Something Big Just Happened at Southwest Airlines

By Adam Levine-Weinberg Markets Fool.com

Southwest Airlines (NYSE: LUV) customers may not have noticed anything different this week. But behind the scenes, the low-fare airline giant just made a huge change, moving to a new integrated reservation system.

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To the casual observer, a change in reservation systems might not seem especially important. However, this is a big step that could unlock opportunities to increase Southwest's annual pre-tax profit by $500 million over the next several years.

Southwest needed some new IT

Airline IT systems are extremely complex and need to be very reliable, as an outage can quickly lead to hundreds or even thousands of delays and flight cancellations. As a result, airlines tend to stick with their proven systems -- even if they are decades old. They then find workarounds to add new functionality on top of the old system.

This has been the case at Southwest Airlines in recent years. However, the status quo was becoming increasingly unworkable. For example, Southwest's old reservation system didn't support international flights. But international growth has been a key priority for the company since its 2011 acquisition of AirTran Airways.

Southwest Airlines has made international expansion a top priority. Image source: Southwest Airlines.

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For the past few years, Southwest Airlines has operated a separate reservation system from Amadeus IT Group for its international routes. As of this week, Southwest has moved all of its domestic flights to the Amadeus platform as well.

Aside from enabling domestic and international flights to be managed on the same platform, the new reservation system will give Southwest additional operational and revenue management capabilities. That's why the company expects the new system to unlock huge profit-growth opportunities.

Southwest Airlines enters the 21st century

Southwest Airlines has now implemented what it calls "Release 1" and "Release 2" of the new reservation system. R1 allowed it to accept bookings on the new system, while R2 included all of the tools needed by employees at ticket counters, gates, and call centers to assist customers.Neither of these releases will have much impact on Southwest's financial performance, though.

The next release (R3), which is scheduled for later this year, will start to provide tangible financial benefits.Most notably, R3 should improve Southwest's revenue performance by linking its revenue-management system directly to the new reservation system. Management thinks R3 alone could boost pre-tax profit by $200 million annually.

Looking further ahead, a key benefit of Southwest's new reservation system is that it is easy to modify. The company has a series of upgrades that it plans to implement in the next few years to reach its target of at least $500 million in incremental pre-tax profit.

Southwest Airlines executives detailed some of these upcoming changes at the company's 2016 investor day. Just to give a few examples, the new reservation system will:

  • enable revenue management for ancillary products
  • increase schedule flexibility
  • improve connection times
  • permit redeye flights
  • support future codeshare or interline agreements
  • allow Southwest to sell tickets in foreign currencies

The new reservation system will also help Southwest Airlines control its costs. Most notably, it will support more automation for rebooking customers when flights are canceled due to major weather events.

Southwest Airlines is ready to return to profit growth

Last quarter, Southwest Airlines reported a disappointing earnings-per-share decline of more than 30%. For the current quarter, analysts expect EPS to be roughly flat year over year.

However, Southwest is well positioned to return to strong profit growth later this year, as labor cost inflation will slow and the company will retire the rest of its aging 737 "Classic" fleet. The company's new reservation system -- and the numerous opportunities it will unlock -- will help Southwest Airlines maintain this earnings momentum in 2018 and beyond.

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Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.