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Southwest Airlines – Case Analysis

MGT 527 02W (Fall 2011)

Submitted By

TAMU – Fall 2011 – MGT 527 02W – Dr. Mildred G. Pryor – Southwest Case Analysis

Contents

Strategic Profile and Case Analysis Purpose................................................................................3

Situation Analysis..........................................................................................................................4

General Environment Analysis...................................................................................................4

Industry Analysis........................................................................................................................5

Competitor Analysis...................................................................................................................6

Internal Analysis.........................................................................................................................7

SWOT Analysis..............................................................................................................................8

Strategies to Address Key Management Challenges....................................................................9

Maintain low fares....................................................................................................................10

Violation of Safety Requirements.............................................................................................11

Union Walkout..........................................................................................................................12

Expansion Plans......................................................................................................................13

References..................................................................................................................................18


Strategic Profile and Case Analysis Purpose

Southwest Airlines, originally known as Air Southwest, was founded by Rollin King and Herb

Kelleher. Southwest took first flight in June 1971, serving three major US cities: Dallas,

Houston and San Antonio. Southwest turned the first annual profit in 1973. By 1977 southwest

operated six airplanes and had transported five million customers. Between 1979 and 1980,

Southwest established its first interstate service to New Orleans and Albuquerque, followed by

Okalhoma City and Tulsa. Southwest expanded west in 1982, when it added servcies to

Phoenix, Las Vegas, and San Diego. After 25 years of service, Southwest owned a fleet of 243

aircraft and continues to grow as provider of high frequency, point-to-point, low-fare airline

services (R. Duane Ireland, 2011).

Southwest has a solid low-cost business model that was instituted largely by strategic

decisions such as fly a single aircraft type; operate an efficient point-to-point route system; and

utilize assets in a highly efficient manner. The power of Southwest Brand today——that sets it

apart from its competitors——is its magnificent People. In 2007, Southwest Employees did a

remarkable job embracing the many changes in its products and processes and rose to the

occasion to took care of each other and its Customers. That focus on service helped Southwest

to be named to BusinessWeek magazine’s first-ever list of “Customer Service Champs.” (2008,

Southwest Airlines 2007 Annual Report)

Southwest airlines reported an operating profit of $449 million for the year 2007, despite

rising operating expenses marking 71 consecutive quarters of profitability. The total opearating

expenses for the year increased 16 percent compared to 2007 and where driven primarily by

higher fuel costs (44 percent), as well as ongoing maintenance costs (exhibit 6 - R. Duane


Ireland, 2011). However, Southwest did make 2008 its thirty-sixth consecutive year with annual

operating profit (R. Duane Ireland, 2011).

Airline industry is facing ever increasing need to keep the costs low to stay afloat. The

current issues and current decision of the company are more critical than ever. The purpose of

this case analysis is to identify key strategic issues by conducting situation/SWOT anlysis,

suggest strategic alternatives to address the issues so that Southwest can continue delivering

above average returns to the shareholders .

Situation Analysis

Financial distress in the airline industry can be tied to the high costs incurred by the airlines to

offer their services and low costs demanded by customers to travel. Southwest also faces

dilemmas associated with its growth strategy, costs incurred to meet safety regulations on its

aircraft, and a dispute with labour union. Southwest’s technological innovations, procedure

changes, price increases, and recent acquisitions are attempts to overcome the looming

challenges in the airline industry (R. Duane Ireland, 2011).

General Environment Analysis

Since the inception of commercial flight, more than 200 airlines have tried and failed in the

commercial airline industry. Some of the best minds in business, including Warren Buffett have

invested in commercial airline industry and failed. These failures are a reminder that airline

business is tumultuous, complex, and in many cases, futile. Financial distress in the airline

industry can be tied to the high costs incurred by the airlines and the increased customer

demand for low cost travel due to current economic conditions (R. Duane Ireland, 2011).


Economic downturn decreased the demand for business travel while leisure travelers choose

surface transportation. To stimulate the demand, businesses are often forced to keep the prices

low and in such situation long term sustenance is possible only if the costs can be kept low

(2008, Southwest Airlines 2007 Annual Report).

Industry Analysis

Factors such as increased fuel costs and other high operating costs, a decrease in business

travelers due to budget cuts, and increased regulations have placed strains on all airline

companies. Many airlines have subsequently been forced out of business or acquired by

competitors. This is illustrated by the fact that the large group of airlines that made up the

industry 30 years ago has narrowed to six major firms that control the majority of the market

(Figure 1). These six carriers constitute five traditional airline companies and Southwest, the

low-cost leader. Many airlines have been forced to file bankruptcy in the recent years. From

2005 to 2007, US Airways, UAL Corporation (United Airlines), ATA Airlines, Northwest Airlines,

and Delta Air Lines all emerged from bankruptcy proceedings. In 2008, Frontier Airlines,

Skybus Airlines, Inc., Aloha airlines, and ATA Airlines (for the second time) filed for bankruptcy.

All of these demonstrate the difficult and competitive nature of industry (R. Duane Ireland,

2011).


Figure 1: Airline Domestic Market Share (March 2009)

Competitor Analysis

Southwest considers any airline offering a flight on the same route it does a competitor,

regardless of the overall size of that competitor’s operation. Since Southwest now operates in

many geographic markets throughout the United States, essentially every airline that offers

services to domestic cities is viewed as a competitor. New competitors still occasionally try to

replace southwest as low-cost leader. Some of those companies Skybus, Frontier filed for

bankruptcies. JetBlue, founded by an ex-Southwest employee, emerged in 1999 and is one of

the few new entrants to successfully become a principle competitor to Southwest both in terms

of route coverage and low-cost, low-fare strategies (R. Duane Ireland, 2011).

Traditional carriers have recently also adopted cost-cutting practices to more effectively

compete with their low-cost counterparts. More than 200 aircrafts were grounded in 2008,

Continental cut 3,000 jobs, and airlines offered fewer flights. Although the major carriers are still

offering higher fares overall, their business models are beginning to mirror those low-cost rivals.


Thus, Southwest has to increasingly improve its marketing efforts to differentiate itself (R.

Duane Ireland, 2011).

Internal Analysis

Southwest’s solid business model was instituted largely by strategic decisions to fly a single

aircraft type; operate efficient point-to-point route system; and utilize assets in a highly efficient

manner. The power of the Southwest brand – which sets it apart from its competitors – is its

magnificent people (2008, Southwest Airlines 2007 Annual Report). In 2007, Southwest was

recognized for eleventh consecutive year by Fortune magazine as one of the 100 Best

Corporate Citizens for eight year in a row (America's most admired companies, Fortune, 2008).

Southwest was also included in the Top 100 Most Innovative Technology Organizations by

InformationWeek magazine in July 2007. Southwest employees our 34,000 employees who are

passionate about their mission to give Customers an affordable air travel with highest

satisfaction (2008, Southwest Airlines 2007 Annual Report).

To reduce fuel costs, Southwest is replacing older airplanes with more fuel efficient

newer models. Southwest will purchase 29 new, fuels efficient Boeing 737-700s scheduled for

2008 delivery and plans to reduce fleet by 22 aircraft, to end 2008 with seven net aircraft

additions (2008, Southwest Airlines 2007 Annual Report).

As a result of their continued attention to detail, SWA is definitely an excellent example

of how a positive corporate culture benefits not only the overall success of the company, but

also of its patrons and employees.

SWOT Analysis

Strengths Weakness


Consistent, proven low-cost airline operating

business model.

Union walkout – unequal pay for members of

ground crew, no salary raises since 2005.

Punctuality, shortest turnaround time. Violation of Safety Requirements

One type of aircraft – reduced cost of

operation, provides flexibility of use.

Only uses point-to-point business model unlike

competition.

Strong organization culture; Most admired

company; Profit sharing plan - Employees own

8% of the company stock.

Lack of alliances.

Highest customer satisfaction.Cut throat operating model leaves no room for

errors.

Use of technology to simplify and reduce

operation costs.Risks associated with fuel hedging strategy.

Opportunities Threats

Replace aging fleet with fuel efficient next

generation fleet.

Increasing fuel costs.

Marketing initiatives such as ‘no baggage fees’

– which are hated by customers

Increasing safety regulatory requirements.

Attract business travelers. Lack of alliances, limits customer affinity.

Expand operations to neighboring courtiers,

popular tourist destinations near USA.

Increased competition from companies

emerging from bankruptcy which have

improved efficiency, cost control than in the

past.


Acquisition of flights previously owned by

defunct airlines.

Prolonged economic downturn.

Implement proven, successful low-cost model

in developing countries

Potential catastrophes, such as terrorism acts

can severely affect the industry.

Campaign safety initiatives, commitment to

flying safe fleet.

Rival distribution channels.

Innovative methods, procedures in reducing

turnaround time, efficient utilization of assets

Strategies to Address Key Management Challenges

The key identified challenges Southwest’s management is facing can be categorized as:

1. Maintain low fares.

2. Violations of Safety Requirements.

3. Union Walkout.

4. Expansion Plans.

Maintain low fares

During the past 36 years, Southwest implemented many cost saving approaches to keep the

operating costs low which include fleet standardization, fuel hedging, upgrading fleet with

blended winglets, and using Pratt & Whitney’s EcoPower engine wash services etc. Most

traditional carriers after emerging from bankruptcies have adopted cost-cutting practices to


effectively compete with their low-cost counterparts. New entrants such as JetBlue were

successful in implementing Southwest’s model. Fuel costs, which depend on many economic,

political and social factors around the world, are on the rise (R. Duane Ireland, 2011). Raising

the fares is not an option in airline industry where customer affinity is low. Southwest needs to

look for strategies to reduce the operating costs (Refer to Tables 1 & 2):

Load Factor: Southwest’s load factor is 8% less than the average load factor of its

competitors. Southwest should form partnership, alliances to sell available seats to

improve the load factor which will increase the revenue with minimal or no increase in

costs.

Wage Benefits: Southwest’s wage benefits as a percentage of operating revenue is 5%

higher than that of its competitors. Southwest won awards as one of the best company

to work for. Money is not the highest priority for employees as per Maslow’s hierarchy

of needs. Southwest’s employees have shown loyalty for three decades and may be

persuaded to take 2 to 3% cut in wage benefits. Alternatively, to a certain extent, the

company can control costs by keeping the employee head count constant while the

business continues to grow.

Long-term debt: Southwest’s long-term debt as a percentage of operating revenue and

long-term debt as a percentage of assets are significantly lower than that of its

competitors. Southwest should increase its financial leverage and invest the additional

capital for upgrading their fleet, fuel hedging, upgrade maintenance infrastructure and

improving fleet safety.

One model fleet: Southwest has the largest fleet of Boeing 737s in the industry. It

should use its loyalty, size to partner with Boeing in identifying solutions for reducing the

fuel costs, use alternate fuels, improvements in aerodynamics, etc.


Fuel Hedging: Southwest has used its credit situation, access to cash wisely and was

successful in its bets with respect fuel hedging. While such fuel hedging practices can

continue, the benefits cannot be always guaranteed as it is hard to predict when the oil

prices have reached a peak and will begin dropping, or if it is still climbing. To minimize

the risks, Southwest should either look for alternate sources of revenue or increase the

fuel efficiency of the fleet.

Violation of Safety Requirements

Early in 2008, it was revealed that Southwest has flown at least 117 aircraft that were in

violation of mandatory safety checks. Southwest ended up paying $10. 2 million in fines to FAA

and had to temporarily ground 47 aircrafts (R. Duane Ireland, 2011).

Aircraft safety is a paramount concern with airline customers. Non-conformance to

safety requirements/regulations tarnishes the image of the company, reduces the revenue and

leaves door open for the competition to entrench. Southwest needs to look for strategies which

will reduce the customer safety concerns:

Long-term Debt: Southwest should increase its financial leverage and invest the capital

in inspection equipment, inspection procedures, send employees to trainings and

upgrade the fleet if necessary.

Marketing: Southwest should initiate marketing campaigns to fix/enhance brand value by

emphasizing its proven history and commitment to safety.

One model fleet: Southwest should work collaboratively with Boeing to identify

procedures for detecting safety related issues as early as possible. By identifying safety

issues earlier, it can reduce the costs associated with fixing the safety issues. By setting


its safety standards better than those of its competitors, better than those required by

FAA regulations Southwest can make a bold statement in its commitment to customer

safety.

Union Walkout

Southwest as a company, which once enjoyed superior employee relations compared to its

competitors, ran into problems in year 2008. Complaints such as unequal pay for members of

ground crew and no raises since year 2005 prompted a walkout by labor union on November

20, 2008. Wage increases, boost in 401K contributions, were promised only to the degree that

such increases will allow Southwest to keep its low-cost advantage (R. Duane Ireland, 2011).

Southwest was the first airline company to adopt the profit sharing plan in US airline

industry. Southwest enjoys one of the lowest employee turnover rates among US airline

industry (R. Duane Ireland, 2011). Southwest need to use its reputation, commitment and

history in formulating strategies which will reduce union related problems:

36 year commitment: Southwest established “no layoff policy” to demonstrate its

commitment to employees since 1973 (R. Duane Ireland, 2011). Southwest rewarded

employees for outstanding customer service. Southwest always communicated to its

employees that they are integral part of the company’s DNA. Southwest is the only major

airline company which had stayed profitable even in tough economic conditions. Southwest

employees take pride in working for the company. Southwest management need to

highlight the partnership model that exists between the company and employees and

prepare policies, procedures to avoid, or resolve union related issues before they start to

hurting the company.


Wage Benefits: Southwest pays higher salaries to its pilots, flight attendants, ground staff

and its management per operating revenue its competitors (2007 Airline Performance

Summary, 2008). Southwest is a profitable company offering continuous employment.

Southwest has the lowest employee turnover in the industry. By preparing salary guidelines

which can be consistently applied across the company, employee ranks; Southwest can limit

employee dissatisfaction due to wages, benefits.

Employee Growth: Companies which can offer continuous employment and opportunities to

grow will have to face less union related issues. Southwest is one of the few jewels in airline

industry which had continuous growth during the last three decades. Southwest has

aggressive growth plans. As Southwest grows in size, the employees must be provided

opportunities to grow.

Expansion Plans

Southwest continues to grow in the domestic market by adding new routes. Southwest is

exploring options to launch services to international destinations such as Caribbean, England.

Southwest is extremely successful in using point-to-point methodology unlike traditional airline

companies which use hub-and-spoke methodology. Some of the growth initiatives include

possible acquisition of flights owned by defunct airlines such as Ted (R. Duane Ireland, 2011).

While Southwest is pursuing expansion plans, it should be cognizant to maintain its very

defining characteristics such as low cost of operation, high employee satisfaction, exceptional

customer service and punctuality. Southwest should always watch out for the initiatives from

competition to erode its existing business. Southwest should use following strategies for

expansion:

Long-term debt: Southwest’s long-term debt as a percentage of operating revenue and

long-term debt as a percentage of assets are significantly lower than that of its


competitors. Southwest should increase its leverage and invest the additional capital for

acquiring companies or by adding more destinations.

Diversification: Southwest has built proven, successful, point-to-point, low-cost business

model in USA. Southwest should consider deploying a similar model in developing

countries such as India and China.

Hub-and-Spoke System: Southwest should not implement hub-and-spoke system as it

complicates the scheduling of flights, create operational inefficiencies as it adds activities

such as baggage transfers, ensuring reservations in all legs, creating dependencies

between one flight departures with another flight arrivals etc. Hub-and-spoke

complicates evaluating competition for each route as competitor airlines may not use the

same connecting cities. Although some large traditional airlines are using such a model,

Southwest should stay away from using such model.

Alliances: Southwest should enter into partnership, alliances with other airlines to

improve its load factors. Southwest should evaluate opportunities in forming alliances to

sell tickets with websites such as expedia.com, orbitz.com such that the revenue per

ticket sold is not impacted significantly. Southwest should enter into mutual alliances

with similar low-cost airlines in routes where they do not compete.


Table 1: 2007 Airline Analyses (2007 Airline Performance Summary, 2008)


Table 2: 2007 Airline Analyses (2007 Airline Performance Summary, 2008)


References

1. 2007 Airline Performance Summary. (2008). Retrieved from airlinesfinancials.com:

http://www.airlinefinancials.com/uploads/2007_mainline_summary.pdf

2. 2008, America's most admired companies, Fortune. (2008, March 17). Retrieved from

http://money.cnn.com

3. 2008, Southwest Airlines 2007 Annual Report. (n.d.). Retrieved from

http://www.southwest.com

4. R. Duane Ireland, R. E. (2011). The Management of Strategy Comcepts and Cases (9

ed.). Canada: South-Western.


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