The traditional discount airline on Wednesday held a "launch party" at its Dallas headquarters, complete with confetti and balloons, to mark the arrival of the first of 33 737-800 planes it will take this year. Southwest (LUV.N) primarily flies the Boeing (BA.N) 737; the newest model Southwest took can carry 175 passengers, 38 more than the version the carrier currently flies.

Chief Operating Officer Mike Van de Ven told employees the new plane marks "a new era" for Southwest.

"It's going to make us more profitable from Day One," Van de Ven said to loud applause.

Southwest, which for decades was the envy of its peers, is now finding it must work harder to stand out and stay profitable as fuel costs rise.

The company's once-celebrated fuel hedges are no longer as effective in blunting surging costs. And because Southwest's labor costs have risen while bigger competitors downsized in bankruptcy, its overall cost advantage against rivals has narrowed.

"The competition is much leaner and meaner than it has been in the past," said William Swelbar, a research engineer with MIT's International Center for Air Transportation. "Southwest I think is struggling mightily to differentiate itself."

Gary Kelly, who became Southwest's chief executive in 2004, said the company is still determined to be the industry's low-cost carrier, despite the macro challenges.

"The big game changer the last decade has been fuel costs," Kelly told reporters on Wednesday. "Our costs are substantially higher today if for no reason than that."

"The rest of our cost structure is in good shape but we have to continue to look for opportunities to become more efficient," he added. "There are lower-cost competitors out there today and we can't accept that."

STUNG BY FUEL

On March 13, Southwest warned it would not post the profit Wall Street had been expecting for the first quarter. At least one analyst downgraded the carrier on that news, questioning whether revenue growth is suffering as the Dallas company integrates last year's AirTran acquisition.

Southwest posted its 39th straight annual profit in 2011. Profit misses and losses have been rare for the company.

"The first quarter was a tough quarter" for all airlines, said Savanthi Syth, an airline analyst with Raymond James. Still, she said Southwest faces its own unique challenges apart from other carriers as its cost advantage isn't as wide as it used to be.

Southwest is "trying to figure out where their niche is and how to differentiate themselves and continue to drive that revenue," Syth said. "I think buying AirTran was one way of doing it, just finding growth and that next leg to push things."

Southwest enjoyed a major cost advantage over competitors in the middle of the last decade thanks to layers of hedges that ensured its fuel costs were well below market prices, which in turn enabled Southwest to pass along lower fares to consumers. Those hedges have since expired and the industry playing field is more level.

"The legacy airlines love the fact that Southwest doesn't have the big fuel hedges it had before because now they can compete ... and be a little more stingy with the cheaper airfares," said Tom Parsons, chief executive of discount travel website Bestfares.com.

While Southwest still offers competitive fares, it isn't always the first with the lowest prices now, Parsons said. And in the past year, Southwest has led the industry in some rounds of airfare increases, according to data from FareCompare.com.

Kelly cautioned staff in a late 2011 memo that Southwest's labor rates had become the industry's highest and the carrier needed to keep costs down. In the wake of American Airlines' Chapter 11 filing last year, Southwest is the only major U.S. carrier that has not filed to restructure through bankruptcy.

The cost challenge has some wondering how long Southwest's "Bags Fly Free" policy -- the airline does not charge for a first or second checked bag -- can continue to fly.

Kelly said on Wednesday that Southwest has no plans to retract that policy, which has helped the company gain market share and goodwill with passengers.

Buying bigger Boeing planes -- Southwest dubbed the jet it showed off on Wednesday as "Warrior One" -- is a key plank in new revenue initiatives Southwest is looking to complete by 2015. They also include integrating the AirTran acquisition, last year's revamp of its frequent flier program and a planned upgrade of the airline's reservation system.

Southwest will be the first customer for the Boeing 737 MAX, having ordered 150 of the new planes that will be equipped with fuel-efficient engines and are expected to be delivered by 2017. At that time, Southwest also ordered 58 of the 737 Next Generation models.

The 737-800, which offers about 8 percent better fuel savings than the older 737s it will replace, will enable Southwest to fly longer-haul routes, transport more people to slot-controlled markets such as Washington, D.C., and offer service to international destinations and Hawaii.

(Reporting by Karen Jacobs; Editing by Patricia Kranz, Phil Berlowitz)

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