Q & A With Southwest Airlines CEO Gary Kelly

With business travel plummeting, consumers demanding deep discounts and oil prices fluctuating wildly, the airline industry is facing one of its worst downturns ever. So when Southwest Airlines (LUV) became one of the few carriers to eke out a profit in the second quarter, you'd think it was time for CEO Gary Kelly to celebrate by tapping that beer vending machine sitting in the corner of his second-floor office.

Not so fast. "The worst is ahead of us," says Kelly, a 23-year veteran of the Dallas-based airline. In Kelly's book, doing less badly than your rivals isn't enough. The low-key executive, who became CEO in 2004 and succeeded chain-smoking, antics-loving cofounder Herb Kelleher as chairman last year, cautioned investors that despite the black ink in the second quarter, he couldn't predict a repeat performance later in the year. That's not to say the 54-year-old executive isn't trying-he's cut the number of planes flying, started service at bigger airports like New York's LaGuardia and Boston's Logan, and charged passengers for priority boarding and for carrying pets on board.

Southwest held up well in past downturns, helped by its low cost structure and knack for savvy long-term planning. But this time around it's had a tougher time: Until last fall it hadn't reported a quarterly loss in 17 years. The firm retains some distinct advantages, like its investment-grade credit rating, modern fleet of Boeing 737s and ability to get planes in and out of the airport faster than rivals. But it also faces new challenges. Other carriers sharply lowered their labor and other expenses during bankruptcy proceedings, slicing into Southwest's long-held cost advantage. To some, the rapidly shifting landscape means Southwest might have to stop trying so hard to be different. They question, for example, its reluctance to follow rivals in charging fees for checking baggage. "Maybe that's not the right way to go," says Helane Becker, analyst at brokerage firm Jesup & Lamont.

For Kelly, who took his first flight on Southwest in 1975, when flight attendants wore hot pants, the challenge is to maneuver through the airline downturn without compromising the carrier's financial strength or its offbeat culture. As Southwest has grown from a scrappy underdog to an airline with more domestic passengers than any other, the flight attendants have traded in their hot pants for khakis. But the quirkiness continues: Take-off instructions are sometimes rapped, and passengers are warned to "keep your tush in the cush" upon landing. We sat down with the sixth-generation Texan in his office outfitted with historical memorabilia from his home state to hear about his plan to get through the turbulence.

A lot of people have talked about "green shoots" signaling economic recovery. Do you see them?

The industry is under tremendous stress. There are absolutely no green shoots. We have to be very prepared for uncertainty and instability, and operate with an abundance of caution.

You've cut about 6 percent of flights this year. How much more is needed?

The question is: What is it going to take to not just survive the recession but maintain our financial position and take care of employees? We will have to continue to trim our flight schedule but at a pace that's not radical, in hopes we can avoid grounding airplanes, furloughing employees and all the bad things that can happen in difficult environments. We'll have to be sure to maintain sufficient levels of cash. We have $2.4 billion and plenty of access to capital markets, and we are going to boost revenue and reduce costs through an early-retirement program.

How do you increase revenue?

Many of the opportunities depend on new technology. We've changed our boarding process, introduced a new fare structure and implemented new technology to manage fares better.

You've held off on baggage charges, much to the dismay of analysts.

Customers hate these fees. Analysts assume you charge the fee and it drops straight to the bottom line. But it's not clear that we'll make more money if we charge than if we don't.

But aren't fliers getting accustomed to these fees?

The potential from charging baggage fees is at most 5 percent of revenue, and it's not a reach to say we are getting that much more from not charging.

Airports are filled with disgruntled passengers. Should there be legislation to ease the frustrations?

I don't accept that. In brand and satisfaction rankings, we were up there with high-end restaurants. Travel is not always perfect; it's about how we deal with those less-than-perfect situations, like delays. Surveys show passengers just want to know if their flight is going to go and at what time. So we stress those things. It's a shame to legislate something that can't be legislated, like weather.

You've been at Southwest 23 years. What is different about this downturn?

I wish steroids were legal, because the speed at which we need to identify issues, study them and make decisions is unlike anything I have experienced before. Anytime you have that many points changing that rapidly, there are bound to be some rough spots. A couple of years ago, we had record earnings, so we were making plans with a lot of comfort. But we've lost our cushion now, so we have to manage our risk much more carefully.

What bothers you?

Generalizations. People think of our low fares, and that implies "cheap." But we have one of the youngest fleets, best compensation packages and have never had furloughs. And some people think all we do is have parties. That's not even close to reality.