Here is a brief excerpt from an interview of Herb Kelleher by Chuck Lucier in 2004 when Kelleher was chairman and CEO of Southwest Airlines. Durting the course of the interview, the co-founder and then chairman of Southwest Airlines tells why “a firm’s people are everything.” In my o[pinion, it is not only one of the most valuable interviews that have appeared in strategy+business magazine, it is also one of Kelleher’s best interviews, period. Congratulations to Chuck Lucier, s+b, and its publisher, Booz & Company.

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Photograph courtesy of Southwest Airlines

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The airline industry is a tough place to make a buck: too many competitors, price-sensitive customers, high capital intensity, boom-or-bust cyclicality, powerful suppliers, and often intransigent unions. Nevertheless, Herb Kelleher, the cofounder and chairman of Southwest Airlines, created the sort of value that any company leader would envy.

From its start in 1971, Southwest has grown into the fourth-largest airline in the United States, with 30 consecutive years of profitability, in an industry in which no other company has been profitable for even five straight years. Total shareholder returns during that period were almost double the returns for the S&P 500. Southwest has managed to accrue a market capitalization larger than that of the rest of the American airlines combined. Major competitors have tried to imitate Southwest with clones. Many entrepreneurial start-ups in the United States and Europe, including JetBlue and Ryanair, cite Southwest as their inspiration.

Southwest’s achievements are widely attributed to its relentless focus. From the start, Southwest’s strategy has been to draw travelers not from other airlines, but from cars, buses, and trains, by providing them the least expensive and fastest service available. To support the strategy, the company determined to fly only one type of airplane, the Boeing 737, and to substitute linear flying for the hub-and-spoke model that had prevailed in the industry. But at the center of Southwest’s success are its culture and employees. “Your spirit,” says Kelleher, a man fabled for his willingness to party hard with his staff, is “the most powerful thing of all.”

In recognition of the inspiration he provides all who study and practice strategy, for his contributions in redefining how companies think about strategy, and for his achievements in redefining an industry, in November 2003 Kelleher was granted the Lifetime Achievement Award by the Strategic Management Society (SMS), the prestigious global association of academic and corporate strategists.

At the SMS annual meeting in Baltimore, Md., where Mr. Kelleher accepted the award,strategy+business contributing editor and “Breakthrough Thoughts” co-columnist Chuck Lucier led a spirited public conversation with Mr. Kelleher about Southwest’s success.

Let’s start with some words from your award. You made an “audacious commitment” to putting employees first, customers second, and shareholders third. How did you get away with that for 20 years?

When I started out, business school professors liked to pose a conundrum: Which do you put first, your employees, your customers, or your shareholders? As if that were an unanswerable question. My answer was very easy: You put your employees first. If you truly treat your employees that way, they will treat your customers well, your customers will come back, and that’s what makes your shareholders happy. So there is no constituency at war with any other constituency. Ultimately, it’s shareholder value that you’re producing.

A dollar invested at Southwest’s 1972 initial public offering is worth $1,400 today. Does that come solely from putting your employees first?

We have been successful because we’ve had a simple strategy. Our people have bought into it. Our people fully understand it. We have had to have extreme discipline in not departing from the strategy.

We basically said to our people, there are three things that we’re interested in. The lowest costs in the industry — that can’t hurt you, having the lowest costs. The best customer service — that’s a very important element of value. We said beyond that we’re interested in intangibles — a spiritual infusion — because they are the hardest things for your competitors to replicate. The tangible things your competitors can go out and buy. But they can’t buy your spirit. So it’s the most powerful thing of all.

Not to deny the importance of intangibles, but what’s the source of Southwest’s cost advantage?

The cost advantage is very important because we started out with a philosophy that we were going to charge low fares, come hell or high water. We were going to enable more people to fly. It didn’t matter whether we had competition or not. In other words, we just said we’re a different type of cat. When we get a load factor that gets into the 70 or 75 percent range over an appreciable period of time, we don’t increase fares. We add flights and put additional seats in. So if you come from that basic position, that this is what you are, then of course you have to have low costs.

Now, how do you get low costs? Through a lot of things, including the inspiration that you give your people, their productivity, the fact that they feel that they’re doing something that is really significant and that they are enjoying themselves at work. If you take all of Southwest’s compensation together — wage rates, profit sharing, the full 401(k) match, the stock options that our people have — Southwest employees are the most highly compensated people in the entire airline industry. One of our pilots just retired with $8 million in his profit-sharing account. Now, you have to do well to produce that.

A compensation scheme based on stock is great when the company is doing well. But when the stock doesn’t do well, you can have a motivation problem.

Absolutely, that is a risk. So we don’t just give people stock options. We have an educational team that goes around and explains to them what stock options are, how they work, the fact that it’s a longer-term investment. From 1990 to 1994, the airline industry as a whole lost $13 billion. Southwest Airlines was profitable during that entire time, but our stock was battered. Eighty-four percent of our employees continued with Southwest Airlines stock during that four-year period. That’s the kind of confidence and faith that you have to engender, so people have a longer-term view, and they’re not trying to outplay the market every day.

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Here’s a direct link to the complete interview.

On July 19, 2007, Southwest Airlines announced that Herb Kelleher would step down from the role of chairman and resign from the board of directors in May 2008, though he would remain a full time employee for another five years. Kelleher ultimately stepped down as chairman on May 21, 2008. Immediately following, Southwest Airlines named current CEO, Gary C. Kelly the new chairman of the board of Directors.mWhen this interview was conducted, Chuck Lucier was senior vice president emeritus of Booz Allen Hamilton and at work on a book as well as consulting on strategy and knowledge issues with selected clients.