Hilary Cheng

Individual Case Analysis for Southwest Airlines 2011

1. I personally would not consider the airline industry as an attractive industry to
compete in. In order to explain my choice, I would like to first analyze the airline
industry structure and its dynamic evolution. Before President Carter signed the
Airline Deregulation Act in October 1978, the Civil Aeronautics Board regulated
airline route entry and exit, passenger fares, mergers and acquisitions, and airline
rates of return. Although there routes covered by only one carrier, two or three
carriers provided service in a given market. Cost increases were passed along to
customers and price competition was almost nonexistent. Deregulation sent airline
fares tumbling and allowed many new firms to enter the new market. The fuel crisis
of 1979 and the air traffic controllers strike in 1981 contributed to the industrys
difficulties, more than 150 carriers, many of them start-up airlines, collapsed into
bankruptcy during the first decade of deregulation. Eight out of the 11 major airlines
dominating the industry in 1978 and the three major carriers survived ended up
with 80% of all domestic U.S. air traffic and 67% of trans-Atlantic business. This
showed that government legislation can be a threat to investors in the airline
industry, and the new legislation which allowed greater access to U.S. markets by
non-U.S. carriers was expected to increase competitive pressure.
At the same time, deregulation made originally high returns in the airline travel
deteriorate as the new entrants provided many more options for customers. With
the low loyalty due to little differentiation in one airline to another, this made the
market structure for airlines became an oligopoly. Price war is one of the
characteristics of oligopolies. When one airline reduces its fares, the other airlines
will have to reduce theirs as well to avoid loss of market share. Price wars happen
as some airlines are trying to grab a larger percentage of the market, and the other
airlines lower their prices to not lose market share. Although people might stick with
their preferred airline even when a competitor offers a lower price if the loyalty
programs or availability of certain flights are attractive enough, if the price
difference between oligopolistic companies is great enough, every customer will
choose the cheaper airline. The reason behind so many airlines being knocked out
was that competition and price wars among the airlines, making them earn a lot
less than the period before deregulation while the fixed-cost remained high. The
average price to fly one domestic mile dropped by more than 50% since
deregulation due to inflation, and many airlines were having trouble meeting this
demand by the mid-1990s. During 1994 to 2004, 66 new airlines were certified by
the FAA but by 2004, 43 had shut down. The low survival rate of new airlines and
the high rivalry among the airlines indicated that investors should think twice before
entering this industry.
Moreover, consumers had substitutes for air travel. Advanced telecommunications
like skype enabled business to be done via video conferences. Rail and bus services
could also be the substitutes of air travel.
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The main suppliers and pilots had power. Due to the lack of choices of suppliers,
airlines had no choice but to pay expensively to get their engines, planes and fuel.
Pilots on the other hand, were highly skilled and unionized which made them
influential.
Customers became more powerful as they became more price-sensitive and more
knowledgeable. They could easily do comparative shopping and get the best price
on the Internet.
Besides the government legislation, the high fixed operation cost and being a nostar industry, there were still a few more threats in airline industry that made me
reluctant from investing in it.
The demand for travelling, especially those for leisure, is very seasonal. Airlines will
suffer from a huge drop in demand except for international holidays unless they
lower the travelling rates and offer discounts to encourage people to travel more
during these periods. The frequency for people to travel for leisure and business
depends greatly on the global economy. A bad global economy will lead to low
income for airlines as less people are willing to use their money to travel for leisure
or business.
Moreover, airlines could suffer great loss due to bad weathers. Heavy storm or snow
would cause delay or even cancel of flights, and this would lead to customer
dissatisfaction and a loss for airlines as they would have to refund the customers
who were supposed to take the corresponding flight. Furthermore, although it is not
common, an aircraft could crash due to bad weather and the airline would suffer a
great loss in asset and reputation, and the latter would be more damaging as this
would make customers reluctant from joining the airline again due to lack of
confidence in its safety level. After 9/11, airlines had lost a large number of frequent
fliers customers as many of them were scared away by terrorists. Airlines were
forced to have more invasive security procedures so as to stop terrorists from
entering the aircraft but this created customer frustration who might choose other
transport instead of taking flights.
High fuel costs were a constant uncertainty as a huge upward surge in fuel prices
can destabilize an investment in the airline industry. New entrants also put pressure
on the incumbents. Increasing number of airlines and aircrafts would lead to a
shortage of airports, airport facilities, pilots and airport staff. The high demand with
limited supply would only increase the operation costs of airlines as they might
have to pay higher than market price for what they needed.
With the above threats, I would rather spend my money in other industry than on
airline industry.
2. The low cost business model is important to Southwests success. From
Exhibit 5 and 6, we can see that Southwest was by far the lowest in Unit Cost
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(CASM) and Unit Costs Without Labor for Major U.S. Airline between 2002 and 2009.
The use of a single aircraft type and highly efficient and frequency use of the
aircraft ad point-to-point route scheme also contributed to the low cost business
model. The average Southwest aircraft trip was 633 miles with an average duration
of about one hour and 52 minutes. This was up from 462 miles in 1999 and 394 in
1996. Southwest had 3,300 flights per day serving 64 cities. Each plane flew about
seven flights daily, almost twice the industry average. Planes were used an average
of 13 hours a day, about 40% more than major carriers like Delta and Northwest.
Southwests cost per available seat mile was the lowest in the industry for the major
carriers according to Exhibit 1, and the average age of its fleet was nine years, the
lowest for the major carriers. Employee cost per available seat mile was much lower
than major competitors as well, although not lower than some smaller carriers like
Allegiant. Southwest major competitors had to provide low fare tickets so as to
regain the market share lost to the smaller lower priced airlines, but Southwests
low cost structure did not have to do so with its original low fare the low operation
cost allowed it to offer to customers, which could save them a large amount of
restructuring cost other major airline had to spend.
Southwest established numerous new industry standards that competitors
would find it hard to replicate. Southwest flew more passengers per employee
than any other major airline while at the same time had the fewest number of
employees per aircraft. Southwest maintained a debt-to-equity ratio much lower
than the industry average and was one of the few airlines in the world with an
investment grade credit rating. The company had never curtailed service because
of a union strike and no passenger had ever died because of a safety incident. Their
customer service far beyond the norm in the airline industry and earned its own
name Positive Outrageous Service. All of these outstanding performances earn
Southwest a very good reputation and a good image in investors and customers
mind as they are hard to be achieved by other airlines.
Unlike other large airline, Southwest decision to operate without major
hubs, together with the appointment of Herb Kelleher as the CEO of
Southwest in 1981, were also the factors for the success of Southwest.
Southwest saw hub-and-spoke arrangements resulted in planes spending more time
on the ground waiting for customers to arrive from connecting points. Without major
hubs, turnaround time was about 15 minutes for Southwest, compared with the
industry average of 45 minutes. This time savings was accomplished with a gate
crew 50% smaller than other airlines. With Kelleher serving as an example for his
employees to help the ground crew unload bags, pilots of Southwest were willing to
help unloading bags when the schedules were tight. Flight attendants regularly
assisted in the cleanup of airplanes between flights. This increased the efficiency of
the use of aircrafts and hence increased revenue.
The correct choice of markets also contributed to the success of
Southwest. It resulted in significant growth in air travel at those locations.
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In Texas, traffic between the Rio Grande Valley and the Golden Triangle grew from
123,000 to 325,000 within 11 months of Southwest entering the market. Within a
year of Southwests arrival, the Oakland-Burbank route became the 25 th largest
passenger market, up from 179th. The Chicago-Louisville market tripled in size 30
days after Southwest began flying that route. Southwest was dominant carrier in a
number of cities, ranking first in market share in more than 50% of the largest U.S.
city-pair markets.
Although Southwest became one of the largest airlines in the United
States, the firm did not deviate from its initial focus. It remained its core
values like primarily short-haul which travelled less than 500 miles, point-to-point
flights, a fleet consisting only of Boeing 737s, high-frequency flights, low fares, and
no international flights. This consistency made them hard to be replicated which
made them unique in airline industry. Southwests strategy spawned numerous
imitators and most of which failed. Two of the more successful start-up firms,
Midwest Express and America West, both went through Chapter 11 bankruptcy
proceedings. Continental Lite (CALite) was an effort by Continental Airlines to
imitate Southwest low-cost service in April 1993. Within a year, Continental
increased CALite service to 875 daily flights and soon encountered major
operational problems as mechanical delays disrupted turnaround times of its fleet of
16 different planes, plus various pricing strategies were unsuccessful, the company
was ranked last among the major carriers for on0time service and complaints
soared by 40%. By mid-1995, CALite service had been largely discontinued. In
October 1995, Continentals CEO was ousted. The consistency of Southwest also
made it hard to compete with. Shuttle by United was created in October 1994 with
many of the same operation elements as Southwest: a fleet of 737s, low fares,
short-haul flights, and less-restrictive union rules. However, the Shuttle was unable
to achieve the same level of productivity as Southwest and in 2001 United
discontinued Shuttle service and folded the remaining flights into its regular service.
3. According to the Oxford Learning Lab (http://www.oxlearn.com/arg_MarketingResources-Porter's-Generic-Strategies_11_33), generic strategy is a framework
used to outline the three major strategic options cost leadership, differentiation
and niche market, open to organizations that wish to achieve a sustainable
competitive advantage. Each of the three options needs to be considered within the
context of two aspects of the competitive environment. Firstly, the sources of
competitive advantage which establish whether the products are differentiated in
any way, or if they are the lowest cost producer in the industry. Secondly, the
competitive scope of the market determines if the company targets a wide market
or if it focuses on a very narrow niche market.
The first source, which was the internal objective of Southwest , was the
ability to offer low fares to customers despite being one of the biggest
U.S. airlines. As I mentioned above, under oligopolistic structure, if the price
difference between oligopolistic companies is great enough, every customer will
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choose the cheaper airline. The primary activities for doing so were to keep the
operation cost low by highly efficient use of planes (i.e. each plane flew about twice
the industry average daily and was used 40% more than major carriers per day) and
to keep the fewest number of employees and hence the employee cost per aircraft.
At the same time, Southwest maintained a low debt-to-equity ratio with an
investment grade credit rating which only few airlines in the world able to do so.
Support activity would be seating was first come first served in Southwest, so that
airplanes could be turned quicker at the game and few more routes each day, which
generated more revenue. With the value chain of comparative low operation cost
and healthy finance, Southwest was able to offer low fare tickets to customers
sustainably who were price sensitive. This was its competitive advantage, as several
competitors tried to replicate Southwests operation style but seldom did it
successfully.
Second source was the fast turnaround time of Southwest, which was 3
times faster than the industry average. This saved customers a lot of time and
had a much higher possibility than other airlines to have flights on time, which
would be extremely important for customers especially for people who did business.
The primary internal activity which allowed Southwest to do so was that they
decided to operate without major hubs as hub-and-spoke arrangements would result
in planes spending more time on the ground waiting for customers to arrive from
connecting points. Support activities were that gate crew was 50% smaller than
other airlines and pilots would sometimes help unload bags when schedules were
tight while flight attendants regularly assisted in the cleanup of airplanes between
flights. All of these created a value chain that helped Southwest to save time
between flights.
Third source was that it was convenient to get a Southwest ticket and
Southwest always stood on its target customers point of view. The internal
activity for providing convenient services and showing they were thoughtful was
that they were the first national carrier to sell seats from an Internet site and was
the first airline to create a home page on the Internet. In the first half of 2010,
online bookings were 81% via southwest.com. Southwest was also one of the first
airlines to use ticketless travel, offering the service first in 1995. This was so
convenient that customers could buy Southwest seats anywhere with internet
without worrying about finding a printer to print a ticket. Southwest was also the
only major airline with a frequent flyer program based on the number of flights
taken by a passenger, not miles flown. With no international flight, Southwest target
customers were all short-haul and so frequent flyer program based on number of
flights would be of customers advantage compared with miles flown.
Fourth source was that Southwest had excellent customer service which
earned its name Positive Outrageous Service. Examples included a gate agent
volunteering to watch a dog for two weeks when an Acapulco-bound passenger
showed up at the last minute without the required dog crate and an Austin
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passenger who missed a connection to Houston, where he was to have a kidney
transplant operation, was flown there by a Southwest pilot in his private plane. With
such a reputation, customers were more willing to choose Southwest as they had an
image that Southwest staff would try their very best to help and serve them. The
primary internal activity was the way Herb Kelleher managed Southwest. He had the
ability to remember employees names and asked after their families to earn their
respect and trust, so that when he served as an example for his employees by often
help the ground crew unload bags or help the flight crew serve drinks, everyone
followed. Besides Herb Kelleher, the company also treated its employees well by
accepting the pilots propose which was a 10-year contract with stock options in lieu
of guaranteed pay increases over the first five years of the contract. In 1974,
Southwest was the first airline to introduce employee profit sharing. By treating the
employees well, they recognized that people were the most important and they
would treat the customers well, this was the value chain.
The fifth source would be the surprises Southwest Spirit provided to
customers and the chill atmosphere it created which made the trip both
comfortable and enjoyable. On some flights, magazine pictures of gourmet
meals were offered for dinner on an evening flight; flight attendants were
encouraged to have fun where songs, jokes and humorous flight announcements
were common. Primary internal activity was the Southwest Spirit created throughout
the firm by intense company communication and camaraderie. Efforts were made to
share and instill Southwests unique culture during initial training periods. For
example, the new employee orientation had in the past included Southwests
version of the Wheel of Fortune game show, scavenger hunts, and company videos
including the Southwest Airlines Shuffle in which each department introduced
itself, rap style, and in which Kelleher appeared as Big Daddy-O. Red hearts and
Luv were central parts of the internal corporate culture, appearing throughout
company literature. Kellehers humor and maverick style was the supporting
activity, where he once served in-flight snacks dressed as the Easter Bunny.
Despite the success of Southwest, I would not spend my money to build my own
airline business as it was a no-star industry in the five forces model hard to enter
the market and survival rate was low; plenty of substitutes available; suppliers and
customers had dictating power as there were limited supply for the former and
customers were price sensitive and more knowledgeable than before due to
existence of internet and the fierce rivalry due to high fixed cost and price wars,
plus other threats mentioned above, spending money elsewhere seemed to be a
wise decision.

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