Southwest Airlines‘ (NYSE:LUV) business has grown due to its successful, low cost operating model which allows it to profitably charge low fares from customers. However, low fares is not the only area of differentiation for Southwest from its major competitors. We believe that its policy for no baggage fees on the first and second checked bags and zero ticket change fee along side some other policies also help separate Southwest from many of its peers especially for budget conscious travelers. 
We currently have a stock price estimate of $14.24 for Southwest, marginally below its current market price.
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Many Carriers Use Baggage Fee To Grow Ancillary Revenues
Many major airlines including Delta (NYSE:DAL), United (NYSE:UAL), US Airways (NYSE:LCC) and Alaska (NYSE:ALK) see baggage and ticket change fees as essential components of ancillary revenues, which are operating revenues excluding passenger and cargo revenues. Recently, Alaska announced a hike in its baggage fee to $25 for each of the first two checked bags and in its ticket change fee to $125 for travel due within 59 days. The carrier contended that incremental revenues from these hikes would add $50 million to its ancillary revenues annually.  As these ancillary revenues do not come at any significant additional costs, they directly boost airline margins and profits. This is highly beneficial to airlines as they suffer from low margins due to their inability to raise airfares unilaterally as well as control fuel costs, which constitute nearly a third of their total costs.
Southwest Uses Baggage Fee Waiver To Attract Passengers
On the other hand, Southwest looks at baggage and ticket change fees differently. The carrier contends that by not charging any fee on first and second checked bags it is able to attract greater passenger traffic, which increases its market share.
We figure this strategy of Southwest supports the gains made from low fares and helps consolidate its position on the routes it expands to. It is not as if the carrier does not seek to grow its ancillary revenues, but due to its large expanding domestic and international network, the gains realized from waiving baggage fee and ticket change fee are likely greater than growing ancillary revenues by raising baggage fee. In our opinion, Southwest’s baggage fee waiver strengthens its low fare advantage to unsettle passenger traffic share as well as the pricing ability of competing carriers. Southwest, too, actively promotes its baggage fee waiver in marketing campaigns as Bags Fly Free to make customers aware about its this point of differentiation from its major competitors.
Additionally, Southwest also does not charge any fee for ticket change, seat selection, snacks, curb-side check-in or telephone reservation. AirTran, which Southwest acquired in 2011, does currently charge a fee for many of these heads including baggage, seat selection and telephone reservation. However, upon full integration, Southwest will bring its no fee on first and second checked bags and ticket change to AirTran as well.Notes:
- Southwest’s checked bags policy, September 24 2013, www.southwest.com [↩]
- Alaska Air Group’s investor update presentation for 8-K, July 11 2013, www.alaskaworld.com [↩]