Southwest airlines: the next fight begins.(Instructor's Note)

Jackson, William T. ; Jackson, Mary Jo

CASE DESCRIPTION

This case was developed through the use of secondary research material. The case has a difficulty level of five and is appropriate to be analyzed and discussed by advanced undergraduate and graduate students in a strategic management class.

The case allows the instructor the flexibility of concentrating on one strategic issue, or as a means of examining the entire strategic management process. The major focus within the strategic analysis as well as excellent stand alone modules is in the area of legal/political influence, economic, leadership succession, or the ability to survive in an unattractive industry. The instructor should allow approximately one class period for each element addressed. Using a cooperative learning method, student groups should require about two hours of outside research on each element researched. The case also provides an impetus to explore a very successful company during the current extreme economic downturn.

CASE SYNOPSIS

This case is a library, popular press and internet case which examines Southwest Airlines--a frequently examined company, yet one facing new challenges in the current economy. The review of annual reports, trade journals, government documents and proposed and enacted regulations must be accomplished carefully. While most students have a general understanding of the airline industry, few have the current knowledge to compare this industry against more traditional operations. A review of these resources should lead students in determining the future of the company and the current CEO, Gary Kelly.

INSTRUCTORS' NOTES

The information available in both the written case as well as outside research material provides a thorough platform for students to conduct a complete strategic analysis of Southwest Airlines as well as discussion of various select elements of that model. Provided in this note are the highlights of each element of the strategic management model.

General Environment

There are numerous issues that can be explored within the general environment. This level of the external environment will provide opportunities and threats that must be faced by all firms. In light of the fact that the issues arising from this level of the external environment are out of the control of individual firms, it is critical to position a firm to grasp emerging opportunities as well as avoid potential threats.

From a historical perspective, the legal/political environment was at the forefront. There had been tremendous influence of government agencies and their influence on competition within the industry. While considerable pressure was removed with the Airline Deregulation Act of 1978, the industry remains heavily regulated in other areas such as FAA, EPA, FCC as well as state and local agencies. The most recent impact of regulation is found with increased security measures as a result of 9/11.

T--Highly regulated industry

The price of fuel is an issue that can be broached in several areas of the general environment. This commodity being a limited resource and being controlled by numerous parts of the world less friendly to the U.S. has created concerns for any energy dependent industry.

An additional concern faced by all carriers is the impact of climate. The firms most often impacted are those that depend on flights in the northern tier of the country. While this once was a major opportunity for Southwest when its route structure was primarily limited to the southwest, it national expansion has exposed the company to delays in some of the major airports it currently serves.

T--Limited natural resource of fuel

T--Political instability in oil rich nation providers

T--Severe winter weather

At the forefront of any discussion of the general environment must be the economy. The economic downturn has resulted in several areas of concern for airlines--slow down in general business activities (thus less business and leisure travel), reduction in disposable personal income (less leisure travel), more difficult credit availability, and lack of confidence in the market.

T--industry is negatively impacted by downturns in the economy

The social force within the general environment also offers fertile ground for discussion. Students should tie in the economic hard times with a more cost conscious consumer, as well as measuring the impact that airport delays due to enhanced security have had on a time poor society.

T--Cost conscious consumer

T--Time poor society

While few discontinuous changes have occurred for technology within the airline industry, there have been some major incremental advances that have been geared toward increased efficiency--new fuselage designs such as sweepback wings, advanced aviation systems, and information systems modifications. Southwest Airlines has advanced many in the hopes of increased cost savings.

O--Aviation and IT systems technological advancements

INDUSTRY ENVIRONMENT

An industry is defined as the group of competitors that produce similar products or services that satisfy the same basic consumer need. In this analysis of the airline industry, the framework made famous by Michael Porter--the five force analysis in used to determine opportunities and threats impacting firms within the industry. According to Michael Porter, the attractiveness of an industry can be gauged by examining the influence of five specific forces: the threat of new entrants into that industry; the power of suppliers; the power of buyers; the threat of substitute products; and usually the fiercest--the rivalry of existing firms.

Each one of these forces addresses a basic issue. The threat of entry seeks to determine how difficult it is for other firms to enter the marker. The power of suppliers and buyers is used to determine who holds an upper hand in the relationship between buyers and sellers. The threat of substitute products is used to determine if some other product/service outside of the industry offers a product/service that could be used by the consumer to meet the basic need of a product/service and in so doing set the price ceiling a firm can charge. Finally, the rivalry of the existing firms is a means of determining how competitive the industry. The combined pressure from these five forces determines the attractiveness, thus profit potential, of the industry.

Threat of New Entrants:

To determine how difficult it is to enter a particular industry, several areas can be examined. The threat of new entrants within an industry is dependent on capital requirements, access to distribution channels, government regulations, economies of scale, and the retaliation of existing firms within the industry. A careful analysis of these issues clearly points to the fact that it will be very difficult for any firm to enter at the scope level maintained by the major airlines. Some opportunities exist (which explains the numerous national and regional participants) to compete at a lesser level.

Support for the position made by Michael Porter that government policy has the potential for being the highest barrier to entry can be found in this industry. Prior to the passage of the Airline Deregulation Act of 1978 (between the years 1938-1978) no new major carrier entered the market. After deregulation, the industry has experienced hundreds of entries even with the other existing barriers.

O--High barriers to entry

Power of Buyers:

The power of buyers within an industry is reliant on several factors including the relative amount of switching costs, the differentiation of products offered by the industry, amount of information available to buyers, and the volume of buyer purchases.

Buyers exert moderate to high control over firms within the airline industry. Minimum switching costs (short of the frequent flyer programs offered by most carriers), and access to considerable online information regarding flights, prices, and service performance makes buyers much more savvy. In addition, the business class customer when seen as a single buyer group can influence the airlines through their buying power.

T--Strong buyer power

Power of Suppliers:

The power of suppliers within an industry is comprised primarily of the number of suppliers, the differentiation of their products, the availability of substitutes, and the amount of switching costs required moving between suppliers. There are three primary supply groups found within this industry--airframes, fuel, and specialized labor (pilots). Each of these has the potential of exerting considerable pressure within the industry.

As discussed within the case, fuel is the highest of the costs associated with running an airline. It has consistently been the most difficult to manage due to the limited ability to influence pricing by individual firms. Many firms have elected to engage in hedging activities to offset the uncertainty of prices.

Availability of supply sources for airframes is also limited. Boeing and Airbus are the two main choices. Even though Airbus has made some strides in the U.S. market in recent years, Boeing still remains the leader.

Because of the specialized skills required by pilots, some consider them another important supply group. Due to the expansion of national and regional carriers, availability of this supply has increased with more pilots getting the opportunity to accumulate necessary flight hours, and salary growth has increased at a much slower rate.

T--Powerful Suppliers

Threat of Substitute Products:

The threat of substitute products for an industry is mostly dependent on whether there are products/services external to an industry which meet the basic need of a consumer and set the price ceiling for a product. Except for some firms, there has been limited pressure from substitute products in the past. Southwest Airlines is one that had greater pressure during its earlier years when average flight lengths were just over 400 miles. The substitute product they competed against was driving and their pricing strategy clearly took this into account. Now with average flights being over 800 miles there is considerably less pressure.

The only main change in the last five years has been the additional time involved in flying--earlier arrival requirements as long delays due to security measures. On short flights (and SWA still has many) the "price" of time needs to be taken into consideration.

Rivalry of Existing Firms:

The rivalry of existing firms is impacted primarily by the growth of the industry, the number of firms in the industry, the exit costs to leave the industry, and the storage costs for firms within the industry. Most will agree that this is usually the force creating the greatest concern in that it measures the competitiveness of the industry.

Because of the equally balanced firms in the industry coupled with slow growth since 2001 and the high fixed costs the airline industry has been characterized as an extremely competitive industry. This imperfect oligopoly has been dominated (in terms of market share) by only a handful of firms in pre deregulation, post deregulation and even now. Currently there are seven firms holding over 80 percent of the market share.

Another event should be addressed when examining the competitors under this force--mergers and acquisitions. The most recent combination of the two previous independent giants Northwest and Delta should have all firms in the industry nervous. This merger has created the largest airline in the world with considerable route coverage without redundancy of operations.

T--Highly competitive industry

Review of the five forces above provides a clear understanding of why the performance of the industry has been dismal over the last 3 decades--the industry is unattractive. The greatest defendable position that exists for the company is the extremely high barriers to entry for any firm wishing to compete at the scope level that Southwest Airline or the other major airlines compete at.

ORGANIZATIONAL DIRECTION

Company Vision:

"The mission of Southwest Airlines is dedication to the highest quality of customer service delivered with a sense of warmth, friendliness, individual pride, and Company Spirit."

It is very clear that the purpose of the company centers on satisfaction of the customer and the delivery system in providing a high level of service--the employee. The core values that drive this purpose--customer satisfaction, employees, efficiency, and an enjoyable work environment are strong and supported by the day-to-day operations of the firm.

While specific published goals and objectives are difficult to find for the company, there are many outcomes that can be inferred by the actions of the company. Some of these outcomes include: expanding its geographical coverage within the U. S. into other profitable markets; have low turnover; maintain high customer satisfaction ratings; maintain efficient operations (the lowest costs in the industry); and achieve high returns for its shareholders. Support that Southwest has consistently met these goals is easy to find in published material regarding the company.

STRATEGY FORMULATION

Corporate Level Strategy:

Southwest Airlines has consistently pursued a corporate level strategy of internal growth--more city pairs, more equipment, more employees and some additional product lines (i.e. vacation packages, freight, general travel arrangements). Planned expansion through external growth using joint ventures with WestJet to serve Canada and Volaris to serve Mexico should be finalized in early 2009.

To date, the corporate level strategy followed by Southwest has been successful. Recent concerns have emerged regarding whether the company can continue to grow while maintaining the unique corporate culture with over 35,000 employees nation wide.

Business Unit Level Strategy:

The business unit level strategy being pursued by Southwest Airlines is open for considerable interpretation and will generate considerable debate within the classroom. On the surface, the strategy most pontiffs will apply to SWA is low-cost and in some circles low-cost niche. Those espousing low-cost industry wide generally come to this conclusion based upon the ruthless efficiency that the company is best known for. Those suggesting low-cost niche point to the original regional coverage beginning. Still others will argue for a combination strategy industry wide. Support for this last position is provided below.

One of the first areas to be examined when determining a firm's business unit level approach is the product/service being offered. Lo-cost firms generally offer a generic, standardized, no-frills product. For the leisure traveler SWA's offerings are just that. However, to the business traveler what is considered high quality to many is the option of having many flight choices that are frequent and leave and arrive on time--a recognized characteristic for the company. Gary Kelly confirmed this approach by suggesting "We offer a no-frills product at a great price with high customer service".

Operationally, SWA maintains the lowest costs in the industry but accomplish this without sacrificing quality to the business travelers. The company has historically had one of the youngest fleets in the industry. The youth of the fleet has resulted in more efficient aircraft in terms of operational costs and allows for fewer delays as a result of less mechanical issues. In addition, due to the fact that the company uses only one type of aircraft (Boeing 737) maintenance quality and costs can be maintained at lower levels. Further, the Boeing 737 requires a cockpit crew of two rather that three as used for some aircraft again lowering operational expense without deteriorating the differential value.

Human Resource Management is another area where a combination strategy can be supported. As mentioned in the case the company is mostly unionized and pays one of the highest salary levels in the industry all pointing to differentiation. Where the company saves in terms of labor costs are in the area of lower retraining due to low turnover and the willingness of employees to put in additional hours for the company. Many will say they do this due to their loyalty to the company as well as their involvement in profit sharing. As mentioned above, savings are also garnered with less training required in the pilot and maintenance areas since it is limited to one type of aircraft.

The same approach can be applied to several other areas within the value chain for Southwest. A few of these include: lower airport fees due to operating in many smaller airports; being very selective and effective with its advertising expenditures; investing significantly in technology that has resulted in costs savings; a lean and efficient organizational structure. None of these areas create a negative view of the product offering.

STRATEGY IMPLEMENTATION

Several areas are often examined to determine if there exist any constraints that might prevent a company from effectively implementing their strategies. Often this focus is on process issues such as leadership, power, corporate social responsibility, or organizational culture. Southwest Airlines provides considerable latitude in addressing these issues.

Leadership:

Herb Kelleher has been the face of Southwest since its beginning. His zany leadership style--"management by fooling around" has been the focus of numerous studies in the management literature for years. He was well recognized as a hard drinking, heavy smoking maverick. Considerable concern initially emerged when he announced in early 2000 that he was stepping down as CEO and president. The company's selection of Coleen Barrett allowed Southwest to maintain its advantage through leadership. The most recent change was with Barrett's retirement and the assumption of total power by Gary Kelly. While, there may still be some concerns, it appears that Kelly will follow the same approach to leadership as his two predecessors.

Corporate Social Responsibility:

Corporate involvement in the communities around them has generated much discussion in terms of sustainability for organizations. Southwest's ability to satisfy all levels of Corporate Social Responsibility (CSR) has allowed the company to earn considerable respect in the business community. The model of CSR developed by Archie Carroll can be used as a framework to discuss this issue. Carroll maintains that companies need to meet economic expectations, adhere to all applicable laws, conduct business in an ethical manner, and to give to its communities. If these areas are completely satisfied it is suggested that the bottom line will also improve. SWA is well recognized in having done just that: 36 years of profits; no legal disparities; no ethical lapses; and considerable philanthropic activities.

Organizational Culture:

Many strategic management gurus will suggest that the only possible sustainable competitive advantage a firm can amass is that of a strong (positive) organizational culture. This is primarily due to the fact that a sustainable competitive advantage can only be created by having something that is not easily copied. Southwest has long been credited with having such a culture. Considerable attention, therefore, should be given to this possibility. In doing so, culture should be defined, the purpose examined, and the components of this process explored.

Culture has been defined as the customary way of doing things, accepted by all members of the organization, and a necessity for new members to accept before becoming a part of the organization. All of these elements are characterized within SWA. First, the ways of thinking and doing things within the company are clear. Second, employees have readily accepted and embraced these actions. Finally, if employees can not demonstrate they would be a good fit with this approach, they are not hired or will not last long as members.

Deal and Kennedy in their book Corporate Culture suggest there are four main purposes of a strong organizational culture--provide a sense of identity, increase employee commitment, serve as a frame of reference of expected behavior, and to ensure organizational stability. Each of these purposes has been achieved within Southwest.

In addition to describing the purposes of a strong culture, Deal and Kennedy also suggested there were four main ingredients for this phenomenon: strong core values; organizational heroes; rituals; and, ceremonies. Again, all of these ingredients exist and can be supported for Southwest. In addition, it may be the inability of others to copy these ingredients that supports the idea of other firms not being able to imitate the company's culture.

SWOT

While it is relatively easy for students to identify strengths, opportunities and possible threats relating to Southwest, they may have some difficulty in identifying weaknesses in a firm that has been profitable for 36 consecutive years. The chart below may be used to highlight some of those possibilities. Students should also be prompted to consider possible areas of concern for the company.

Possible concerns:

* Has growth eroded ability to be as cost efficient

* Has growth created issues that damage culture

* Will new leadership live up to predecessors

* Are new northern routes good for the company

* Will competition drive prices too low

STRENGTHS

* Strong culture

* Efficient operations

* Strong customer/employee focus

* Low turnover

* Young, efficient fleet

* Low debt

* Strong financial position

* Strong leadership

* Strong web site

* Well respected company

* Distinctive marketing

OPPORTUNITIES

* Falling interest rates

* New technologies increasing efficient

* Limited substitute products

* High entry barriers

* Bargaining power with Boeing

* Declining fuel prices

* Receptive business traveler

* Underserved markets

WEAKNESSES

* Pending/potential expiration of fuel hedging contracts

* Increasing costs

* Expiring labor contracts

THREATS

* Uncertainty in fuel prices

* Increased airport security

* Weather

* Strong power of buyers

* Substitute products in short-haul markets

* Intense competition

* New Northwest/Delta merger (increased competition)

* Labor union demands

STRATEGIC CONTROL

The final element of the strategic management model is strategic control. This case provides an excellent platform for examining the use of financial analysis of a firm with very specific measurement concerns. In addition, this analysis should be challenging to students in examining a company that has been profitable for 36 consecutive years but may suddenly find itself in a situation where the 38th year may be its hardest to achieve that milestone.

Changes in operating expenses for airlines are driven by changes in capacity, or changes in ASM (Available Seat Miles). As ASM increases, expenses are expected to increase proportionately. If efficiencies are maintained, expenses should remain the same on a per unit (per seat) basis. Airlines monitor these per unit cost by calculating CASM (cost per available seat mile). This is computed by dividing total operating expenses by total available set miles. The last two years has witnessed a significant increase is the cost per unit for SWA. In 2006, this amount was $8.80. It rose to $9.10 and $10.24 for 2007 and 2008 respectively. The major increase has been attributed mainly to the increase in fuel costs and a less successful hedging operation for the airline.

The following tables (Tables 1-6) provide additional comparative data that students should gather related to the competitive position of Southwest. Students should come to the conclusion that although the company still remains profitable, the performance gap is shrinking and that 2009 may be much more discerning for the company. TABLE 1: Comparative Net Income: 2002-2007 Company 2007 2006 2005 2004 2003 2002 Southwest 645 499 548 313 442 241 American 504 231 (861) (761) (1,228) (2,523) Continental 459 369 (68) (409) 38 (451) Delta 1,612 (6,203) (3,818) (5,198) (773) (1,272) US Air 427 303 (335) (89) 57.4 (179.7) * Note: Not all airlines had reported their 2008 results at the time of the case TABLE 2: Available Seat Miles (in millions) AMR CONT Delta NWA SWA United USAIR 2007 169.9 103.1 127.7 86.1 99.6 141.8 75.8 2006 173.9 97.7 125.5 85.6 92.7 142.8 77.0 2005 175.9 89.6 133.9 91.7 85.2 139.8 83.6 Total Industry 2007 883.0 2006 866.0 2005 859.6 TABLE 3: Revenue Passenger-Miles Flown AMR CONT Delta NWA SWA United USAIR 2007 138.4 84.3 103.5 72.9 72.3 117.4 61.3 2006 139.4 79.2 98.9 72.6 67.7 117.2 60.7 2005 138.2 71.3 103.7 75.8 60.2 113.9 63.2 Total Industry 2007 711.5 2006 690.7 2005 674.7 TABLE 4: Passenger Load Factor AMR CONT Delta NWA SWA United USAIR 2007 81.5 81.7 81.0 84.7 72.6 82.8 80.8 2006 80.1 81.1 78.8 84.8 73.1 82.1 78.8 2005 78.6 79.5 77.5 82.6 70.7 81.5 77.0 Total Industry 2007 80.6 2006 79.8 2005 78.5 TABLE 5: Select Ratios ROR ROA ROE Current 2007 2006 2007 2006 2007 2006 2007 2006 Southwest 6.5 5.5 4.3 3.6 9.6 7.6 .9 .9 American 2.2 1.0 1.7 .8 49.1 n/a .9 .8 Continental 3.2 2.8 3.9 3.4 48.4 128.8 1.0 1.0 Delta 8.5 nm 6.2 nm n/a n/a .8 .9 USAIR 3.6 2.6 3.2 3.6 35.5 43.6 1.3 1.2 Debt/Capital 2007 2006 Southwest 17.8 15.5 American 79.2 105.3 Continental 69.6 90.5 Delta 42.1 (97.5) USAIR 67.8 75.0 TABLE 6: Compound Annual Growth Rate Company 10yr 5yr 1yr Southwest 10.0 12.4 8.5 American 2.1 5.8 1.5 Continental 7.0 11.1 8.4 Delta 3.4 7.3 9.3 US Air 20.1 41.7 1.2

William T. Jackson, University of South Florida St. Petersburg

Mary Jo Jackson, University of South Florida St. Petersburg