It's the end of budget airlines as we know them

Airlines have been forced to seek alternative revenue opportunities as tough economic conditions reduce profits despite record travel demand.

• Southwest Airlines is ending its famous open seating policy.
• Assigned seating could generate up to $2 billion in revenue for Southwest, one analyst estimated.
• The change represents a larger evolution of budget airline business models in the US.

Budget airlines are upending many their original business plans as increased costs wreak havoc on their bottom lines.

On Thursday, Southwest Airlines announced the end of its open seating policy, a 50-year practice of letting passengers choose their seats based on their boarding order instead of having one pre-assigned.

Instead, the airline will follow most other airlines in the world in assigning seats and offering premium options on all of its flights, saying internal research found this to be preferred by a vast majority of customers. More details will be revealed in September.

The move was an expected but nonetheless shocking reversal by the US's arguably last remaining low-cost airline that had thus far resisted the changes implemented by many competitors.

But industry conditions, like higher labor and fuel costs and overcapacity, mean airlines like Southwest are struggling with reduced profits despite record travel demand — forcing them to seek alternative revenue opportunities.

Analyst Savanthi Syth of Raymond James estimated in June that paid seat assignments could generate between $600 million and $2 billion in revenue. Adding basic economy and premium seating could add another $400 million and $1 billion in revenue, respectively, they said.

Budget flying has been moving in this direction for years.

The industry's sea change has left budget carriers scrambling to increase revenue without turning away customers, prompting major policy changes.

Travel analyst Henry Harteveldt told BI these adjustments come as operators evolve to keep up with changing customer preferences, noting things like credit cards and certain routes can be lucrative for these carriers.

"The new seating policy can further pump up Southwest's credit card, where maybe it can offer cardholders free seats or other awards for being loyal frequent flyers," he said, noting how adding red-eye flights will also make it more competitive against legacy competitors.

Other budget airlines have been similarly evolving their business models in recent years.

Frontier Airlines and Spirit Airlines, for example, ditched most cancellation and change fees for ticket holders. These were typically moneymaking for the carriers but irritating for customers.

In July, Spirit warned of a revenue decline because fewer passengers are buying the add-ons that are a mainstay of the budget airline business model.

Those fees were critical to carriers like Spirit, which can't rely on things like free carry-ons and sodas like legacy airlines.

Meanwhile, JetBlue now charges up to $49 for "Core Preferred" seats — the window and aisle seats toward the front of the regular economy cabin.

That came after a federal judge blocked JetBlue's planned merger with Spirit. Struggles with profitability also saw JetBlue shake up its route network.

The carrier has even delved into business-class seating with its lie-flat Mint product — something not typically seen on budget carriers.

Frontier has recently added a "business class" where the middle seat is blocked off to attract more high-paying customers, while Spirit has its "Big Front Seat."

United Airlines CEO Scott Kirby previously criticized ultra-low-cost airlines. "It's a fundamentally flawed business model," he said. "The customers hate it."

What comes next for Southwest?

Southwest says more details about its plans will be revealed at a September investor day.

"This is what our customers want," CEO Bob Jordan told CNBC Thursday, noting the company has been working toward the changes for over a year.

An activist hedge fund breathing down the company's neck and demanding a C-suite shake-up, he said, had nothing to do with the changes.

"I know there are going to be customers who say 'I want to stay with open seating,'" Jordan said. "It's a minority, but we had the same thing when we switched from plastic boarding passes; we had the same thing when we when we took peanuts out of the cabin, so I'm convinced we can win them over."