Southwest Airlines 2011

Forest David

A.

Case Abstract
Southwest Airlines is a comprehensive strategic management case that includes the companys year -end 2010 financial statements, organizational chart, competitor information and more. The case time setting is the year 2011. Sufficient internal and external data are provided to enable students to evaluate current strategies and recommend a three-year strategic plan for the company. Headquartered in Dallas, Texas, Southwests common stock is publicly traded under the ticker symbol LUV. Southwest Airlines operates only Boeing 737s and let passengers sit anywhere they like as long as they get there first. Southwest has expanded its low-cost, no-frills, no-reserved-seats approach to air travel throughout the US to serve almost 70 cities in more than 35 states. Now among the leading US airlines, Southwest still stands as an inspiration for scrappy low-fare upstarts the world over. The carrier has enjoyed 38 straight profitable years, amid the airline industry's ups and downs. Southwest's fleet numbers about 550 aircraft. The company acquired AirTran Holdings, the parent company of AirTran Airways, in May 2011 for about $3.2 billion.

B.

Vision Statement (proposed)

To become the number one airline in market share in the world.

C.

Mission Statement (proposed)

At Southwest we hire innovative people (9) dedicated to delivering and growing (5) the best domestic and international (3) flying (2) and working experience in terms of safety and service (self 7, 6) to our employees and smart travelers (1). Striving every day to keep our promise of not only safety and customer service (8), but also leaving a small footprint in the environment through advances in mechanical technology (4) everyday. 1. 2. 3. 4. 5. 6. 7. 8. 9. Customers Products or services Markets Technology Concern for survival, growth, and profitability Philosophy Self-concept Concern for public image Concern for employees

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D.

External Audit
Opportunities 1. 2. 3. 4. 5. 6. 7. 8. 9. According to World Travel and Tourism Council, world travel and tourism is expected to grow 4.3% annually. Down cycle of economy has increased potential profit because people are more cost sensitive. Lower interest rates. Year-to-date 2010 travel stats for industry show passenger revenues rose 7.3%. Oil prices have dropped from $150 a barrel to under $100 a barrel. Regional jets have transformed short haul markets previously abandoned by major airlines. Repeal of the Wright Amendment. ATA Domestic Code-Sharing Agreement. Cancun, Mexico, and the Caribbean markets, accessible from AirTran merger, offer first international opportunities.

Threats 1. 2. 3. Fuel accounted for 26% of revenues in 2010. Mergers among the largest airlines. Delta announced that it would add or expand service to 36 cities for NYC flying from both JFK and LaGuardia. 4. Continued threat to industrys human relations concerning displeasure over carbon dioxide emissions. 5. In 2010, labor accounted for 25% of revenues. 6. Cost of investment in sophisticated satellite-based GPS Technology has halted replacement of outdated air traffic control systems, thus forecasting congestion problems to continue. 7. Security measures implemented in airports since 9/11 have made flying less convenient and less ideal for travelers. 8. Fees on airlines for keeping passengers on the tarmac for extended periods of time. 9. Internet has led to more competitive pricing and more price sensitivity to industry. 10. Many new carriers have adopted Southwests model. Competitive Profile Matrix
Southwest Critical Success Factors Advertising Market Penetration Customer Service Airports Used Business Class Employee Dedication Financial Profit Customer Loyalty Market Share Product Quality Top Management Price Competitiveness Totals Weight 0.08 0.08 0.05 0.10 0.05 0.05 0.12 0.11 0.10 0.07 0.07 0.12 1.00 Rating 4 2 4 2 1 3 3 4 2 2 4 4 Score 0.32 0.16 0.20 0.20 0.05 0.15 0.36 0.44 0.20 0.14 0.28 0.48 2.98 Delta Rating 3 3 1 3 4 1 4 2 3 3 3 2 Score 0.24 0.24 0.05 0.30 0.20 0.05 0.48 0.22 0.30 0.21 0.21 0.24 2.74 UAL Rating 2 4 2 4 3 2 2 1 4 4 2 1 Score 0.16 0.32 0.10 0.40 0.15 0.10 0.24 0.11 0.40 0.28 0.14 0.12 2.52

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EFE Matrix
Weight Rating Weighted Score Opportunities 1. According to World Travel and Tourism Council, world travel 0.05 3 0.15 and tourism is expected to grow 4.3% annually. 2. Down cycle of economy has increased potential profit because 0.06 3 0.18 people are more cost sensitive. 3. Lower interest rates. 0.07 4 0.28 4. Year-to-date 2010 travel stats for industry show passenger 0.06 3 0.18 revenues rose 7.3%. 5. Oil prices have dropped from $150 a barrel to under $100 a barrel. 0.03 2 0.06 6. Regional jets have transformed short haul markets previously 0.05 2 0.10 abandoned by major airlines. 7. Repeal of the Wright Amendment. 0.04 3 0.12 8. ATA Domestic Code-Sharing Agreement. 0.04 3 0.12 9. Cancun, Mexico, and the Caribbean markets, accessible from 0.03 4 0.12 AirTran merger, offer first international opportunities.
Threats Fuel accounted for 26% of revenues in 2010. Mergers among the largest airlines. Delta announced that it would add or expand service to 36 cities for NYC flying from both JFK and LaGuardia. Continued threat to industrys human relations concerning displeasure over carbon dioxide emissions. In 2010, labor accounted for 25% of revenues. Cost of investment in sophisticated satellite-based GPS Technology has halted replacement of outdated air traffic control systems, thus forecasting congestion problems to continue. Security measures implemented in airports since 9/11 has made flying less convenient and less ideal for travelers. Fees on airlines for keeping passengers on the tarmac for extended periods of time. Internet has led to more competitive pricing and more price sensitivity to industry. Many new carries have adopted Southwest's model. TOTALS Weight Rating Weighted Score 0.10 1 0.10 0.05 1 0.05 0.02 0.03 0.10 0.03 2 2 2 2 0.04 0.06 0.20 0.06

1. 2. 3. 4. 5. 6.

7. 8. 9.

0.04 0.05 0.05 0.10 1.00

2 4 3 2

0.08 0.20 0.15 0.20 2.45

E.

Internal Audit
Strengths 1. 2. 3. 4. 38 consecutive years reporting positive net income. Airtran merger provides access to the busiest airport domestically- HJI in Atlanta. Multi-functional and interactive website competes favorably to competitive pricing and demand. Fly to more than 100 airports.

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Company was able to stimulate a significant amount of demand through fare sales, th rough its Bags Fly Free advertising campaign. 6. Low cost structure relative to large carriers. 7. Operational efficiencies relative to large and low-cost carriers. 8. High number of established, high frequency discount routes. 9. Merger with AirTran Holdings Inc. 10. Southwest plans to add as many as 200 pilots and 300 flight attendants in 2011. 5. Weaknesses 1. As a result of a significant decline in fuel prices at the end of 2008, the Company significantly reduced its net fuel hedge position in place for 2009 through 2013, leaving it with less protection against future increases. Credit rating recently downgraded from a BBB+ to a BBB, based on lower demand, especially among business travelers, and continued volatility in fuel prices. Execution of Freedom 09 resulted in a one-time charge of $66 million creating to offset capacity reduction in 2009. Aircraft type versus long trans-continental routes limits market growth and potential revenues. Most of the employees are members of the employee union, who are responsible for spikes in labor costs. It has not offered any segmented seating (business class or 1st class seating arrangement). A minority of its tickets are purchased through agents. Addition of 86 Boeing 717s through AirTran merger abandons its single jet type strategy aimed towards cutting maintenance and training costs. Merger with AirTran creates overlap in on 32 markets, more than twice as many as United-Continental merger.

2. 3. 4. 5. 6. 7. 8. 9.

Financial Ratio Analysis Growth Rate Percent Sales (Qtr vs year ago qtr) Net Income (YTD vs YTD) Net Income (Qtr vs year ago qtr) Sales (5-Year Annual Avg.) Net Income (5-Year Annual Avg.) Dividends (5-Year Annual Avg.) Profit Margin Percent Gross Margin Pre-Tax Margin Net Profit Margin 5Yr Gross Margin (5-Year Avg.) Liquidity Ratios Debt/Equity Ratio Current Ratio Quick Ratio Profitability Ratios Return On Equity Return On Assets Return On Capital Return On Equity (5-Year Avg.) Return On Assets (5-Year Avg.) Southwest 35.10 NA -168.30 9.80 -1.06 0.00 Industry 24.80 NA -47.60 13.50 12.07 9.45 S&P 500 14.50 NA 48.60 8.30 8.72 5.61

18.4 1.9 1.1 22.6

25.2 7.5 6.0 26.0

39.5 18.2 13.2 39.7

0.65 0.9 0.8

0.70 1.0 0.9

0.98 1.3 0.9

2.5 1.0 1.3 6.2 2.6

17.2 4.6 6.2 16.7 4.3

26.0 8.8 11.8 23.8 8.0

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Return On Capital (5-Year Avg.) Efficiency Ratios Income/Employee Revenue/Employee Receivable Turnover Inventory Turnover Net Worth Analysis (in millions)

3.3

5.9

10.8

4,498 420,160 42.3 32.9

28,998 425,198 43.0 261.1

126,792 1 Mil 15.2 12.4

Stockholders' Equity Net Income x 5 (Share Price/EPS) x Net Income Number of Shares Outstanding x Share Price Method Average

$ $ $ $ $

6,237.00 2,295.00 17,857.29 6,356.26 8,186.39

IFE Matrix
Strengths 1. 38 consecutive years reporting positive net income. 2. Airtran merger provides access to the busiest airport domestically- HJI in Atlanta. 3. Multi-functional and interactive website competes favorably to competitive pricing and demand. 4. Fly to more than 100 airports. 5. Company was able to stimulate a significant amount of demand through fare sales, through its Bags Fly Free advertising campaign. 6. Low cost structure relative to large carriers. 7. Operational efficiencies relative to large and low-cost carriers. 8. High number of established, high frequency discount routes. 9. Merger with AirTran Holdings Inc. 10. Southwest plans to add as many as 200 pilots and 300 flight attendants in 2011. Weight Rating Weighted Score 0.07 4 0.28 0.04 0.04 0.05 0.05 0.04 0.05 0.04 0.10 0.07 4 4 4 4 4 4 4 4 4 0.16 0.16 0.20 0.20 0.16 0.20 0.16 0.40 0.28

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Weight Rating Weighted Score Weaknesses 1. As a result of a significant decline in fuel prices at the end of 2008, the Company significantly reduced its net fuel hedge 0.06 2 0.12 position in place for 2009 through 2013, leaving it with less protection against future increases. 2. Credit rating recently downgraded from a BBB+ to a BBB, based on lower demand, especially among business travelers, 0.07 1 0.07 and continued volatility in fuel prices. 3. Execution of Freedom 09 resulted in a one-time charge of $66 0.04 2 0.08 million creating to offset capacity reduction in 2009. 4. Aircraft type versus long trans-continental routes limits market 0.05 1 0.05 growth and potential revenues. 5. Most of the employees are members of the employee union, who 0.10 1 0.10 are responsible for spikes in labor costs. 6. It has not offered any segmented seating (business class or 1st 0.02 1 0.02 class seating arrangement). 7. A minority of its tickets are purchased through agents. 0.02 2 0.04 8. Addition of 86 Boeing 717s through AirTran merger abandons its single jet type strategy aimed towards cutting maintenance 0.04 1 0.04 and training costs. 9. Merger with AirTran creates overlap in on 32 markets, more than 0.05 2 0.10 twice as many as United-Continental merger. TOTALS 1.00 2.82

F.

SWOT
SO Strategies 1. 2. Expand into 10 new airports along the East Coast (S4, S6, O6). Hire a marketing research firm to determine when to offer the lowest rates and when higher rates can be charged (S5, S6, S7, S8, O2, O6).

WO Strategies 1. 2. Reduce overlap in the 32 markets acquired in the AirTran merger (W9, T6). Increase fuel hedge to protect against rising fuel costs (W1, O5).

ST Strategies 1. Continue to let bags fly free and offer free refreshments on all flights (S5, S6, S7, S8, T10).

WT Strategies 1. Increase fuel hedge to protect against rising fuel costs (W1, T1).

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G.

SPACE Matrix
FP 7 6 5 4 3 2 1

Conservative

Aggressive

CP

-7

-6

-5

-4

-3

-2

-1 -1 -2 -3 -4 -5 -6 -7

IP

Defensive

SP

Competitive

Internal Analysis: Financial Position (FP) Return on Equity (ROE) Return on Assets (ROA) Debt/Equity Ratio Gross Margin Current Ratio Financial Position (FP) Average Internal Analysis: Competitive Position (CP) Market Share Product Quality Customer Loyalty Technological know-how Control over Suppliers and Distributors Competitive Position (CP) Average

1 1 4 3 4 2.6

External Analysis: Stability Position (SP) Rate of Inflation Technological Changes Price Elasticity of Demand Competitive Pressure Barriers to Entry into Market Stability Position (SP) Average External Analysis: Industry Position (IP) Growth Potential Financial Stability Ease of Entry into Market Resource Utilization Profit Potential Industry Position (IP) Average

-2 -3 -2 -6 -3 -3.2

-3 -3 -1 -3 -5 -3.0

4 5 3 5 5 4.4

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H.

Grand Strategy Matrix

Rapid Market Growth Quadrant II Quadrant I

Southwest

Weak Competitive Position

Strong Competitive Position

Quadrant III Slow Market Growth

Quadrant IV

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I.

The Internal-External (IE) Matrix

The Total IFE Weighted Scores
Strong 4.0 to 3.0 4.0 I Average 2.99 to 2.0 II Weak 1.99 to 1.0 III

High

3.0

IV

VI

The EFE Total Medium Weighted Scores

Southwest

2.0

VII

VIII

IX

Low

1.0

Passengers account of 95% revenues with the balance coming from freight and other sources.

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J.

QSPM
Expand into 10 new airports

Increase fuel hedge

AS 2 2 2 2 4 0 0 0 2 TAS 0.10 0.12 0.14 0.12 0.12 0.00 0.00 0.00 0.06

Opportunities 1. According to World Travel and Tourism Council, world travel and tourism is expected to grow 4.3% annually. 2. Down cycle of economy has increased potential profit because people are more cost sensitive. 3. Lower interest rates. 4. Year-to-date 2010 travel stats for industry show passenger revenues rose 7.3%. 5. Oil prices have dropped from $150 a barrel to under $100 a barrel. 6. Regional jets have transformed short haul markets previously abandoned by major airlines. 7. Repeal of the Wright Amendment. 8. ATA Domestic Code-Sharing Agreement. 9. Cancun, Mexico, and the Caribbean markets, accessible from AirTran merger, offer first international opportunities.

Weight 0.05 0.06 0.07 0.06 0.03 0.05 0.04 0.04 0.03

AS 4 3 4 3 2 0 0 0 4

TAS 0.20 0.18 0.28 0.18 0.06 0.00 0.00 0.00 0.12

Threats 1. Fuel accounted for 26% of revenues in 2010. 2. Mergers among the largest airlines. 3. Delta announced that it would add or expand service to 36 cities for NYC flying from both JFK and LaGuardia. 4. Continued threat to industrys human relations concerning displeasure over carbon dioxide emissions. 5. In 2010, labor accounted for 25% of revenues. 6. Cost of investment in sophisticated satellite-based GPS Technology has halted replacement of outdated air traffic control systems, thus forecasting congestion problems to continue. 7. Security measures implemented in airports since 9/11 has made flying less convenient and less ideal for travelers. 8. Fees on airlines for keeping passengers on the tarmac for extended periods of time. 9. Internet has led to more competitive pricing and more price sensitivity to industry. 10. Many new carries have adopted Southwest's model.

Weight 0.10 0.05 0.02 0.03 0.10 0.03

AS 2 0 4 0 0 0

TAS 0.20 0.00 0.08 0.00 0.00 0.00

AS 4 0 2 0 0 0

TAS 0.40 0.00 0.04 0.00 0.00 0.00

0.04 0.05 0.05 0.10

0 0 0 4

0.00 0.00 0.00 0.40

0 0 0 2

0.00 0.00 0.00 0.20

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Expand into 10 new airports

Strengths 1. 38 consecutive years reporting positive net income. 2. Airtran merger provides access to the busiest airport domestically- HJI in Atlanta. 3. Multi-functional and interactive website competes favorably to competitive pricing and demand. 4. Fly to more than 100 airports. 5. Company was able to stimulate a significant amount of demand through fare sales, through its Bags Fly Free advertising campaign. 6. 7. 8. 9. 10. Low cost structure relative to large carriers. Operational efficiencies relative to large and low-cost carriers. High number of established, high frequency discount routes. Merger with AirTran Holdings Inc. Southwest plans to add as many as 200 pilots and 300 flight attendants in 2011. Weight 0.07 0.04 0.04 0.05 0.05 0.04 0.05 0.04 0.10 0.07
Weight 0.06

Increase fuel hedge

AS 0 2 0 1 0 3 0 1 1 1
AS 4

AS 0 4 0 4 0 1 0 3 4 4
AS 1

TAS 0.00 0.16 0.00 0.20 0.00 0.04 0.00 0.12 0.40 0.28
TAS 0.06

TAS 0.00 0.08 0.00 0.05 0.00 0.12 0.00 0.04 0.10 0.07
TAS 0.24

Weaknesses 1. As a result of a significant decline in fuel prices at the end of 2008, the Company significantly reduced its net fuel hedge position in place for 2009 through 2013, leaving it with less protection against future increases. 2. Credit rating recently downgraded from a BBB+ to a BBB, based on lower demand, especially among business travelers, and continued volatility in fuel prices. 3. Execution of Freedom 09 resulted in a one-time charge of $66 million creating to offset capacity reduction in 2009. 4. Aircraft type versus long trans-continental routes limits market growth and potential revenues. 5. Most of the employees are members of the employee union, who are responsible for spikes in labor costs. 6. It has not offered any segmented seating (business class or 1st class seating arrangement). 7. A minority of its tickets are purchased through agents. 8. Addition of 86 Boeing 717s through AirTran merger abandons its single jet type strategy aimed towards cutting maintenance and training costs. 9. Merger with AirTran creates overlap in on 32 markets, more than twice as many as United-Continental merger.

0.07

0.00

0.00

0.04 0.05 0.10 0.02 0.02 0.04 0.05

0 0 0 0 0 4 2

0.00 0.00 0.00 0.00 0.00 0.16 0.10

0 0 0 0 0 1 1

0.00 0.00 0.00 0.00 0.00 0.04 0.05

TOTALS

3.22

2.09

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K.

Recommendations
1. 2. 3. 4. Expand into 10 new airports along the East Coast at cost of $150M. Hire a marketing research firm to determine when to offer the lowest rates and when higher rates can be charged at cost of $20M. Reduce overlap in the 32 markets acquired in the AirTran merger at cost of $20M. Increase fuel hedge to protect against rising fuel costs at cost of $50M

L.

EPS/EBIT Analysis (in millions)

Amount Needed: $240M Stock Price: $7.64 Shares Outstanding: 778 Interest Rate: 5% Tax Rate: 38%

EBIT Interest EBT Taxes EAT # Shares EPS

Common Stock Financing Recession Normal $300 $1,000 0 0 300 1,000 114 380 186 620 782 782 0.24 0.79

Boom $2,000 0 2,000 760 1,240 782 1.59

Recession $300 12 288 109 179 778 0.23

Debt Financing Normal $1,000 12 988 375 613 778 0.79

Boom $2,000 12 1,988 755 1,233 778 1.58

EBIT Interest EBT Taxes EAT # Shares EPS

Recession $300 10 290 110 180 779 0.23

20 Percent Stock Normal $1,000 10 990 376 614 779 0.79

Boom $2,000 10 1,990 756 1,234 779 1.58

Recession $300 2 298 113 185 781 0.24

80 Percent Stock Normal $1,000 2 998 379 619 781 0.79

Boom $2,000 2 1,998 759 1,239 781 1.59

M.

Epilogue
Southwest Airlines third quarter 2011 results revealed a net loss of $140 million compared to net income of $205 million for third quarter 2010. The companys operating income was $225 million for Q3 2011, compared to $355 million for Q3 2010. The compa nys Q3 operating revenues reached an all-time quarterly record of $4.3 billion. Passenger revenues were driven by strong load factors, revenue yields, and unit revenues, which were all third quarter records. Third quarter passenger unit revenues increased approximately six percent, compared to third quarter last year. Also, the companys Q3 2011 Other revenues grew approximately 18 percent, compared to Q3 last year, largely due to the All-New Rapid Rewards program and continued growth in the EarlyBird Check-In revenues.

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AirTran became a wholly-owned subsidiary of Southwest Airlines on May 2, 2011. Southwests total operating revenues for Q3 2011 increased 35.1 percent to $4.3 billion, compared to $3.2 billion for Q3 2010. Operating unit revenues increased 3.6 percent, compared to third quarter 2010. Operating unit revenues increased 6.7 percent from third quarter 2010's combined unit revenues. Operating income for Q3 2011 was $225 million, compared to $355 million in third quarter 2010. Excluding special items in both periods, operating income was $285 million for Q3 2011, compared to $389 million for third quarter 2010, and compared to $447 million for Q3 2010 on a combined basis. Southwests total operating revenues for the nine months ended Sep tember 30, 2011 increased 28.5 percent to $11.6 billion, while total operating expenses increased 33.9 percent to $11 billion, resulting in operating income of $546 million, versus $772 million for the comparable period in 2010. The companys net income for the nine months ended September 30, 2011 was $26 million, or $.03 per diluted share, compared to $328 million, or $.44 per diluted share, for the same period last year. Southwests passenger revenues jumped 32 percent y-o-y in Q3 2011 with over 60 percent growth coming from AirTrans results. The airline witnessed strong passenger demand during Q3 with no softening in business travel, which helped implement fare hikes. Also during Q3, Southwests Rapid Rewards program was revamped in favor of expenditure-based earnings system where points are awarded based on the amount of money spent on the carrier rather than the miles flown as in the earlier system. The improved program contributed to revenues by increasing business partner income as well as the premium in fares paid by Rapid Rewards members. Southwest is also enjoying excellent results from its EarlyBird product, which allows customers to automatically obtain a reserved boarding position before general check-in begins and has recorded over $100 million in revenues, year-to-date.

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