Southwest Airlines 2007.(Instructor's Note)
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.
INSTRUCTORS' NOTES
Learning Objectives
This case is intended to teach and reinforce various aspects of strategic analysis and choice including internal and external analysis, strategic choice as a function of SWOT analysis, implementation of a Low Cost Leadership generic strategy, utilization of Financial Ratio Analysis and modification of strategy as time unfolds. The case can also be used to examine the potential benefits and risks of overseas expansion for a domestic concern.
Teaching the Case
We suggest that a practical starting point for this case analysis is a discussion in class of mission, vision and SWOT analysis. This case illustrates how a Low Cost leadership generic strategy can be extremely successful in a very competitive industry--passenger airlines. Southwest has enjoyed profitability and continued growth for thirty five years. It should be noted that as of the date of the case (February, 2008) that Southwest Airlines' market cap was $9.42 billion while American Airlines, United, Delta, Northwest and Continental had substantially lower market caps.
When assigning this case for classroom discussion, we recommend that the instructor require the students to read the case, review a selection of the references and jot down answers to the discussion questions before class. Then, in class, we suggest that individual students assemble themselves into teams of three to four students and prepare consensus answers to the five discussion questions. The answers should be presented by a team representative. This allows about ten minutes for presentation of each team answer and works well in a traditional seventy five minute class.
Incase the instructor wants to make this a two-day discussion, other topics and questions can be included:
1. How can Southwest Airlines accommodate the rapid, recent increases in fuel costs? A recent technology advance is the addition of Boeing winglets (vertical fins) to the ends of the wings on roughly one-third of Southwest's fleet. See http://www.b737.org.uk/ winglets.htm
2. What can any airline do about the implicit threat of shoulder-fired Stinger missiles? See http://business.timesonline.co.uk/tol/business/industry_sectors/transport/ article3025938.ece
3. Beyond modified seating and boarding arrangements, what can Southwest do to attract larger numbers of business travelers? Consider the "bundle" of service surrounding the flight alone.
4. Can Southwest (today) incorporate elements of Guerrilla Marketing as Lamar Muse did in the airline's early history? See: http://www.gmarketing.com/
We recommend and use Kantola Productions' Stanford Executive Briefing Videos in class. One that is particularly relevant to this case is "Colleen Barrett: What Drives Phenomenal Success?" Colleen Barrett has been with Southwest since its beginnings and is today President and Corporate Secretary. Her video, in addition to enriching the discussion of Southwest Airlines, can also be used as a "bridge" device into a discussion of female executive leadership in modern organizations.
DISCUSSION QUESTIONS
1. Do a SWOT Analysis for Southwest Airlines and interpret your findings.
A SWOT Analysis is a procedure used to identify the important characteristics of the firm's internal environment and the salient characteristics of the external environment. Strengths are those things that a firm has (like human and physical resources) that can provide a competitive advantage. For Southwest, strengths would include its culture and people together with its systems and operating results. Weaknesses are just the reverse of Strengths and it is difficult to identify any significant weaknesses at this time. Opportunities and Threats are those things external to the firm that represent real opportunities for enhanced growth and profitability or threats to enhanced growth and profitability. Opportunities for Southwest would include the possibility of a route map expansion to include the Caribbean, Mexico and Canada. Threats obviously include competition from other low cost airlines and fuel costs.
Interpretation of a SWOT analysis means more than compiling a list of strengths, weaknesses, opportunities and threats. It means combining these factors in combinations that will lead to the creation of competitive advantages. For example, Southwest's fuel hedging procedures (a strength) combined with the current cost of aviation fuel (a threat) suggests that continued, active fuel hedging programs now is the time will be a major source of competitive advantages for the foreseeable future.
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?
It is true that most introductory accounting texts recommend a Current Ratio of 2.0 or above. However, it is also true that some industries commonly exhibit Current Ratios of 1.0 or slightly less. This is true of both airlines and utilities. The logic here is that both of these industries have a steady, daily inflow of cash (revenues) and are thus able to manage their Current Liabilities easily. Two points are worth noting. Southwest's Current Ratio did decline from 2005 to 2006 and this is not a positive sign. Also, in order to interpret any financial ratio, we should consider changes over time and the specific ratios for the industry in which it participates. We recommend that students consult http://finance.yahoo.com for current financial ratios.
3 Southwest revised its boarding procedure in 2007 with the introduction of Business Select seating and boarding. Will this introduction generate expected revenue increases and resolve complaints about boarding policies?
The most commonly-heard complaint about Southwest Airlines has historically been its boarding procedures. Southwest has boarded customers in groups of thirty on a first-come, first-served basis. There were no assigned seats and many people commonly lined up at the gate an hour before departure time to get a chance for a preferred seat. The reason for this boarding procedure was that it minimized the cost of boarding and facilitated quick gate turnarounds.
Beginning in late 2007, Southwest began offering Business Select seating on many flights which entailed an additional charge of $10-$30 each way and guaranteed those customers paying the additional ticket price the opportunity to be in the first group of customers boarded. Additional inducements for the extra fare include a free drink, more frequent flyer rewards and refundable, reusable tickets. Southwest estimates that Business Select will increase annual revenues by $100 million. Since Southwest flew roughly 1.1 million flights in 2006 this means that earning an additional $100 million in revenue would only be roughly $100 per flight. With an average load factor of 73%, this means about 5 people per flight would need to utilize business select to realize the revenue goal. On this basis the expected incremental revenue looks conservative.
The larger question though is "Will this reduce the complaints about boarding, in general?" One must realize that many passengers flying Southwest do so because of their historic low ticket prices. It is unlikely that many of these passengers would select business select and so the complaints may not be resolved.
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?"
On the "plus" side of the question would be the opportunity to increase the number of flights but there are several potential "minuses." Flying to some airports in the Caribbean, Mexico and Canada would include the added complexity and cost of working with foreign governments. Access to gates at the airports can be a considerable expense and easy access to maintenance services adds an additional dimension.
In general, adding to the route map with destinations outside the United State would be a clear departure from Southwest's traditional business model and, obviously, needs to be carefully considered. In additions to the concerns above, it would be appropriate to consider the distances involved and the passenger traffic volume that currently exists. For instance, travel is quite heavy between New York City and San Juan, Puerto Rico. The distance is approximately 1650 miles and well within the range of a 737-800. Other popular destinations in the Caribbean such as Nassau, the Virgin Islands and Jamaica are within the "reach" of a 737. One interesting potential route is the possibility that the United States government will relax travel restrictions to Cuba since Fidel Castro stepped down as President and there are more than 1.2 million Cuban Americans living in the United States with relatives and friends still in Cuba.
5. Is Southwest more or less profitable than other major US airlines? Why?
Southwest Airlines has been profitable since its inception--35 years ago--and continues that amazing track record today. No other major airline has matched this consistent performance and that is probably reflected in the market cap for the majors. At $9.5 billion, Southwest is more than double the other major carriers. It could be argued that Southwest's profitability reflects their Low Cost Leadership strategy but the real answer goes much deeper than that. Southwest has a business model that others have attempted to copy with limited success.
Important elements of the business model include the corporate culture, the dedicated, hard-working workforce and the ability to react quickly to new opportunities and challenges. Most important, perhaps, is the belief that Southwest is a fun place to work and the employee stock ownership program builds wealth quickly for those who stay with the airline.
REFERENCES
IATA's December 2007 Financial Forecast. (n.d.) Retrieved December 22, 2007, from http://www.iata.org/NR/rdonleyres/DA8ACB38-676F-4DBI-A2AC-F5CEF74CBC2/ O?ndustry_Outlook_December07.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) B1-B2.
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
