Southwest Airlines 2007.
Box, Thomas M. ; Byus, Kent
CASE DESCRIPTION
The primary subject matter of this case concerns Southwest
Airlines. A secondary issue concerns the appropriateness of modifying a
Generic Strategy that has lead to thirty five years of uninterrupted
growth and profitability. The case has a difficulty level of four
(senior-level undergraduates). The case is designed to be taught in one
fifty minute class period and is expected to require about two hours of
outside preparation by students.
CASE SYNOPSIS
Southwest Airlines has long been cited in Business Strategy classes
as an exemplar of Porter's Low Cost Leadership strategy. Through
fiscal year 2006, they have enjoyed thirty five years of uninterrupted
profitability. In 2007, they began considering several fundamental
changes in their long-term business model to address the realities of
increased competition, rapidly-escalating fuel costs and the threats of
world-wide terrorism.
New competition--particularly JetBlue and ATA have modeled their
operations on the original "Southwest model." Interestingly,
David Neeleman--founder of JetBlue in 2001--was a former southwest
Airlines executive and Michael O'Leary--CEO of Ryanair (Dublin,
Ireland)--spent several weeks in 1991 at Southwest Airlines headquarters
in Dallas, Texas learning the Southwest model. Ryanair is the lowest
cost major airline in Europe at this time.
Fuel prices--the second largest component of operating cost for
airlines--has increased dramatically (about 50%) in the last three
years. As a result, airline profits in 2008 will be lower than
originally forecast in early 2007.
The most common complaint about Southwest Airlines has been its
boarding policy. For many years, passengers were assigned to groups of
thirty with those arriving early at the gate getting into the first
group of thirty and, thus, the first choice of seats. In 2007, Southwest
began two experiments in seating--the first in San Diego--with assigned
seats and later a differential pricing scheme whereby those willing to
pay $10--$30 more per ticket were allowed to board first.
Southwest is also considering the possibility of extending its
route map to include large cities in Canada, Mexico and the Caribbean.
An additional consideration is the possibility of buying smaller
regional jets to serve smaller markets in the United States.
INTRODUCTION
Rollin King, a San Antonio entrepreneur, convinced Herb Kelleher in
1966 that a commuter airline serving Houston, Dallas and San Antonio was
a feasible business proposition. King, at that time owned a small
commuter air service and Kelleher, an attorney, had done legal work for
King. Houston, Dallas and San Antonio were the Golden Triangle of Texas
with rapid economic and population growth. The distance between these
three cities was long enough that travel by bus and automobile was
somewhat inconvenient.
On March 15, 1967, Kelleher incorporated Air Southwest Company
(later Southwest Airlines) and on November 27, 1967 filed an application
with the Texas Aeronautics Commission (TAC) to fly between Houston,
Dallas and San Antonio. TAC approved the application on February 20,
1968 and the next day Braniff, Trans Texas and Continental filed a
restraining order to prohibit Southwest from beginning to fly in the
summer of 1968. After a series of legal challenges including a Supreme
Court appeal, Southwest won the right to commence operations in late
1970.
H. Lamar Muse was hired as Southwest Airline's first president
in January 1971 and quickly assembled a group of experienced airline
executives that came to be known as 'the Over the Hill Gang."
Despite a series of legal challenges, Muse was able to secure financing,
buy three new Boeing 737-200s and commence flight operations on June 18,
1971. Because they were an in-state airline, Southwest had considerably
more latitude in terms of operations than the flagship carriers
(intrastate carriers). Muse came to be known as the master of the
gimmick but what he was really doing was to employ Guerrilla Marketing
techniques that were notably successful. Muse created the
"LUV" culture at Southwest that continues to this day. He
emphasized fun and created very dedicated and loyal customers.
By 1973, Southwest Airlines was operating at a profit and that has
continued every year since. No other airline in the world has been able
to match Southwest's track record of consistent profitability and
growth. Southwest has employed Low Cost Leadership as its generic
strategy and it has been able to offer some of the lowest ticket prices
in the airline industry for the last thirty four years.
Southwest has implemented its Low Cost Leadership strategy in a
number of ways. It flies a route map that is basically point to point as
opposed to other carriers who fly a hub and spoke route map. Southwest
also flies only one type of aircraft--Boeing 737s and generates
industry-high utilization rates by achieving very quick gate
turnarounds--less than thirty minutes. They do not serve meals and were
known for many years for only serving peanuts as snacks. Southwest is
also unusual in that all employees are expected to "pitch in"
when necessary to solve problems and speed gate turnarounds.
ABBREVIATED TIMELINE
1974: Southwest carries its one millionth passenger and remodels
the terminal at Houston's Hobby Airport.
1977: Southwest carries its five millionth passenger and its stock
is listed on the New York Stock Exchange as "LUV."
1982: Herb Kelleher is named President, CEO and Chairman of the
Board.
1992: Southwest wins the first annual "Triple Crown" in
aviation. This award reflects on time service, baggage handling and the
level of customer complaints.
1997: Jacksonville, Florida is added as Southwest's 50th city
and the airline takes delivery of its first 737-700. The Shelby
Amendment modifies the Wright Amendment and permits nonstop service from
Dallas Love Field to Mississippi, Alabama and Kansas.
2001: Colleen Barrett becomes President of Southwest and Jim Parker
becomes CEO. Terrorists attack the World Trade Center and the Pentagon.
The airline industry is decimated by these attacks. At the end of the
year, Southwest has 29,274 employees and 344 aircraft.
2004: Southwest Airlines announces its 31st consecutive year of
profitability. Southwest announces service to Philadelphia--its 60th
airport. Gary Kelly replaces the retiring Jim Parker as CEO.
2005: Southwest announces its code share agreement with ATA,
substantially increasing the number of connecting flights including
flights to Hawaii. This agreement increases revenue by about $50
million, annually.
2006: Southwest reported record revenues and net profits despite
the impact of rapidly escalating fuel costs. At the end of the year,
Southwest had 481 airplanes (all Boeing 737s) and 33,000 employees.
SOUTHWEST CULTURE
An axiom of business that many of us learned early was that the
primary responsibility of executives was to maximize shareholder wealth.
That nostrum gets dumped on its head at Southwest Airlines where the
primary responsibility of executives is to take care of employees first
which will lead to employees taking good care of the airline's
customers and that will, finally, result in appropriate rewards for the
shareholders. More than anything else Southwest has been a fun place to
work since its inception. This fact is illustrated by a display in the
boardroom. At the initial meeting, over cocktails, between Rollin King
and Herb Kelleher, King sketched the triangular route map (Dallas, San
Antonio and Houston) on a cocktail napkin with the note, "Herb,
let's start an airline." Kelleher replied, "Rollin, you
are crazy. Let's do it." This "can do" and somewhat
irreverent attitude pervades the entire organization.
Lamar Muse (the first president) was also a bit of a maverick that
shaped the Southwest culture in many ways. For example it was
Muse's idea to foster the LUV philosophy by flying out of Love
Field in Dallas and hiring very attractive stewardesses who were
outfitted in hot pants designed by his wife. Another time, a competing
carrier decided to offer $13 tickets for flights from Dallas to Houston
to compete with Southwest's $26 ticket price. Muse (in a famous ad)
offered to match the competing carrier's price or to price the
ticket at the original $26 with a free bottle of Chivas, Crown Royal or
Smirnoff vodka. The tag line for the ad was "Nobody's going to
shoot Southwest Airlines out of the sky for a lousy $13." The ad
worked and the media loved every minute of it. It is believed that for a
two-month period, Southwest was the largest distributor of Chivas, Crown
Royal and Smirnoff vodka in Texas.
Employees are hired at Southwest, in many cases, on the basis of
attitude. People who do get hired are screened by a group of future
peers and must demonstrate a sense of humor to get an offer. The basic
philosophy is that "you hire for attitude and train for
skills." Despite its attitude about having fun, the airline
emphasizes that hard work is expected (and rewarded.) This has not
curtailed the applicant list for Southwest employment. In 1995, they
accepted 124,000 external applications, interviewed 38,000 people and
actually hired 5,473.
Regular parties, picnics and other ways to celebrate employees are
all part of the Southwest culture. In the headquarters at Love Field are
hundreds of employee photographs on the walls. In addition, employees
are encouraged to donate free time to a multitude of charities including
Ronald McDonald House and Habitat for Humanity. The result of these
activities (and many others) is that Southwest employees feel a
"kinship" with the organization. They find it relatively easy
to align their personal goals with the organization's goals.
Summarizing the Southwest Airlines cultural attributes, one finds:
* An egalitarian attitude that extends from top management to the
newly-hired hourly worker.
* A serious concern for the wellbeing of customers.
* A very strong work ethic throughout the organization.
* A dedication to issues of social responsibility.
* A "fun" orientation throughout the organization.
* A creative approach to maintaining the lowest cost per seat mile
metric in the airline industry.
A NEW BUSINESS MODEL
Southwest Airlines has been, since its inception, an example of
Porter's (1980) Low Cost Leadership strategy. They have achieved a
low cost leadership position in their industry by emphasizing such
things as faster than average gate turnarounds to yield higher
utilization rates, one class of seating and no meals on board, one type
of airplane--Boeing 737, no hub and spoke routes, the ability to move
very quickly when establishing a new city presence, and a very
successful fuel hedging program that began in 2000.
Gate turnaround times are a key performance metric in the airline
industry. Southwest Airlines has historically had the quickest
turnarounds in the industry--averaging about 20 minutes. They recognized
early on that airlines only generate revenue and profits when they are
flying. They achieve better than average turnaround times as a result of
superb communications and coordination. It is not unusual to see flight
attendants and pilots working with the provisioning and ramp crews to
pick up trash and load bags. It is worth noting that if Southwest in
1995 had the same turnaround times as others in the industry, they would
have needed an additional 25 airplanes in the fleet.
For many years Southwest used plastic boarding cards and assembled
passengers in groups of thirty to board the plane. There were no
assigned seats and only one class of service. This was done to simplify
boarding and speed up the gate turnaround time. Since there were no
assigned seats, passengers frequently arrived at the gate an hour before
the scheduled departure so as to be one of the first to board the plane.
This "cattle call" approach to boarding created
dissatisfaction for some passengers and, as a matter of fact, was the
leading passenger complaint about Southwest Airlines. Quite recently,
Southwest has experimented with assigned seat boarding in San Diego and
has also just initiated what amounts to a group of three classes of
service. By paying an extra $50 for a Business Select ticket (one way)
passengers can be among the first 15 to board and thus able to get the
preferred aisle or window seat. This is a recent innovation and it is
too soon to measure results. CEO Gary Kelly expects the Business Select
ticketing option to add $100 million in additional revenue in 2008.
Southwest is a point-to-point airline. It does not have a hub and
spoke route map like most of the other major carriers. Two additional
possible changes to the Southwest business model is the possibility of
extending their route map to include large cities in Mexico, Canada and
the Caribbean. CEO Kelly remarked recently that this was a change that
was when, not if. Kelly is also intrigued by the possibility of flying
to smaller city pairs in the United States in regional (100 passenger)
jets.
Fuel costs are the second largest item on a list of operating
expenses. Personnel costs are the largest. The cost per barrel of crude
oil has doubled in the last year and this increased cost has
dramatically affected the price of jet fuel. Southwest owns long term
contracts to buy most of its fuel at the equivalent of $51 a barrel
through 2009. This active fuel hedging program produced gains for
Southwest of $892 million in 2005, $675 million in 2006 and $439 million
for the first 9 months of 2007.
DISCUSSION QUESTIONS
1 Do a SWOT analysis for Southwest Airlines and interpret your
findings.
2. At the end of 2006, Southwest had a Current Ratio of 0.90. At
the end of 2005, it was 0.94. Most introductory accounting texts suggest
that the appropriate ratio is 2.0. Does Southwest have a serious problem
with working capital management?
3. Southwest revised its boarding procedure in 2007 with the
introduction of Business Select seating (and boarding). Will this new
introduction generate expected revenue increases and resolve complaints
about boarding policies?
4. Southwest is considering the possibility of adding Canadian,
Mexican and Caribbean destinations to its route map. Comment on this
possibility. Does it make sense? What are the "plusses and
minuses"?
5. Is Southwest more or less profitable than other major US
airlines? Why?
REFERENCES
IATA's December 2007 Financial Forecast. (n.d.) Retrieved
December 22, 2007, from http://www.iata.org/NR/rdonleyres/DA8ACB38-676
F-4 DBI-A2AC-F5BCEF74CB2C/O?industry_Outlook_December 07.pdf.
Freiberg, K. & Freiberg, J. (1996). Nuts! Southwest Airlines
recipe for business and personal success Austin, TX: Bard Books.
Porter, M.E. (1996 November-December). What is strategy? Harvard
Business Review. 62-79.
Reed, D. (2007a) At 35, Southwest's strategy gets more
complicated. Retrieved November 11, 2007, from
http://www.usatoday.com/money/biztravel/2006-07-11-southwest-usat_x.htm.
Reed, D. (2007b) Southwest hopes ch-ch-changes add up to some
ch-cha-ching USA Today (December 28, 2007) B1B2.
Southwest Airlines 2006 Annual Report
Southwest Airlines (October 19, 2007) 10Q Report
Thomas M. Box, Pittsburg State University
Kent Byus, Texas A&M University--Corpus Christi
Table 1: Financial Data
2006 2005 2004
Operating Revenues ($) 9,086 7,584 6,530
Operating Expenses ($) 8,152 6,859 6,126
Operating Income ($) 934 725 404
Other Expenses (net) ($) 144 (54) 65
Income Tax ($) 291 295 124
Net Profit After Tax ($) 499 484 215
Total Assets ($) 13,460 14,003 11,137
Long Term Debt ($) 1,567 1,394 1,700
Equity ($) 6,449 6,675 5,527
Net Income per Share $.63 $.61 $.27
Dividends per Share $.018 $.018 $.018
Note: All $ amounts are millions (except per share data)
Source: Southwest Airlines 10K Report--January 31, 2007
Table 2: Operating Data
2006 2005 2004
Passengers Carried 83,814,823 77,693,875 70,902,773
Trips Flown 1,092,331 1,028,639 981,591
Load Factor (Utilization) 73.1% 70.7% 69.5%
Fuel Cost per Gallon $1.53 $1.03 $.83
Number of Employees 32,664 31,729 31,011
Number of Planes 481 445 417
Source: Southwest Airlines 10K Report--January 31, 2007
