It has been a pillar for Southwest Airlines since its inception – customers boarding a flight and filling seats on a first come, first serve basis. The no-frills philosophy has separated Southwest from the rest of the major airlines for more than 50 years. However, this year, Southwest will end its longstanding approach to boarding and will assign individual seats for the first time. In addition, the airline announced in March that it will start charging customers for checked baggage, ending its decades-long "Bags Fly Free" policy. Ed Rogowski says the moves are a chance for Southwest to take advantage of the many ancillary benefits that increase the profits for other airlines in the 21st century.

Rogowski, a long-time auditor for United Airlines, continues to follow the developments in the airline industry from his current role as a professor at Gies College of Business. Rogowski was United’s chief audit executive from 2003-2010 and director of financial accounting, including the development of all SEC financials from 1996 to 2003. During that time, he regularly met with his counterparts at other major airlines, including Southwest, to discuss common industry topics and issues. Rogowski is credited with United’s adoption of cashless cabins, for developing its international accounting system, accounting for UAL’s bankruptcy, and for finding root causes of operational inefficiencies and trying to solve them.

“I’ve observed Southwest for a long time,” Rogowski said. “We used to do a lot of competitive analysis at the airline in all phases of the business, benchmarking it with Southwest to understand what they were doing and how they were doing it.”

Rogowski notes that to understand the Southwest philosophy, you must go back to its inception in 1967. Herb Kelleher and Rollin King founded the airline and based it in Dallas’ Love Field, while the other airlines moved to the newly constructed Dallas-Fort Worth airport. While many were trying to decommission Love Field, the duo with a background in law, found a loophole that would allow Love to remain open and Southwest to use it as part of a Texas Triangle with Houston and San Antonio.

“Herb Kelleher was a larger-than-life airline figure,” Rogowski said. “His loophole, while limiting where Southwest could fly, still allowed it to operate out of Love Field, hop around in this regional area and serve those markets.”

At this time, other airlines were developing a hub-and-spoke model of service, flying passengers from regional ports into its hubs like Dallas, Denver, Chicago’s O’Hare, Los Angeles, New York, and Atlanta, and then routing them to larger places. Southwest, in an important point of differentiation, followed a point-to-point model.

“If you were flying from Dallas to L.A. [on Southwest], for instance, you might stop in Wichita, El Paso, and Albuquerque, before getting to your final destination,” Rogowski explained.  “It was a show up at the gate, no-frills approach. And customers were okay with it because the prices were so much cheaper.”

Customers could pay cash at the gate and instead of an assigned seat, they would be assigned a group number and get to choose their seat upon boarding. Those loyal to Southwest appreciated its flexibility, and Southwest prided itself on its relationship with customers. Its NYSE ticker symbol is, after all, LUV.

“They were all about minimizing the time on the ground between flights because the way their schedule was built, they needed to turn those aircrafts around quickly,” Rogowski said. “So, they developed this seating methodology where it was basically a cattle call. When you showed up, you got on. They found that passengers would do that in an effective, efficient way, which would enable those aircrafts to turn around quicker than an airline like a United or American, whose hub-and-spoke model made for longer turnaround times.”

The other piece to the Southwest model was that in addition to no seating assignments, their transaction processing systems were much more basic.

“Airlines recognize revenue when they provide the service,” Rogowski said. “They encourage customers to buy those tickets at least 2-3 weeks in advance because that is when those prices are the cheapest. In turn, the airlines get 2-3 weeks of cash flow. They record the liability and exchange it for a boarding pass.”

While Southwest would have about four or five different fares for each flight, United might have closer to 100.

“United’s method was designed to maximize the fact that inventory is fungible, so you want to sell it for as much as you can,” Rogowski said. “The closer you get to the flight, the more likely someone is going to be in need and willing to pay more. But at some point, when it is too close, you give the inventory to the internet and sell it that way. Southwest didn’t play that game. Their passengers felt they were paying the same price as the person sitting next to them. It was a very easy revenue model.”

Rogowski admits that Southwest’s model has been very successful for the past 50 years. He even helped United replicate Southwest’s point-to-point model to target leisure and last-minute business customers in 2004 on a United led project called “Ted.” His team would monitor Southwest ticket counters, note the number of walk-up passengers and figure the load in flights from Los Angeles to San Francisco. Ted also introduced a new boarding process to emulate Southwest’s quick boarding process to reduce the turnaround times between Ted flights. Ted’s boarding process was called, “WILMA” --a system designed to speed up boarding by prioritizing passengers seated at the window before those in the middle and aisle seats. Rogowski noted that tighter turns of the aircraft from arrival to departure, increased aircraft utilization and reduced costs enhancing profitability.  “Southwest has the tightest turn times in the industry.”

Those simple processes have finally caught up with Southwest, however. At the turn of the century as airlines consolidated and profit margins were razor thin, they turned to ancillary charges, such as seat choices, cabin upgrades, baggage charges, offerings of faster check-in lines, more services to buy in the cabin like internet to increase revenue. As today’s customers are more inclined to amenities, they are willing to pay a modest fee for these seat upgrades. Southwest’s systems and models don’t provide an opportunity for these additional revenue sources to the extent that their competitors do.

Rogowski adds that Southwest has been able to delay this switch by about a decade because its profits were skewed during the 2000s. Because fuel is the second to third largest expense and by far the most volatile, the airlines regularly hedge by buying future contracts to lock in the rates. While most airlines might do that for a percentage of their total fuel cost, Southwest invested in hedges for almost all their fuel needs for some periods and for large percentages of its’ fuel costs in other periods and reaped the benefits.

“Nobody did that kind of stuff to the level of Southwest,” Rogowski said of the long-term hedges. “First, you wouldn’t have enough collateral/cash. Secondly, it was a risky proposition because sometimes you are going to get burned by that, and sometimes you are going to be at an advantage. They bought it at a time where they got a huge advantage because fuel prices generally rose.”

As United compared its revenues to Southwest from publicly available SEC and filings required to be made with the Department of Transportation data, they realized that the only reason Southwest was making money from about 1998-2008 was because this hedge was so lucrative. “During the period of 1998 to 2008, 83% of Southwest’s profit was related to their hedges. Southwest estimated that their hedges saved approximately $3.5 billion during this period,” Rogowski said.

Since 2008 it has been a different story. Because Southwest had rather simplistic revenue and operating systems, it hasn’t been in position to offer the same type of cabin upgrades for additional revenue that cater to business and frequent travelers those other airlines like American, Delta and United offered. Customers are also no longer seeing the benefit in Southwest’s boarding process.

“Over time customers have also decided this kind of a boarding hassle isn’t worth it anymore and the prices aren’t that much different,” Rogowski said. “Southwest has realized it was getting harder to compete now that customers have more choices. They want a more predictable experience.

“If you look at a financial statement from United, Delta or American, the profits are coming from all these ancillary charges are highly profitable as there is very little cost associated with them. Southwest doesn’t have that same opportunity. With assigned seats, Southwest can now chunk up their aircraft cabin into different zones, allow people to pick seats in those zones, and upcharge them if they want to move to different zones. This flexibility though does come at a cost as Southwest will have to build a new boarding system that will allow them this flexibility that other major airlines have long used.”

When at Arthur Andersen and after joining United, Rogowski helped build the revenue system for United, which allowed the airline to match sales for each ticket, reconcile revenue, and give more details about the passengers. Since then, they can do a digital analysis from the sales and can find ways to incentivize and reward customers to spend more on their airline.

Although he doesn’t see Southwest adopting the hub-and-spoke model, Rogowski says this switch will afford them the opportunity to share in a much more sophisticated revenue model – a model that has benefited the rest of the airlines for the past quarter century.

“Their systems weren’t allowing them to maximize these ancillary opportunities like the other airlines did until they were able to build systems that would allow them to do that. Now their system will mirror every other airline. They will have a component that matches the sale to the lift that also creates boarding passes and seat assignments. Seat assignment will allow Southwest to maximize revenue on their aircraft and their long tradition of no assigned seats will no longer be a Southwest hallmark, Southwest will look more like a mainstream airline.”