What’s the airline-industry jargon for unconventional wisdom? Southwest Airlines. By some estimates, the country’s major carriers have consumed perhaps $100 billion in capital during the past decade, but Southwest Airlines continues to be profitable. It’s been in the black for 33 consecutive years and, last week, for the 127th consecutive quarter, it paid a modest dividend. Its balance sheet, with about $3 billion in cash on hand and $600 million in available credit, is the envy of an otherwise fuel-price-ravaged industry.
Its competitors among the network carriers—American, United, Delta, Continental, Northwest and US Airways—are shrinking passenger capacity by more than 10 percent and grounding hundreds of aircraft starting in the fall.
Southwest will add a handful of daily flights. It will take delivery of another dozen aircraft next year and still plans to grow by 2 to 3 percent. And Southwest now carries more passengers annually (101 million last year) than any other U. S. carrier, a nifty trick for an airline that didn’t fly outside Texas at the dawn of deregulation in 1978.
Even the fickle financial markets, which have long discounted Southwest’s relentless growth and steady profits, have finally taken note. As oil prices doubled in the past year, share prices of the six network carriers have slid, with the drop-offs ranging from 76 to 94 percent. Southwest’s decline has been more modest, within a point of the Dow’s 21 percent 52-week drop. As a result, Southwest’s market capitalization yesterday (about $9. 7 billion) is now more than the combined $5. 7 billion market cap of its Big Six competitors. What does Southwest know that no one else in airlines does?
It keeps things simple and consistent, which drives costs down, maximizes productive assets, and helps manage customer expectations. One Plane Fits All Unlike the network carriers and their commuter surrogates, which operate all manner of regional jets, turboprops, and narrow-body and wide-body aircraft, Southwest flies just one plane type, the Boeing 737 series. That saves Southwest millions in maintenance costs—spare-parts inventories, mechanic training and other nuts-and-bolts airline issues. It also gives the airline unique flexibility to move its 527 aircraft throughout the route network ithout costly disruptions and reconfigurations. Point-to-Point Flying Network carriers rely on a hub-and-spoke system, which laboriously collects passengers from “spoke” cities, flies them to a central “hub” airport, and then redistributes them to other spokes. Not Southwest. Most of its flying is nonstop between two points. That minimizes the time that planes sit on the ground at crowded, delay-prone hubs and allows the average Southwest aircraft to be in the air for more than an hour longer each day than a similarly sized jet flown by a network carrier.
Southwest’s avoid-the-hubs strategy also pays dividends in on-time operations. According toFlightStats, Southwest’s 78 percent on-time performance in June is eight percentage points higher than the industry average and higher than that of any of its major competitors. Simple In-Flight Service Business travelers haven’t always loved Southwest’s uber-simple service, but it’s looking better and better as competitors cut back. There is just one class of service, a decent coach cabin that is slightly more spacious than those of Southwest’s competitors. There are no assigned seats.
There have never been meals, just beverages and snacks. Keeping it basic allows Southwest to unload a flight, clean and restock the plane, and board another flight full of passengers in as little as 20 minutes compared with as much as 90 minutes on a network airline. Airline efficiency experts say that the savings allow each Southwest jet to fly an extra flight per day. Extra flights mean extra revenue. No Frills, No Fees As other carriers have rushed to remove perks and pile on fees and restrictions, Southwest has kept its customer proposition streamlined and transparent.
The airline only sells one-way fares and only in a few price “buckets. ” That not only keeps costs down—complex fare structures are expensive to manage—it convinces fliers that they are getting value for money. Prices are all-inclusive too. Southwest doesn’t have fuel surcharges, doesn’t charge for standby travel or ticket changes, and continues to permit travelers to check two pieces of luggage free. And since every seat on every flight is virtually identical, travelers know exactly what they will get when they make a purchase. Strong Management.
The public face of Southwest Airlines for a generation, hard-drinking, chain-smoking, always-leave-’em laughing Herb Kelleher, finally stepped away from the carrier earlier this year. Kelleher’s bonhomie masked the discipline that Southwest has had throughout its history. The airline has always avoided fads and eschewed anything that increased costs or complicated the basic travel proposition. When it has changed—last year it ended its infamous cattle-call boarding process to favor its most frequent fliers and highest-fare customers—it has done so without slowing down the movement of aircraft.
Management ranks are lean, but well compensated and, most importantly, productive. I once calculated that the top executives of Southwest generated 10 times more revenue per dollar of compensation than did the C-suite types at some of the network carriers. A Relatively Happy Workforce Network carriers have railed for decades about the power of their employee unions. But guess who’s the most unionized carrier in the nation? Southwest, of course. The airline says that 87 percent of its employees belong to a union.
Southwest has never had a strike, and now that the network carriers have whacked away at salaries and benefits, Southwest staffers are generally the highest paid in the industry. But since Southwest has about 30 percent fewer employees per aircraft than its network competitors, it has the lowest non-fuel C. A. S. M. (cost per available seat mile) of any of the major carriers. Aggressive Fuel Hedging Rampaging fuel prices now represent around 40 percent of an airline’s costs, but, as usual, Southwest Airlines has been ahead of the curve. Since 1999, the airline’s aggressive fuel-hedging program has saved it an estimated $3. billion. In the first quarter, for example, it paid $1. 98 a gallon for fuel, approximately a dollar less than its network competitors. And Southwest’s future position is admirable: It is 70 percent hedged at $51 a barrel through the end of the year and 55 percent hedged at the same price next year. In a world of $140-a-barrel oil, suggesting that any airline is a guaranteed winner is beyond hubris. But this much can be said: Southwest Airlines is sitting on a pile of cash and fuel hedges and has a proven and easily adaptable service model.
And history shows that Southwest has comfortably survived every airline-industry downturn, then grown rapidly and profited hugely when the business cycle turns. The Fine Print… British Airways announced last week that it would buy L’Avion, the French carrier that flies all-business-class jets between Newark and Paris. B. A. says that it will integrate L’Avion with its own boutique carrier, OpenSkies, which launched last month. L’Avion was the last of the four independent all-business-class trans-Atlantic carriers that have launched since 2005. The others—Maxjet, Eos, and Silverjet—all folded in the past seven months.
Ref: http://www. wired. com/cars/futuretransport/news/2008/07/portfolio_0708 Case study: Executive Summary Southwest Airlines is competing with “Shuttle by United” head to head in about 9 routes. United has just announced that it is discontinuing its Oakland – Ontario route and hiking the fares in all the 14 routes by $10, which calculated to be 14. 5% increase in the fare. Southwest has to respond effectively to these unexpected developments and has to act accordingly while maintaining their current low fare image and increasing their daily operating profits.
We have considered the elasticity of the market to be 1. 15. In order to achieve these objectives, Southwest has the following alternatives to choose from in order to respond effectively: ? Maintain the current fare. ?Follow United by increasing the fare by $10. ?Follow United but increase fare by only $5. After analyzing the alternatives, we conclude that it will be appropriate for Southwest to increase its fare by $5 so as to increase its daily operating profits while maintaining the low fare airline image. Problem Definition and Statement of Alternatives
Problem definition: The problem in this case for Southwest Airlines is to workout a strategy to respond to the unexpected developments and changes made by the United Airlines in their services and pricing. United has increased its fare on all 14 “Shuttle by United? routes by $10 and is planning to discontinue its service between Oakland-Ontario effective April. The Decision Objective: The decision objective is to regain the lost market share and to increase the daily operating profits while maintaining the low fare carrier image.
The Success Measure: The success measure is to maximize the daily operating profit and to gain market share. Decision Constraints: The constraints are: ?Maintain the low-fare carrier image. ?Protect the current market share. Alternative actions: There are three alternatives that Southwest Airlines could use to respond against the action taken by United Airlines. The alternatives Southwest could consider are: ? Maintain the current fares. ?Follow United by increasing the fare by 14. 5% i. e. $10. ?Follow United but increase fare by only 7. % i. e. $5. Analysis of Alternatives The Air Transportation Elasticity In order to measure the impact of United’s price increase, we would need the price elasticity of the demand. The main problem is that there is no agreement as to whether, generally speaking, air transportation is or is not relatively price elastic.
There is ample evidence that the introduction of deeply discounted fares by the low cost carriers can be very price elastic, although, each type of traveler has its own price characteristics. For xample, it is widely known that leisure passengers are more price sensitive than business passengers and shorthaul passengers more so than longhaul ones. For the low fare market, where competition is high and consumers seems to be price-sensitive, we define it as relatively price elastic, with elasticity equals 1. 15. The 4th Quarter Estimates without Changes On Appendix A are estimated the fourth quarter operating profits for Southwest and for “Shuttle by United? For Southwest it was analyzed only the 9 markets that competes directly with United.
On the other hand, all 14 markets operated by the “Shuttle by United? were considered for United fourth quarter estimate. It was considered that United’s average fare was $20 higher than Southwest’s average fare on the markets that they don’t compete and 7. 5% higher on the others. The total daily operating profit for Southwest is $41,509 while the “Shuttle by United? has a loss of $266,303 (Appendix A). Alternative 1: Maintain the Same Fair as United Increases $10 The first alternative takes in consideration the $10 increase on United’s fare and assumes that Southwest prices are going to remain the same.
Considering a regular fare of $69, the $10 increase represents a price variation of 15. 5%. The price change is going to contribute negatively to the demand for the “Shuttle by United? decreasing its load factor by 16. 7%. This decrease on demand is going to more than offset the price increase and the total daily operating loss for United is going to increase to $293,097 (Appendix B). As Southwest is going to maintain the same price, it will take advantage of the cross elasticity factor. We assumed that Southwest’s load factor would change by half of the change on United’s load factor.
So, the $10 price increase of United’s fare would provide an 8% increase on Southwest’s load factor. Keeping the same fare and with the load factor increase, the total daily operating profit for Southwest is going to increase to $108,850 (Appendix B). Alternative 2: Follow United’s Move and also Increase Fares by $10 The second alternative is to follow the competitor’s move and also benefit from a price increase of $10. On this situation, both airlines are increasing the fare by the same amount and none is going to benefit from the cross-elasticity.
Both are going to diminish their load factor by 16. 7%. United is still making a loss of $293,097, while Southwest increases the total daily operating profit to $59,606 (Appendix C). Alternative 3: Increase Fare by $5 while United Increases by $10 The last alternative suggests that Southwest increases its fare by as much as half of United’s fare raise. On this case, two effects are overlapped, the benefit of the cross-elasticity with the competitor’s higher price increase and the disadvantage of its own price increase. A $5 price change, or 7. %, would change the load factor by 8. 3% (7. 2% x 1. 15). As in the same case of alternative 1, the cross-elasticity would benefit Southwest with an 8% increase on the load factor. So, as one effect neutralizes the other, we assume that on this situation the load factor for Southwest is not going to change. United is still making a loss of $293,097, while Southwest increases the total daily operating profit to $136,650 (Appendix D). As it can be easily seen, the best alternative is the third one, once it is going to provide the highest total daily operating profit to Southwest.
Increasing the fare by $5 seems to be the best strategy to increase its daily operating profits while maintaining the low fare airline image. Plan Development Price: Southwest’s cost per available seat mile was the lowest among all major U. S. carriers. Its advertising campaign: “When you want a low fare, look to the airline that other airlines look to? distinguished Southwest as the image of a low-fare airline. By maintaining the lower prices, Southwest can preserve its image, increase its load factor, profitability and empower its competitive strategy.
Services: Southwest focus on customer service produces tangible results. Services such as on-time performance, baggage handling and overall customer satisfaction, has rewarded them to be the “triple crown? of the airline industry. The employee attitude towards the customers is one of the keys to the success of Southwest Airlines. Promotion: Southwest has implemented effective marketing strategies which have led them to be the most profitable airlines. Creative marketing has differentiated them from the other airlines since its beginning.
Service, convenience and price represented three pillars of Southwest’s success. Distribution: Southwest differentiated itself from other airlines by choosing a different reservations system. They chose not to rely on travel agents as compared to other airlines. This attracted customers by having direct communication with the airline and also by saving on the commission expenses. Their operations started in smaller cities and they avoided hubs like major airlines thereby minimizing their landing time.
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