Intelligent Fanatics Project-Paperbacknothard · Chapter 5 Low-Cost Airline Wizard: Herb Kelleher...

Chapter 5Low-Cost Airline Wizard: Herb Kelleher

Southwest Airlines

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.

—Warren Buffett, Telegraph interview

According to the unofficial records of Airlines for America, there have been 198 airline bankruptcies since the aviation industry deregulated, in 1978, and since then the U.S. airline industry alone has lost $60 bil-lion. No industry can match these staggering statistics. Even so, neither Airlines for America nor the Department of Transportation has official statistics on the number of bankruptcies—likely because everyone has lost count. Multiple carriers have declared Chapter 11 reorganization

8/27/2016 © Sean Iddings & Ian Cassel

mrwigglesworth

Typewritten Text

Low-Cost Airline Wizard: Herb Kelleher | 83

multiple times during that period. One U.S. airline, however, has bucked the trend.

Southwest Airlines is nearing its forty-third consecutive year of profitability. That means it has made a profit nearly every year of its corporate life, minus the first fifteen months of start-up losses. Given such an incredible track record in a horrible industry, luck cannot be the only factor. There had to be at least one intelligent fanatic behind its success.

In Southwest’s case, there were many intelligent fanatics behind the company, led by Herb Kelleher. Early on, it could have been apparent to investors that Southwest had some special people behind it.

In 1973, the upstart Texas airline, Southwest Airlines, with only three airplanes, turned the corner and reached profitability. This was a significant achievement, considering that the company had to over-come three and a half years of legal hurdles raised by two entrenched and better-financed competitors: Braniff International Airways had sixty-nine aircraft and $256 million in revenues, and Texas International had forty-five aircraft with $32 million in revenues by 1973. How Southwest achieved the company’s first year of profitability demonstrated clearly that Lamar Muse, Herb Kelleher, and other early Southwest managers and board members had the iconoclastic charac-teristics of intelligent fanatics, which foreshadowed what was to come for the business.

Prior to February 1973, Southwest was struggling with lower load factors on the San Antonio to Dallas route. To combat this, Lamar Muse, then CEO of Southwest and longtime, experienced executive at Universal Airlines, and Herb Kelleher developed a strategy to lower prices by half (from $26 to $13) to improve the load factor on that route. There were no restrictions on the discount. The tactic subse-quently worked, improving the load factor.

Unfortunately, Braniff, the largest airline operator in Texas, which


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had tried hard to prevent Southwest from flying in the first place, reacted to Southwest’s price move by lowering its own Houston to Dallas route fare to $13, encouraging customers to “get acquainted” with the airline. This was a tremendous blow to Southwest. At the time, this route was relatively small for Braniff and the cheaper fare could have been sustained by its other operations. Southwest, on the other hand, could easily have gone bankrupt; the Houston to Dallas route was its only profitable route, and accounted for more than 70% of its revenues.

Muse and Kelleher quickly reacted and devised a marketing strat-egy that not only allowed them to win but also led Braniff to exit the route two years later. Following Braniff’s announcement, Southwest put a two-page advertisement in Houston and Dallas newspapers, with the caption “Nobody’s going to shoot Southwest Airlines out of the sky for a lousy $13.” The ad went on to describe that Southwest was giving customers a choice: customers could choose to pay the reduced $13 fare, or they could pay the normal fare of $26 and receive a compli-mentary fifth of Chivas Regal scotch, Crown Royal Canadian whisky, or Smirnoff vodka. Nondrinkers would receive a complimentary leather bucket.

For the duration of the deal, roughly 76% of passengers chose the normal fare price and gift. Southwest was the largest liquor distribu-tor in Texas for a few months. Business travelers loved the deal—they charged the higher-cost fare to their expense accounts and took the alcohol as a gift. Southwest had outsmarted the established competitor and displayed the creativity to compete successfully in one of the worst industries known to capitalism.

If that stroke of marketing genius had not perked your interest in 1973, you might also have observed, through significant due diligence, that Southwest Airlines was trying to change the commercial airline industry by doing more than just lowering airfares. The company had



to dispose of a newly acquired Boeing 737, for a tidy $500,000 profit, after the federal court ruled that Southwest could not fly out of state, which was the main reason for the purchase of the plane. The company also needed the cash to stay in business.

With only three planes and many scheduled flights, peers in the industry thought it would be impossible to maintain the sched-ule. Fortunately, Southwest’s ground operations guru, Bill Franklin, stepped up to the plate and said that it was possible to maintain the schedule if the company kept the three planes en route and minimized plane turnarounds to ten minutes or less. A turnaround means pulling a plane up to a gate, unloading passengers, loading new passengers, and pushing back from the gate.

Neither the FAA, Braniff, nor the manufacturer of the Boeing 737 thought a ten-minute turn could be accomplished. Average turn-around times for airlines were forty-five minutes to an hour. Bill, on the other hand, had experience with older DC-3 airplanes regularly turning quickly at Trans-Texas. He believed that a Boeing 737 could be turned in ten minutes or less, and the workers at Southwest were too new and inexperienced to know any different. Southwest was able to pull it off, and the ten-minute turn became one of the hallmarks of the company.

Southwest was tapping into a market with great possibilities. Southwest’s management was determined to bring air travel to the masses. Prior to 1971, air travel was restricted to the elite, who could afford the high prices regulated by the government. Southwest was at the forefront of deregulation of the airline industry with its low fares. If successful with their model, there was plenty of runway for Southwest to grow at abnormally high rates for a long time.

Many competitors shrugged Southwest off as an afterthought, and few U.S. competitors cared to clone Southwest’s zany model. Companies that did care to clone Southwest, like People Express or


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American West, did not possess the iron discipline Southwest possessed and ended up failing. Those companies lost focus by stepping out-side of their niche and losing control of their spending, and so forth. Southwest was able to maintain its focus on being profitable and pro-viding job security for its employees.

It took twenty years for someone in the airline industry to steal Southwest’s ideas and maintain focus. Twenty-six-year-old Michael O’Leary was the first. O’Leary was the accountant of Tony Ryan, CEO of a poorly performing Ryanair, and was charged with getting the com-pany to profitability. He took a trip to Dallas in early 1991 to learn all of Herb Kelleher’s secrets and went on to create a fairly true clone of Southwest in Europe, albeit with some differences. Michael O’Leary had this to say about the trip:

We went to look at Southwest Airlines in the U.S. It was like the road to Damascus. This was the way to make Ryanair work. I met with Herb Kelleher. I passed out about midnight, and when I woke up again at about 3 a.m., Kelleher was still there, the *********, pouring himself another bourbon. I thought I’d

pick his brains and come away with the Holy Grail.1

Since Ryanair’s initial public offering in 1997, the stock is up more than 2,000%, a return of 19.4% compounded annually. Compare that with the S&P 500’s total return of 6.4% over the same period. So, if you were not able to identify Herb Kelleher and other Southwest man-agers as intelligent fanatics in the early 1970s or the 1980s, an investor could have been redeemed by following another intelligent fanatic into a Southwest clone in Europe twenty years later.

Michael O’Leary was not the only individual to borrow heavily from Herb Kelleher and succeed. Kip Tindell borrowed many ideas from Southwest Airlines’ corporate culture, in a totally different industry, when he founded The Container Store in Dallas, in 1978.



According to Tindell, The Container Store believed “in the vision of Herb Kelleher, the legendary cofounder of Southwest Airlines, who said ‘a company is stronger if it is bound by love rather than by fear.’ I was completely taken by it.”2 The Container Store has fostered employ-ees who have been, and continue to be, more productive than average employees, and this has led to better customer relations. Tindell says he pays anywhere from 50% to 100% more for every employee and gets about two to three times more productivity out of them. Tindell also says that The Container Store has a 10% employee turnover rate, compared to the retail industry average of 100%.

* * *

Herbert Kelleher was born on March 12, 1931, in Haddon Heights, New Jersey. He grew up during the Great Depression; however, he did not experience the Depression as many other kids in his neigh-borhood or other parts the United States experienced it. His father provided the family with financial stability as a general manager at the Campbell’s Soup plant and benefited from the recession-proof nature of the business.

Herb was a hard worker in school, in sports, and outside of school. He excelled in all of his activities and had a knack for leadership. Herb not only learned at school but also was interested in reading stories of heroes and adventure; later, he continued to be a voracious reader and learner. When Herb was eleven or twelve years old, he experienced a change in his family dynamic that shaped him. His brothers and sisters, all older, had by that time all moved out of the house, and his older brother Richard died in World War II, in 1942. Not long after that, his ill father died.

Herb was left with his mother, who had a great influence on how he was to look at the world, in terms of ethics, morals, and how to treat others. Herb said:


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She used to sit up talking to me till three, four in the morn-ing. She talked a lot about how you should treat people with respect. She said that positions and titles signify absolutely nothing. They’re just adornments; they don’t represent the substance of anybody . . . She taught me that that every per-son and every job is worth as much as any other person or any other job.3

Many of these lessons would later be infused in Southwest Airlines, and the idea of a company treating employees as it treats its customers turned out to be a very powerful competitive weapon.

After working six summers at Campbell’s, doing various jobs—as a soup chef, a warehouse foreman, and a part-time analyst—Kelleher went to and graduated from Wesleyan University. Like the other CEOs profiled in this book, Herb did not graduate with a degree in business but with a bachelor’s degree in English and philosophy. He had an eye on becoming a journalist. Luckily, a mentor at the college steered Herb into law, which became his conduit into the business world and ulti-mately into Southwest Airlines.

Herb Kelleher graduated with a law degree in 1956, and after work-ing for a few years as a clerk in New Jersey, then as a partner at a law firm, he moved with his wife to San Antonio, Texas, in 1961. As Sol Price had done in San Diego, twenty years prior, Herb Kelleher gained immense business experience by representing many different types of businessmen at the law firm Matthews, Nolin, MacFarlane & Barrett.

It was also at the firm that Herb met client Rollin King, an entre-preneur who had been running a third-level charter airline doing short-haul routes out of Twin Beaches since 1964. By 1967, King had observed and studied the success of Pacific Southwest Airlines, which was the first large discount airline operating within California. Rollin King met with Herb Kelleher soon after at a bar, where King sketched the triangle diagram of the three-city route on the back of a cocktail



napkin. After some thought, Kelleher was on board with a $10,000 investment and to provide legal services.

Southwest was going to need a lawyer with a warrior spirit to over-come the challenges the company was about to face. After two rounds of financing, the company was able to raise $543,000. Soon, Southwest’s application to fly between Dallas, Houston, and San Antonio had been approved by the aeronautics commission. However, it was not until 1971 that Southwest was able to make its first flight.

As already described, the competitive landscape for airlines in Texas was substantial. Incumbents were benefiting from a regulated monopoly established by the government. Southwest was entering the market as a discount airline, which worried competitors. With their large resources, competitors did everything in their power to prevent Southwest from getting off the ground, and they were successful in temporarily delaying Southwest’s first flight. The incumbents filed a temporary restraining order that prohibited the aeronautics commis-sion from issuing Southwest a certificate to fly. The case went to trial in the Austin state court, which did not support another carrier entering the market.

Southwest proceeded to appeal the lower court decision that the market could not support another carrier. The intermediate appellate court sided with the lower court and upheld the ruling. In the mean-time, Southwest had yet to make a single dollar in revenues and had already spent a vast majority of the money it had raised.

Like any other investor in such a situation, board members were getting frustrated and nervous about the future prospects of Southwest Airlines. Herb Kelleher proposed to the board one last shot at over-turning the ruling, saying, “I will continue to represent the company in court, and I’ll postpone any legal fees and pay every cent of the court costs out of my own pocket.”4 With little left to lose, everyone agreed


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to give Herb one last chance and allow him to argue in front of the Supreme Court of Texas.

The only problem was that the company needed highly experi-enced operators and cash. Southwest had only $142 left in the bank and roughly $80,000 in overdue bills. These problems were resolved after King and Kelleher hired the qualified Lamar Muse as CEO, in January 1971. Muse had many years of experience managing opera-tions at a number of airlines and was the iconoclastic entrepreneur to get the company up and running. Acting quickly, Muse was able to raise a significant amount of cash to buy aircraft from his expansive network of contacts, and he was able to enlist a group of highly quali-fied operators to help him.

How was Southwest able to acquire talent? This is where luck came into play. The recession had impacted the airline industry to the point that there were many talented individuals available—individu-als who were open to thinking differently about the airline industry. Bill Franklin later dubbed this early group of talented managers at Southwest “The Over-the-Hill Gang.”

Southwest’s competitors continued to fight. Braniff and Texas International filed complaints with the U.S. Civil Aeronautics Board and also put pressure on Southwest’s initial public offering underwrit-ers to withdraw the offering. Fortunately, Southwest was able to retain another brokerage firm to underwrite the offering, and shares began trading publicly on June 8, 1971.

The aeronautics board also threw out the complaint from Braniff and Texas International, just two days before Southwest’s inaugural flight. Kelleher was able to convince the supreme court to rule in Southwest’s favor and to order the lower courts not to enforce the injunction. Only ten days after its initial public offering, Southwest was able make its inaugural flight. Through the public offering, Southwest was able to



raise $7 million to purchase aircraft and to execute its strategy, and it has been fighting with a warrior spirit ever since.

Lamar Muse did have a large impact on building Southwest Airlines from scratch to fourteen airplanes, $81 million in revenues, and 1,325 employees in 1978, which is the year Muse resigned and Herb Kelleher became chairman. More than a year later, in 1980, Lamar and his son founded Muse Air. Lamar came out of retirement to run the opera-tion, which competed with Southwest. However, Muse Air could not compete successfully and was subsequently purchased by Southwest, in 1985.

Howard Putnam became CEO after Lamar Muses’s departure, but his tenure only lasted until 1981, when he decided to become the president and chief operating officer of Braniff International. But Braniff was too big and too late. As Howard Putnam said, “They liked what Southwest was doing, and their sense was that the only way Braniff would be saved was to simplify and make it a transcontinental Southwest Airlines. Unfortunately, there wasn’t enough cash to do it.”5

Herb Kelleher was appointed CEO in 1982 and ran Southwest until 2001. He led Southwest from $270 million to $5.7 billion in revenues, every year being profitable. This is a significant feat, and no other airline has been able to match that kind of record in the United States. No one could match the iron discipline that Herb Kelleher instilled in Southwest Airlines from the first day and maintained so steadfastly throughout the years.

* * *

If you ever hear the words conventional and wisdom conjoined, reject them. Because if it is conventional, it isn’t wisdom. And if it’s wisdom, it isn’t conventional.

—Herb Kelleher


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How has Southwest been able to attain uncommon results in the worst industry in capitalism? The company has succeeded by being uncon-ventional. Herb likes to tell the story of how a Washington think tank told the company that it would not be able to survive without six of the “keys to success” that other carriers have used. Southwest followed none of those keys to success. At every point of Southwest’s history, the company has successfully challenged industry norms.

Southwest differed from the competition because of its low-cost fares. In the 1970s, before deregulation, flying was expensive, because the government controlled the prices. Rollin King and Herb Kelleher’s idea was to provide lower fares and enable a greater number of Americans to fly. Southwest would not be competing with other airlines but with other forms of transportation.

To lower its fares, Southwest did four things. First, the company operated out of less-costly and less-congested airports, such as Dallas’s Love Field and Hobby Airport in Houston. Direct flights between these small airports allowed the company to utilize its aircraft most efficiently and to get passengers directly to their locations; smaller airports are generally situated closer to downtown locations, making them more attractive to customers who are time sensitive, such as busi-nessmen. Love Field, for instance, is only a fourteen-minute drive from the heart of downtown Dallas. Compare that with the distance from Dallas/Fort Worth International Airport, which is twenty-five to thirty minutes from downtown Dallas by car.

Second, Southwest focused on operating only one type of aircraft, the Boeing 737, which gave the company bargaining power in new air-plane purchases and the power to make suggestions in the manufacture of those planes, to improve plane efficiency. Additionally, operating one type of aircraft lowered the labor hours necessary to train pilots, mechanics, and other workers.

Third, Southwest understood that planes are only good if they are



in the air. The company reduced the amount of time planes were on the ground by 90%, to ten minutes, and has maintained quicker turn times throughout the years than its competitors. Southwest has been able to get the most efficiency from a smaller number of planes and employees.

Finally, Southwest focuses first on its employees. Southwest is able to retain highly qualified, hardworking employees by providing an atmosphere that reinforces individual responsibility and offers oppor-tunities for advancement. As a result, employee turnover at Southwest has been well below the industry average. Lower turnover cuts down on costs and maximizes investment in employees.

There were other ways that Southwest was able to lower prices without affecting the customer experience. In the late 1970s, the com-pany was considering whether to install a multimillion-dollar ticketing system to automate tickets. Instead of parting ways with millions of dollars for such a system, an employee suggested that Southwest get a machine that produced a ticket that simply stated, “This is a ticket,” and nothing else. The ticketing system was simple and highly cost effective, because if a customer’s dog ate the ticket or the customer lost it, the customer could easily obtain another ticket. This reduced costs with respect to labor hours and materials.

Southwest could get clever, simple, cost-effective solutions from its employees because those employees thought and acted like owners. Employees also possessed copious amounts of curiosity, a characteris-tic sought by Southwest’s hiring team. Learning the lessons from his mother, Herb Kelleher built an egalitarian culture at Southwest. Each employee was treated the same as every other employee. Management was open to listening to all workers and to trying new, often uncon-ventional ideas.

To get employees to think and act like owners, management aligned employees with Southwest’s actual owners, both fiscally and intellec-tually. On the financial side, Southwest Airlines was the progenitor


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of profit sharing within the airline industry. Each employee had the opportunity to participate in the profit-sharing program and to con-tribute to a 401(k) retirement account, with a hefty employer match.

Intellectually, employees at Southwest are given autonomy to make their own decisions. Giving such power to employees enables them to act quickly to resolve a customer’s problems, as an owner would do. Planning and corporate layers dilute customer service, increasing the time needed to find a solution. Not every decision will be perfect, so Kelleher has been a big proponent of the motto “Ready, fire, aim.” It’s much better to clean up a mess and learn from the experience than to continually prepare but never act on an opportunity.

A great example of how quickly Southwest Airlines capitalized on opportunities occurred in 1990. Midway Airlines announced that the company was out of cash and was closing its doors in Chicago, provid-ing any airline an opportunity to swoop in and take over. Southwest was already prepared, with a team in Chicago before Midway’s announcement was made. The next day, Southwest’s team of lawyers was negotiating with Chicago city officials, trying to get the use of gates at Midway Airport, while a team of service personnel was already at Midway, on standby. By early afternoon, Southwest had agreed to spend $20 million on Midway Airport.

Shortly after, the mayor had a press conference announcing the deal, during which a reporter asked Southwest’s vice president and general counsel when the public could see a sign of Southwest’s com-mitment. The VP replied, “Go out to the airport; you’ll see it right now.”6 This speed allowed Southwest to capitalize on eighteen gates at Midway Airport and gain a more than 50% market share.

By this time, Southwest had $1.19 billion in revenues and $45 million in profits. Thinking small and acting small was not lip service. Southwest Airlines acted with nimble precision, whether it was gener-ating $5 million in revenues or $5 billion in revenues.



Additionally, each employee had a set of guidelines on how to man-age their affairs within the company. Southwest Airlines has a crystal clear mission that all employees can understand. Herb Kelleher has gone so far as to state that if an individual were to ask any employee the company’s mission, the employee would be able to describe it more eloquently then Kelleher himself, because employees are on the front lines. This mission and management philosophy had been embedded in the culture from day one, and as the company grew larger, the com-pany stuck to its principles with laser focus.

The first principle was to maintain a start-up-like corporate culture. As other CEOs profiled here have demonstrated, a can-do, action-ori-ented work environment is much more efficient than a bureaucracy. And as Southwest grew, Herb promoted the idea to continue simplify-ing. He has said on many occasions, “If we think small, we’ll grow big, but if we think like we’re big, we’ll grow smaller.”7

Although Kelleher said “Think small,” this didn’t include simplify-ing by eliminating large numbers of employees. Southwest Airlines is the only airline—and one of the few corporations in any industry—that has been able to run for decades without ever imposing a furlough. Cost reductions are found elsewhere, and that has promoted a healthy morale within the Southwest Airlines corporate culture. Employees have job security. A happy, well-trained labor force that only needs to be trained on one aircraft promotes more-efficient and safer flights. Southwest is the only airline that has a nearly perfect safety record.

* * *

There is a clear path of teaching from our first intelligent fanatic, John H. Patterson, indirectly to Herb Kelleher. As we saw in chapter 1, many men who worked under Patterson at National Cash Register went on to become successful on their own, using many of Patterson’s principles. One of the more famous examples was Thomas Watson,


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who went on to mentor many others at IBM. In an interview, Herb Kelleher told the following story about where he originally learned the culture of risk taking and how to apply it at a company:

What I remember is a story about Thomas Watson. This is what we have followed at Southwest Airlines. A vice president of IBM came in and said, “Mr. Watson, I’ve got a tremendous idea.” (Of course, this was long ago; the original Mr. Watson.) “And I want to set up this little division to work on it. And I need ten million dollars to get it started.” Well, it turned out to be a total failure. And the guy came back to Mr. Watson and he said that this was the original proposal, it cost ten million, and that it was a failure. “Here is my letter of resignation.” Mr. Watson said, “Hell, no! I just spent ten million on your education. I ain’t gonna let you leave.” That is what we do at Southwest Airlines.8

There are many examples at Southwest Airlines that demonstrate exactly this type of risk-taking culture. One notable example, high-lighted in the book Nuts!, by Kevin and Jackie Freiberg, is of Matt Buckley, a manager of cargo in 1985. After working at Southwest for three years, Buckley thought of a great idea: a same-day door-to-door cargo service. The service would compete with Federal Express, which Southwest had been using. Buckley drew up a detailed plan for his ser-vice, called Rush Plus, and presented it to Herb Kelleher and Colleen Barrett. Both managers agreed to give the idea a chance and urged Southwest to use Rush Plus exclusively.

It quickly turned out to be a mistake, but Kelleher and Barrett did not think it was an absolute failure. Management had given an employee the chance to try something out and to learn something, even if it was unsuccessful. Buckley, on the other hand, reacted as most employees would, with shame and embarrassment. The support of the company helped Buckley learn from the situation:



The more I was exposed to the jokes and jabs, the better I felt. I finally realized that people were actually trying to help me heal. Despite my overpromising and underproducing, people showed support and continued to reiterate, “It’s okay to make mistakes; that’s how you learn.” In most companies, I’d prob-ably have been fired, written off, and sent out to pasture. But, in this lifetime, I’d be hard-pressed to find the kind of love and forgiveness bestowed upon me by so many to allow me to save face.9

To Herb Kelleher, “anything worth doing always requires some risk, and with risk comes failure.”10 Instead of thinking of risk in terms of gambling and payoffs, Herb thought of risk-taking more like a sci-entist. The scientist sees whether something works, and if it doesn’t, he quickly changes course, with little hesitation. The quicker an organi-zation, management, and employees cut their losses, the quicker the company can find a solution.

Herb Kelleher wanted employees to take risks; however, Southwest as a whole never took big financial risks. It grew conservatively. The company took its time when expanding outside of Texas, and only expanded into areas that made financial sense. Expansion was done mainly with internally generated funds, whereas other airlines were piling on debt and growing for market share rather than for profits. Southwest was preparing for a rainy day, and for opportunities.

Take, for instance, the Iraqi invasion of Kuwait, in 1990. Jet fuel costs surged along with an economic recession—possibly the worst combination of events for the airline industry. The lower traffic and high fuel costs led two major U.S. carriers to file for bankruptcy and one to liquidate. The remaining eight major airlines and two medium-sized national carriers were having significant difficulties, due to high debt and being unprepared for the worst. Debt defaults, employee


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layoffs, and towering reported operating losses were common among all of them, except one.

Southwest reported only a $4.6 million loss for the fourth quarter and ended the year with more than $40 million in profits. Southwest went on to have one more unprofitable quarter, in the first quarter of 1991. However, the company quickly turned the corner in the second quarter and maintained profitability for the year.

There is another clear connection between Herb Kelleher and other intelligent fanatic CEOs in this book: he created a culture that focused on communication within Southwest and with the outside world. Kelleher was able to distill complex ideas into comprehensible information that every employee, regardless of position or intelligence, could understand.

Southwest employees were encouraged to create the same type of simple, effective communication. The employee communications department produces the corporate newsletter LUV Lines, which clearly communicates complex issues, such as how valuable each customer interaction is to the company as a whole and how important every employee’s efforts are to the company. An excerpt from Southwest’s LUV Lines in 1995 shows how clear internal communication with employees was:

How important is every Customer to our future? Our Finance Department reports that our break-even Customers per flight in 1994 was 74.5, which means that, on average, only when Customer #75 came on board did a flight become profitable!

Aside from that statistical data, let me share with you a down-to-earth formula devised by our Dallas chief pilot, Ken Gile. It utilizes our annual profit and total flights flown to clearly illustrate how vital each Customer is to our profitability and our very existence.



When you divide our 1994 annual profit by total flights flown, you get profit per flight:

Then, divide profit per flight by Southwest’s systemwide average one-way fare of $58:

The bottom line, only five Customers per flight accounted for our total 1994 profit! In other words, just five Customers per flight—only 3 million of the 40 million Customers we car-ried—meant the difference between profit and loss for our airline in 1994. To take it a step further, to have lost the busi-ness of only one of those Customers would have meant a 20 percent reduction in profit on that flight. That’s how valuable each Customer is to Southwest and you!11

Such clear communication helped employees understand their significance in a large, multibillion-dollar organization. It also shows how important each customer interaction is for the company’s well-being. As a result, employee morale continued to be as strong while the company grew as it would have been if the company had never grown at all. Communication with employees at Southwest is not much different from the clear communication Warren Buffett has had with shareholders and with his owned operations, through Berkshire Hathaway’s annual shareholder letters. Intelligent fanatics are teachers to every stakeholder.

* * *


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Herb Kelleher and other early Southwest Airline managers could have been identified as intelligent fanatics early. So, what would be the reward for investing with such special individuals, in such a horrible industry? Investing in Southwest Airlines in June of 1971 and holding until Herb Kelleher stepped down as CEO in 2001 would have pro-duced life-changing returns, turning $10,000 into $7.4 million dol-lars, excluding dividends. This would be a 25% CAGR, compared to the S&P 500’s return of 8.5% over the same period (see figure 5.1).

Figure 5.1$10,000 Investment in Southwest Airlines Compared to S&P 500 (1971–2001)

Source: Compustat data

Interestingly, if one waited to invest until Southwest Airlines was nearly profitable, in 1972, and held it until the end of 2015, then that $10,000 investment would have turned into $52.4 million dollars. That would be a 21.49% compounded annual return. The S&P 500 grew $10,000 into $184,500 during the same time period, or a 6.85% compounded annual growth rate, which is barely visible in figure 5.2.





A true sign of an intelligent fanatic–led organization is that the business continues to outperform even after the intelligent fanatic has fully exited the business. Herb Kelleher stepped down as chairman of Southwest Airlines in 2008, yet the company has been able to maintain its culture and performance. Sales have grown from $11 billion in rev-enues and $178 million in profits, in 2008, to $20 billion in revenues and profits of $2.2 billion in fiscal year 2015. The stock has continued to outperform the S&P 500 (see figure 5.3).


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