Public Benefits and Private Success: The Southwest Effect Revisited

Abstract

After Southwest Airlines was formed in 1967 and commercial operations began in 1971 the Company was engaged in 31 judicial and administrative proceedings through 1976 that challenged its right to operate. From its beginning the Company delivered a simple product with exceptional consumer value – low fares, high frequency of service, single aircraft type, simple product design, and a fun and friendly experience. Virtually every market entered by Southwest experienced a significant reduction in average market fares due to Southwest’s low fare initiatives, and passenger volumes responded disproportionately. The U.S. Department of Transportation’s landmark study in 1993 captioned this price-traffic stimulation phenomenon the SOUTHWEST EFFECT. Southwest began by serving three markets within the state of Texas and a fleet of four B737 airplanes. In July, 2017 it served 703 nonstop markets and 101 airports, using more than 700 B737 airplanes. This study reviews the framework for gauging the effect of entry (and potential entry) on markets for domestic air travel in the US. It provides an empirical survey of routes entered by Southwest from its beginning to the present. The presence and magnitude of the Southwest Effect has endured through time. Even today, when new markets have frequently been affected already by Southwest’s fares on connecting services, the Southwest Effect still shows, on average, an additional market fare reduction of 15% and corresponding traffic increase of 28% to 30%, from the introduction of nonstop service by Southwest. A few industry writers have questioned whether the Southwest Effect still exists today, or has it been overtaken by the fares/traffic effect created by other low cost carriers. The answer is clear. The Southwest Effect is alive and well. We find no evidence that the Southwest Effect has been eroded or overtaken in significance or magnitude by other airlines. This study set out to demonstrate in quantitative terms the Southwest Effect over the past four decades. Using regression analysis we developed a model to measure the current impact on market fares due to competition from Southwest. Our study finds that Southwest produces $9.1 billion annually in domestic consumer fare savings. One-way average market fares are $45 lower when Southwest serves a market nonstop than when it does not. If Southwest provides only connecting service in a city-pair market, average market fares are $17 lower (one-way) than when there is no competitive effect from Southwest.