How Better Risk Management Could Have Saved Southwest’s Investors $3 Billion

By: | February 17, 2023

Nir Kossovsky is CEO of Steel City Re, which mitigates the hazards of reputation risk with parametric reputation insurances, ESG insurances, and risk management advisory services.

The commercial flight risk scenario is well known.

A holiday flight cancellation fiasco by Southwest Airlines crushed the company’s market capitalization and caused the company to take an $800 million dollar write-down for Q4 and record losses three times greater than analysts had expected.

Equity returns 42 days into the crisis show Southwest trailing the Dow Jones U.S. Airlines Index by 18.4%. Had it merely kept pace with that index, Southwest’s market cap would have been more than $3.3 billion higher.

This is now much more than an operational crisis involving the failure of tottering software. It is an ongoing reputational crisis whose proximate cause was a technology issue but whose root cause was  poor risk management and governance.

Southwest, unlike its peers, could not fulfill its most fundamental business purpose for an entire week, and some customers no longer trust it to do so in the future. The airline is projecting more than $300 million in reduced revenue for Q1 from cancellations and slower new sales.

Stakeholders will judge for themselves the effectiveness of the post-mortem analyses of the crisis by an internal committee and outside consultants, and the marketing campaign to lure back customers.

But unless Southwest recognizes that a trustworthy reputation requires an effective enterprise-wide risk strategy to avoid future debacles of this nature, and unless the company is able to communicate about implementation of a new reputation risk management and oversight process, it will continue to leave stakeholders badly disappointed.

The Road Ahead, and the Road Not Taken

Mission critical risk denial can be costly. Disappointment and anger will affect all aspects of the company’s operations — including revenues, litigation, cost of capital, and the recruitment and retention of employees.

Negligence may be alleged. Regulatory affairs will face scrutiny from the Department of Transportation and congressional committees. Insurance professionals will fight claims denials as they seek indemnification for business interruption, various damages and D&O liability issues.

All of these will continue the downward spiral of Southwest’s reputation.

Risks, when well-managed, are relatively benign. What if Southwest, which built an excellent reputation over time, had actually built a robust process for managing risks to its reputation? Suppose Southwest had implemented an enterprise reputation risk committee years ago, comprising senior executives who knew how to gauge the expectations of their respective stakeholders?

Suppose those who had their fingers on the pulses of key stakeholder groups were empowered by an existing risk strategy to observe, orient, decide and act (OODA)?

Suppose they were able to anticipate and calculate in advance the extent of the damage that would occur if Southwest’s inadequate scheduling software was overwhelmed — by peak travel and widespread inclement weather caused by climate change, for example? And suppose this process had made senior management feel compelled to invest in an upgrade of their scheduling software?

Southwest Airlines investors would probably be $3 billion richer, for one thing.

The Value of Strategy

It may seem an obvious point that if companies anticipate potential crises in advance and avoid them, they’ll be better off. But it’s much more than that.

Our data show that risk management excellence reliably yields a going-forward return on investment provided that stakeholders know about it.

We’ve shown firms that preemptively disclose a risk strategy for issues that are mission-critical can rapidly realize a 9.3% equity boost. Even firms that are tested by a crisis but have not prepared their shareholders by disclosing their risk strategy, and that (unlike Southwest) are shown to be resilient, can pick up an average of 5% in equity value relative to their peers.

Chief executive Bob Jordan announced recently that Southwest is “re-examining the priority of technology and other investments planned in 2023.” But stakeholders are now left wondering if there are other mission-critical risks the company hasn’t accounted for.

Rather than focusing exclusively on the latest crisis in their rear-view mirror, Southwest would do well to also re-examine its reputational risk strategy in its entirety. &