Read Case 10 Airlines

Read Case 10: Southwest Airlines.  Answer questions 1-4 in a three to five page APA style paper, and supported with the concepts outlined in your text and from your previous classes.

1. Describe the current state of the airline industry and analyze what an airline can do to be successful in the current industry climate.

2. Perform a SWOT analysis for Southwest Airlines.

3. Assess the competitive position of Southwest Airlines by completing a competitor profile for Southwest airlines and at least two of its major competitors.

4. What alternatives does Southwest Airlines face to address the problem of declining financial performance?

Southwest Airlines 2008

1 In 2008, Southwest Airlines (Southwest), the once scrappy underdog in the U.S. airline industry, carried more domestic passengers than any other U.S. airline. The company, unlike all of its major competitors, had been consistently profitable for decades and had weathered recessions, energy crises, and the September 11 terrorist attacks. In the first quarter of 2008, the company was profitable and experienced record first quarter revenue and a record pas- senger load factor (percentage of available seats sold). However, the earnings release made it clear that the “threat of volatile and unprecedented jet fuel prices” was a major issue that threatened future growth. Operating expenses were rising, and Southwest announced that it would cut 2009 growth in available seats to less than 3%. Over the previous decade, growth had been about 5–10% a year. This cut in planned growth was consistent with previous responses to difficult environments. An insight into Southwest’s operating philosophy can be found in the company’s 2001 Annual Report:

Southwest was well poised, financially, to withstand the potentially devastating hammer blow of September 11. Why? Because for several decades our leadership philosophy has been: We manage in good times so that our Company and our People can be job secure and prosper through bad times. . . . Once again, after September 11, our philosophy of managing in good times so as to do well in bad times proved a marvelous prophylactic for our Employees and our Shareholders.

THE U.S. AIRLINE INDUSTRY

The U.S. commercial airline industry was permanently altered in October 1978 when Presi- dent Carter signed the Airline Deregulation Act. Before deregulation, the Civil Aeronautics Board regulated airline route entry and exit, passenger fares, mergers and acquisitions, aattract and retain the world’s top talent have combined to create a combination of path-dependent resources that are very difficult for even the wealthiest software and Internet companies worldwide to easily emulate, acquire, or accelerate. It will take years for any competitor to develop the expertise, infrastructure, reputation, and capabilities to compete effectively with Google. Coca-Cola’s brand name, Gerber Baby Food’s reputation for quality, and Steinway’s exper- tise in piano manufacture would take competitors many years and millions of dollars to match. Consumers’ many years of experience drinking Coke or using Gerber or playing a Steinway would also need to be matched.

• Causal ambiguity is a third way resources can be very difficult to imitate. This refers to situations in which it is difficult for competitors to understand exactly how a firm has created the advantage it enjoys. Competitors can’t figure out exactly what the uniquely valuable resource is or how resources are combined to create the competitive advantage. Causally ambiguous resources are often organizational capabilities that arise from subtle combinations of tangible and intangible assets and culture, processes, and organizational attributes the firm possesses. Southwest Airlines has regularly faced competition from major and regional airlines, with some like United and Continental eschewing their tra- ditional approach and attempting to compete by using their own version of the Southwest approach—same planes, routes, gate procedures, number of attendants, and so on. They have yet to succeed. The most difficult thing to replicate is Southwest’s “personality,” or culture of fun, family, and frugal yet focused services and attitude. Just how that works is hard for United and Continental to figure

screen. Collectively, the industry made enough money during this period to buy two Boeing 747s.1 The three major carriers that survived intact—Delta, United, and American—ended up with 80% of all domestic U.S. air traffic and 67% of trans-Atlantic business.2

Competition and lower fares led to greatly expanded demand for airline travel. Control- ling for inflation, the average price to fly one domestic mile dropped by more than 50% since deregulation. By the mid-1990s, the airlines were having trouble meeting this demand. Travel increased from 200 million travelers in 1974 to 700 million in 2007, with increases in runway and airport capacity lagging far behind. Exhibits 1A–E provide industry financial and operating data.

Despite the financial problems experienced by many airlines started after deregulation, new firms continued to enter the market. Between 1994 and 2004, 66 new airlines were certified by the FAA. By 2007, 43 had shut down. Most of the new airlines competed with limited route structures and lower fares than the major airlines. The new airlines created a second tier of service providers that saved consumers billions of dollars annually, and provided service in markets abandoned or ignored by major carriers.

Although deregulation fostered competition and the growth of new airlines, it also cre- ated a regional disparity in ticket prices and adversely affected service to small and remote communities. Airline workers generally suffered, with inflation-adjusted average employee wages falling from $42,928 in 1978 to much lower levels over the subsequent decades. About 20,000 airline industry employees were laid off in the early 1980s, while productiv- ity of the remaining employees rose 43% during the same period. In a variety of cases, bankruptcy filings were used to diminish the role of unions and reduce unionized wages. In the most recent round of bankruptcies, airline workers at United, Delta, and other major airlines were forced to accept pay cuts of up to 35%.

Industry Economics

About 80% of airline operating costs were fixed or semi-variable. The only true variable costs were travel agency commissions, food costs, and ticketing fees. The operating costs of an airline flight depended primarily on the distance traveled, not the number of passen- gers on board. For example, the crew and ground staff sizes were determined by the type of aircraft, not the passenger load. Therefore, once an airline established its route structure, most of its operating costs were fixed.

Because of this high fixed-cost structure, the airlines developed sophisticated software tools to maximize capacity utilization, known as load factor. Load factor was calculated by dividing RPM (revenue passenger miles—the number of passengers carried multiplied by the distance flown) by ASM (available seat miles—the number of seats available for sale multiplied by the distance flown).

On each flight by one of the major airlines (excluding Southwest and a few other carri- ers), there were typically a dozen categories of fares. The airlines analyzed historical travel patterns on individual routes to determine how many seats to sell at each fare level. All of the major airlines used this type of analysis and flexible pricing practice, known as a “yield management” system. These systems enabled the airlines to manage their seat inventories and the prices paid for those seats. The objective was to sell more seats on each flight at higher yields (total passenger yield was passenger revenue from scheduled operations divided by scheduled RPMs). The higher the ticket price, the better the yield

screen. Collectively, the industry made enough money during this period to buy two Boeing 747s.1 The three major carriers that survived intact—Delta, United, and American—ended up with 80% of all domestic U.S. air traffic and 67% of trans-Atlantic business.2

Competition and lower fares led to greatly expanded demand for airline travel. Control- ling for inflation, the average price to fly one domestic mile dropped by more than 50% since deregulation. By the mid-1990s, the airlines were having trouble meeting this demand. Travel increased from 200 million travelers in 1974 to 700 million in 2007, with increases in runway and airport capacity lagging far behind. Exhibits 1A–E provide industry financial and operating data.

Despite the financial problems experienced by many airlines started after deregulation, new firms continued to enter the market. Between 1994 and 2004, 66 new airlines were certified by the FAA. By 2007, 43 had shut down. Most of the new airlines competed with limited route structures and lower fares than the major airlines. The new airlines created a second tier of service providers that saved consumers billions of dollars annually, and provided service in markets abandoned or ignored by major carriers.

Although deregulation fostered competition and the growth of new airlines, it also cre- ated a regional disparity in ticket prices and adversely affected service to small and remote communities. Airline workers generally suffered, with inflation-adjusted average employee wages falling from $42,928 in 1978 to much lower levels over the subsequent decades. About 20,000 airline industry employees were laid off in the early 1980s, while productiv- ity of the remaining employees rose 43% during the same period. In a variety of cases, bankruptcy filings were used to diminish the role of unions and reduce unionized wages. In the most recent round of bankruptcies, airline workers at United, Delta, and other major airlines were forced to accept pay cuts of up to 35%.

Industry Economics

About 80% of airline operating costs were fixed or semi-variable. The only true variable costs were travel agency commissions, food costs, and ticketing fees. The operating costs of an airline flight depended primarily on the distance traveled, not the number of passen- gers on board. For example, the crew and ground staff sizes were determined by the type of aircraft, not the passenger load. Therefore, once an airline established its route structure, most of its operating costs were fixed.

Because of this high fixed-cost structure, the airlines developed sophisticated software tools to maximize capacity utilization, known as load factor. Load factor was calculated by dividing RPM (revenue passenger miles—the number of passengers carried multiplied by the distance flown) by ASM (available seat miles—the number of seats available for sale multiplied by the distance flown).

On each flight by one of the major airlines (excluding Southwest and a few other carri- ers), there were typically a dozen categories of fares. The airlines analyzed historical travel patterns on individual routes to determine how many seats to sell at each fare level. All of the major airlines used this type of analysis and flexible pricing practice, known as a “yield management” system. These systems enabled the airlines to manage their seat inventories and the prices paid for those seats. The objective was to sell more seats on each flight at higher yields (total passenger yield was passenger revenue from scheduled operations divided by scheduled RPMs). The higher the ticket price, the better the yield