Southwest Airlines, often called a low-cost carrier and renowned for its short-haul, point-to-point service, is the seventh largest domestic airline in the US. It holds the distinction of being the pioneering example of a low-cost airline.
The concept has been so successful that other new airlines have modeled their business strategies after Southwest. Currently, two other low-cost airlines (considered national rather than major carriers) are aggressively competing with Southwest for customers and profits. Despite the current state of the US economy, all three American low-cost airlines are still making profits. Southwest is in the lead, followed by JetBlue and Air Tran in terms of profitability.
Despite the major six airlines suffering significant financial losses every quarter, how is it possible for one airline to offer the same product as another airline – a single available seat mile (ASM) for sale? The answer to this question dates back approximately 30 years ago.
Each airline’s marketing, routing, pricing, executive decision-making, and operating strategies determine the difference between them. Profitability relies on finding productivity in total revenue passenger miles (RPM) flown through these strategies.
When a fare-paying passenger fills the ASM, sales or income is acknowledged, and it converts into an RPM. The ASM and RPM have a direct relationship and this is expressed as Load Factors (LF) in percentages. LF is a management tool to assess the efficiency and viability of the airline. It is crucial to maintain a balance between these two variables.
Southwest Airlines, a point-to-point short haul airline, has successfully demonstrated its ability to maintain low costs and generate profits. Despite facing the challenges of deregulation and cyclical business cycles, which could result in recessionary or inflationary periods, Southwest Airlines has managed to maintain a strong financial condition for 25 years since deregulation. This resilience has been sustained regardless of current economic trends.
The airline management has demonstrated sound decision-making in both governed and ungoverned airline markets. It adheres to a conservative financial philosophy and only pursues growth when financially feasible. While other airlines have experienced consistent losses, Southwest Airlines has consistently performed exceptionally for 30 years.
According to Meyer and Oster (p. 50), in order to maintain low airfares, airlines must focus on reducing costs through various means. These include having less unionization, which leads to lower wage rates and less restrictive work rules, increasing the number of hours that aircraft are flown per day, giving managers more discretion in assigning labor, utilizing cheaper satellite airports or terminals, eliminating unnecessary service frills, encouraging passengers to carry their own luggage, not interlining reservations or luggage, and possibly adopting an all coach-class seating arrangement.
Southwest’s airline operation strategy has been guided and conducted by these ideas. The brainstorming of Rollin King and Herb Kelleher led to the formation of a new company and the imminent birth of an innovative airline. This company opted for a distinct infrastructure and operations, making it the pioneer in its industry.
The company’s operational strategy revolved around offering frequent short-haul flights from less busy airports with minimal air traffic delays. These airports would minimize ground time for their aircraft and have a local population that could generate enough revenue to sustain operations. In order to successfully establish a new airline, the company needed to understand what passengers desired. The structure of the new airline was conceived based on passengers’ desires for desired destinations, punctuality, and the lowest possible fares.
The two gentlemen, Rollin and Herb, used their understanding of a passenger’s needs to find solutions. The company determined that the most effective approach to handle the problem of destinations was to offer point-to-point service. This would allow for more direct nonstop routes, resulting in fewer connections, delays, and overall trip time for all flights (Annual Form 10-K Report, p.3 & 22).
This meant that passengers would no longer have to go through the company’s main hub in Dallas, Texas for connecting flights, reducing the total travel time. By avoiding the hub connection, the company could achieve a higher percentage of on-time arrivals, showcasing their commitment to service excellence. Currently, the company’s average aircraft trip stage length is 548 miles, with an average duration of about 1.5 hours (Annual Form 10-K Report, p. 3).
In conclusion, Southwest Airlines was established with the goal of providing affordable and high-quality services to fare-paying passengers. The founders, Rollin and Herb, aimed to offer the lowest fares possible without compromising on quality or operational feasibility. Their belief in the allure of low fares ensured the efficient operation of the company and its planes.
Southwest Airlines started its first service on June 18, 1971, in Texas, connecting Dallas, Houston, and San Antonio. They used three Boeing 737 aircraft as their preferred choice. The airline’s operating strategy included using only one type of aircraft to lower costs related to pilot and flight attendant training, maintenance, scheduling, flight operations, and spare part inventories. Southwest Airlines opted for the Boeing 737 because it is a technologically advanced, efficient, and short-ranged aircraft. Additionally, it is the smallest twin-engine jetliner that can accommodate 115 to 169 passengers.
The aircraft is versatile and can easily be converted from an all passenger configuration to an all cargo configuration, or a combination of both, within an hour. This has been a significant advantage for Southwest Airlines since they now offer cargo freight services. Additionally, the aircraft is aerodynamic and has been retrofitted with Performance Data and Navigation Computer Systems.
The aircraft is specifically designed and certified for a two-man crew, resulting in cost controls. It also offers other features. The pilots only need to be trained on one type of aircraft, while flight attendants only require training to provide in-flight service for this specific model. Similarly, the mechanics’ focus is solely on maintaining one type of engine.
The engines are situated beneath the wings, allowing for easier access to perform mechanical tasks. This design choice enables mechanics to stand on the ground while reaching the engines. These strategies result in cost reduction for Southwest Airlines due to the efficiency of uniformity. It is evident why Southwest Airlines selected this specific jetliner as their preferred aircraft, as it aligns with their financial strength demonstrated by their current and future fleet.
As of December 31, 2002, the company had a total of 357 B737 aircraft. Out of these, 97 were under operating and capital leases while the remaining 278 aircraft were wholly owned. Currently, Southwest plans to retire its fleet of 27 B737-200 series aircraft within the next three years. Additionally, as of February 1, 2003, Southwest has scheduled the delivery of new aircraft from Boeing. Specifically, they are set to receive a total of 17 B737-700 series aircraft in 2003, followed by deliveries of 23 in 2004, 24 in 2005, another batch of 22 in 2006, followed by additional deliveries of25 in both years: first in year seven (2007) and then six more will arrive on or around year eight (in this case presumably that means six planes will be delivered at some point during calendar year eight which is actually also within fiscal year eight). Finally rounding out their orders are six more expected for arrival sometime during calendar/fiscal year eight aka “FY08” or just plain old “In two thousand-eight”.
The company has a total of 79 purchase options for new B737-700 aircraft from 2004 to 2008 and also has purchase rights for an additional 217 B737-700s within the period of 2007-2012. These details can be found in the Annual Form 10-K Report on pages 6 and 7. It is important to note that the company has the ability to substitute B737-600s or B737-800s for the B737-700s, as long as this substitution occurs two years before the contractual delivery date. Additionally, the company has achieved profitability in just two years, with a net income of $175.00.
The company was happy with its performance and planned to expand its services to the Rio Grande Valley by applying for authority through the Texas Aeronautics Commission. In 1975, the application was accepted, and Southwest Airlines began expanding by operating four roundtrips daily from Harlingen Airport. By 1976, which marked the fifth year of operation, the company was still making modest profits while continuing to grow. This growth was shown in two notable ways: firstly, another B737 aircraft was added to bring the total inventory up to six.
The Texas Aeronautics Commission granted permission for the expansion of service to various regions in Texas. Concurrently, Southwest Airlines announced that they had successfully transported over 1.5 million passengers during that year. The airline’s consistent growth by 1977 can be attributed to its effective management decisions and practices.
The airline disclosed its profits and posted a net income of $7,545.00, marking an increase from the previous year. The company’s expansion was acknowledged when it became listed on the New York Stock Exchange (NYSE) as “LUV”. Presently, the trading symbol LUV is pronounced as “Love” (“A Brief History,” p. 1-5), and is frequently incorporated in their marketing slogans and advertising strategies. In addition to joining the stock exchange, the company experienced growth in their passenger service by achieving the milestone of transporting five million contented passengers.
President Carter signed the “Airline Deregulation Act” into law on October 24, 1978, which ended the government’s economic control over the airline industry’s routes and fare pricing that was previously managed by the Civil Aeronautics Board (CAB). This act had various objectives and continues to have significant impacts even after 25 years.
The deregulation act presented airlines with the chance to expand by restructuring routes and prices, as well as decreasing passenger fares. Airlines were compelled to become self-sustaining businesses and find novel methods to attract customers. Consequently, intense competition arose among airlines.
Many airlines suffered severe negative impacts and collapsed as a result. These failures showed the vulnerability of the airlines and the inexperience of their management in strategic route planning in the deregulated environment (Wolfe and NewMyer, p. 5) (Meyer and Oster, p. 55). However, national carriers were able to register profits despite adverse economic conditions, suggesting that they were flexible enough to adapt to deregulation (Wolfe and NewMyer, p. 5).
Since then, numerous airlines have emerged while others have vanished, and many are currently at risk of vanishing. Luckily, Southwest Airlines already operated on the basis of a low fare system, so deregulation did not impact the airline in that aspect.
The company was impacted by deregulation when the government approved service routes that were previously controlled. This gave the company the opportunity to expand its services beyond Texas, which they did in 1979. In 1980, the company further expanded its aircraft inventory by acquiring its 22nd B737, which was notable as it was the first B737 to be fully owned by Southwest Airlines (“A Brief History,” p. 2-3).
In 1981, the company celebrated its tenth anniversary and pledged to maintain its commitment to providing excellent service to passengers. By then, other airlines were starting to take note of the company’s young age and consistent profitability. Despite facing a challenging economic environment, the company achieved a positive net income of $34,165.00, whereas other airlines were grappling with declining cash flows and resorting to high-interest debt financing. The effects of deregulation, which had been in place for almost ten years, continued to affect the airline industry as markets became increasingly competitive due to public demand for air travel.
Despite slow but determined service route expansions to other states, the company’s strong financial position remained intact. Furthermore, the company was honored with multiple awards for its commitment to customer satisfaction and for holding the title of having the “Best Consumer Satisfaction record of any continental U.S carrier” (“A Brief History,” p. 3).
In addition to winning numerous awards for baggage handling, on-time records, and minimal customer complaints, the airline also faced a growing demand for air travel in the mid-1980s. This led to increased competition and improved profitability for the surviving airlines after deregulation. However, a downside was that these airlines had aging aircraft that required replacement.
Several companies used their profits to upgrade their fleets with newer and larger aircraft of various types, resulting in immediate depletion of any profits earned. After almost two decades of spreading love (as stated in “A Brief History,” pages 3-4), the company reaches the billion dollar revenue milestone and achieves the status of a major airline (as mentioned in “A Brief History,” page 4) within the industry. Southwest Airlines now captures the complete attention of other airlines, analysts, and economists.
Undoubtedly, this company is efficiently managed as evidenced by the successful mechanics of its infrastructure and strategies. Over the course of the 90’s, Southwest Airlines consistently expanded its service routes throughout the United States. Presently, the airline operates in 58 cities, employing over 350 B737 aircraft.
Southwest Airlines has been successful enough to paint schemes on its aircraft in different themes to honor individuals, objects, or places. The company’s overall net income still indicates its strong and prosperous financial position.
In 2002, Southwest Airlines’ net income was $240.97 million dollars. According to Chief Executive Officer James Parker, the company’s financial results for the fourth quarter and full year of 2002 were disappointing compared to historical standards, but their performance in relation to the industry as a whole was excellent (Southwest Airlines posts, p. 1).
During the 1990s, there was an increasing dissatisfaction with airline ticketing practices, specifically due to restrictions on lower priced tickets and price increases for unrestricted tickets (Transportation Research Board and National Research Council, p. 3).
As corporations were reducing travel expenses, they started conducting business meetings through video or conference calls. This decrease in business travelers had a negative impact on airline profits. However, Southwest Airlines remained unaffected by the discontent and profit decline faced by other airlines, as they had already been providing low-fares and implementing effective policies.
The Southwest Airlines Company has specific rules and restrictions for tickets and refunds. The company offers a fare structure that includes both low, unrestricted coach fares and even lower fares with restrictions. The majority of tickets sold are nonrefundable, leading to forfeited tickets. If a ticket is sold but not used on the travel date, it can be reused for another flight within a year or refunded if it is eligible. Only a small percentage of tickets or partial tickets expire unused. Fully refundable tickets are rarely forfeited (Annual Form 10-K Report, p.3 & 22).
In order to maintain low-cost fares and exceptional quality performance, the Southwest Airlines Company made a renewed commitment in the new millennium. It proudly asserts itself as the only short haul, low-fare, high frequency, point-to-point carrier in America. Other airlines were facing financial problems during this time, which some attribute to deregulation and adverse economic conditions (Wolfe and NewMyer, p. 177).
There are differing opinions on what caused the decline of airline profits. Some believe that the terrorist attacks in September 2001 are to blame. Others point to factors such as the increase in regional jets, low-cost carriers, high taxes, and economic trends, along with rising fuel and labor costs. Although regional jets are more cost-effective to operate, they do not result in significant revenue losses for airlines. The arrival of low-cost carriers has intensified competition in the market and led to decreased profits for other airlines.
The airline industry faces high taxation, which hampers overall profits while rising fuel costs also have a significant impact on airlines. However, Southwest Airlines has managed to minimize costs by engaging in fuel price hedging.
In my opinion, the combination of various factors, such as the absence of economic forecasting, the inability to respond to current economic situations, and faulty financial consultancy, suggestions, and executive choices, has resulted in unpredictable and unstable financial conditions for many airlines. It is important to note that the air carrier industry has never been known for its strong financial performance (Meyer and Oster, p. 18).
The airlines have been facing ongoing difficulties due to the unions’ demand for higher wage rates and the precedent set by United Airlines. About 80% of Southwest Airlines’ workforce is unionized, but the company counters this by offering profit sharing to all employees. This profit sharing arrangement encourages high productivity among employees and secures the company’s future success, as they have a vested interest in its performance. Analysts even state that Southwest is renowned for its worker-friendly policies, with its loyal employees supporting this claim (“Newsweek Web,” p. 1).
On September 11, 2001, the entire aviation industry in the US was incapacitated for three days due to a significant event. This event had a profound impact on both producers and consumers in the industry. All aircraft, except for military ones, were prohibited from flying within the continental US. The consequences of this complete incapacitation resulted in severe economic losses nationwide, affecting all markets.
Following the attacks, the federal government enforced expansionary and discretionary fiscal policies to implement security measures, leading to various additional costs. Regrettably, the burden of these financial increases fell on the airlines. Impacted by reduced revenue and heightened security expenses, the airlines sought assistance from the federal government.
The government set up the Air Transportation Stabilization Board (ATSB) in response to the terrorist attacks. The ATSB allocated $10 billion to the airline industry, with each airline receiving a specific amount based on their overall losses during the grounding. Southwest Airlines received around $283 million from the ATSB. As some airlines were already facing financial problems, the attacks worsened their financial situation even further.
The funds received from the ATSB were insufficient in helping companies recover from the negative impact. The attacks had a severe impact on consumers, causing a majority of them to develop a fear of flying and resulting in airlines facing difficulty in filling their aircrafts to capacity. This is particularly evident in the northeastern corridor of the country.
While searching for transportation alternatives, people have not turned to air travel. After the grounding was lifted, Southwest Airlines resumed full service. The initial load factors were low but have gradually increased. By offering special low fares, the company has been able to generate profits. Although their forward looking statements express optimism, they are aware that their streak of 30 profitable years could end if the industry fails to return to pre-911 levels or if consumer confidence wavers.
In July 2001, Southwest Airlines welcomed a new CEO, who assumed leadership just before the tragic events in New York City. Despite the challenging circumstances within the airline industry, this CEO has successfully guided Southwest through this turbulent period. Notably, they have achieved cost reductions, effectively managed aircraft orders, and avoided employee layoffs—a notable contrast to other airlines’ mass layoffs.
Unfortunately, when a seat goes unsold, all airlines experience the same outcome – it cannot be recovered as revenue and is lost permanently. Currently, the air travel industry is encountering significant decreases in demand. Unless we discover resolutions for the empty seat issue and the financial challenges that currently afflict our industry, even major airlines in our country are at risk of disappearing. This includes Southwest Airlines, which is affected by these factors that undermine overall company strength and stability.
The airline industry is heavily impacted by economic trends in the general economy, regardless of whether there is a recessionary or inflationary gap. It is unclear whether providing financial assistance or implementing regulations again is the solution to the current industry problem. Airlines currently have difficult problems to resolve, and many have no other option but to undergo expensive restructuring, file for bankruptcy, or shut down completely. However, there is one airline, Southwest Airlines, that continues to operate with a profit and is still making a profit, although not as much as before.
