a disaster for Southwest?

Was it because of Southwest's cost cutting?

Was this one of the ways they cheaped out by having like a nineteen seventies internal system.

So the CEO perhaps predictably said no, no, this was just like an unfortunate you know, actually, I think used the phrase perfect storm.

But the union leaders at the company, the people you know who had been negotiating with the CEO for years, said no, no, we have been telling you for years that this system is out of date and it's going to fail.

So maybe it was because they were too cheap.

You know what is efficient and what is too cheap.

In any case, this is a disaster for Southwest right, days and days of news coverage.

So Southwest winds up paying something like seven hundred and fifty million dollars in reimbursements and penalties, and now things are bad the company.

Right, Their profits are stagnant, even as the industry is coming back.

Their stock price falls by more than fifty percent between twenty twenty one and twenty twenty three.

By twenty twenty four, the stock is still below where it was before the pandemic.

I feel like if herb Kelleher were still around, he would say go with the plan, like this is what our company does.

Stay the course and yes there will be disasters that happen, but like we have the better business model.

Go go go.

I mean, it's interesting to think about him having died like just before Southwest ran into so much trouble.

Is that correlated.

I don't know in any case, that is basically what Southwest was trying to do, just to keep being Southwest.

But if you're a publicly traded company with a still a pretty good brand and your stock price is way down, what happens to you?

You get a call from Wall Street.

You get a call from Wall Street, right, And in this case, it was an activist hedge fund called Elliot that bought something like ten percent more than ten percent of the company's stock.

And what Elliott does is this kind of thing.

They buy up stock and try and turn companies around.

Yeah, you accumulate until you have to announce how much you own of the company, and then you write a strongly worded letter to the.

Board to the board.

So, in its letter to the board in twenty twenty four, Elliott writes, quote, while Southwest has a proud history, that history is not an argument for supporting poor leadership and sticking with the strategy that no longer succeeds in the modern airline industry.

This is what they do, and they're hoping they're taking the bat that they can make dramatic changes, maybe not long term changes, but maybe some short term changes to.

Increase the value of the company and then get out of the business.

And they're saying, like their idea is Southwest, you should become more like everybody else.

Right, That is the subtext of a strategy that no longer succeeds in the modern airline industry.

Oh and also they wanted to fire the CEO, of course, because they always I wanted to fire the CEO.

But what's interesting to me is that other part, right, their strategy no longer succeeds in the modern airline industry because in a lot of ways, if you think about Southwest at the time of deregulation and the rest of the industry or in the eighties when they're all going wild like, in some ways, it's the rest of the industry that has become more like Southwest.

Right.

What made Southwest different was really cheap prices, Right, But now there are ultra low cost carriers with really cheap prices.

They are also you can fly basic economy on Delta.

As I do every time, I'm wearing extra sweaters because I can't sit in my luggage.

I'm sitting across from you in the road, just one from the back of the plane.

You paid less close to the bathroom.

You know, even in terms of vibes, right, think about vibes.

When Southwest launch, they were like the friendly hey where your pal airline and the others are like the more formal kind of corporate airlines.

Now like every company is your pal, right, And when you fly now, right, when you fly now and you see college students flying for the weekend, you see ordinary people who are not business people flying.

When you see people flying who aren't rich, frankly, who aren't you know, upper middle class, like that is Southwest.

This is fascinating.

So I'm right in a way that's sticking with the plan is the most efficient way to go.

But what I didn't include is that other airlines are also doing the same plan.

Your competitive advantage was that you were cheaper, more nimble, able to make these decisions better than other airlines.

And once everyone does it, what do you got?

So what has Southwest done under this pressure?

Well, they didn't fire the CEO, but they are changing, right, there were still those things about Southwest that were different.

You know, they still had one kind of seat.

You still didn't get a seat assignment no longer.

Starting on January twenty seventh, twenty twenty six, Southwest passengers will have the choice of Standard, Preferred or Extra legroom.

I'm a little sad.

Yeah, end of an era.

An era, Yeah, it was a pain in the but end of an era.

I mean it was a good run.

It was a great rout for the airline industry.

Like I'd take forty eight years for the first time in the history of Southwest, Everybody's going to buy an assigned seat.

Not me.

I'm going Herb Kellerhurst style.

I'm gonna just walk on the plane and sit wherever I want to.

I love it.

That's the end of the show.

We'll put a list of sources in the show, notts.

That's the end of the show.

Shows in the airline.

That's the end of the show.

We'll put a list of the sources in the show notes.

I do want to mention one book that I found particularly useful.

It's called Hard Landing.

It's by Thomas Petsinger, Junior, and it's an old book.

It's the story of what happened right around deregulation, kind of before, during, and after, and it's it's a very good nonfiction book.

Our showrunner is Ryan Dilly, Our producer is Gabriel Hunter Chang.

And our engineer is Sarah Bruguier.

I'm Jacob Goldstein.

I'm Robert Smith.

We'll be back next week with another episode of Business History, a show about the history of business.