1 Strategy & Policy BUS4360-002 Matthew Patterson Chris Hushka Brandon Walden Nick Rodgers 05/24/08 Introduction 2 We are going to be talking about the Southwest Airlines industry. The key areas that we are going to talk about are a brief history of the company, current strategy that company implements, several strategic challenges that Southwest currently faces along with the recommendation that we as a group have discussed and believe would be beneficial for Southwest to implement. We also included a brief SOWT analysis discussing what we believe are the strengths weaknesses opportunities and threats of the industry along with a Porter’s Industry Analysis. History of Southwest Airlines On June 18, 1971, a Boeing 737 took off from Love Field, and thus, Southwest Airlines was born. Southwest Airlines is an American low-cost airline based in Dallas, Texas. It is the largest airline in the United States by number of passengers carried domestically per year and (as of December 31, 2007) also the largest airline in the world by number of passengers carried. Today, Southwest Airlines flies almost 100 million passengers a year to 63 great cities all across the country, and they do it more than 3,300 times a day. (Southwest, 2008) So how did Southwest Airlines become what they are today? Southwest Airlines was originally incorporated to serve three cities in Texas as Air Southwest in 1967. In early 1971, Air Southwest changed its name to Southwest Airlines. Its first flights were from Love Field in Dallas to Houston and San Antonio. These short hops with no- frills service and a simple fare structure were the features that formed the basis for Southwest's popularity and rapid growth in the coming years. They started off with three Boeing 737’s, and eventually added a fourth later in their first year. Southwest only flies Boeing 737’s for a reason. The main reason is to hold down operating costs. The Boeing 737 is a short to medium range, single aisle, and narrow body jet airliner. 3 Since there is only one kind of plane, every mechanic can work on every plane, without needing any additional training. At the same time, every Southwest Airlines pilot can also fly any Southwest Airlines plane. By simplifying training, maintenance, and ground operations, Southwest revolutionized the industry’s approach to building aircraft fleets. (Southwest, 2008) Southwest turned its first annual profit in 1973, and has done so every year since. They have a simple notion. “If you get your passengers to their destinations when they want to get there, on time, at the lowest possible fares, and make darn sure they have a good time doing it, people will fly your airline.” (Rollin King and Herb Kelleher, founders of Southwest Airlines) And they were right. Southwest has been profitable every since, and has made their way to the top in the low-cost airline industry. Customers come first at Southwest Airlines. In 1980, Southwest was ranked number one in customer satisfaction. It maintained that title for six consecutive years, (the longest record in aviation history at the time.) In 1989, Southwest reached the one billion dollar in revenues mark, officially making it a “Major” airline. Even in 2001, after the September 11 attacks, Southwest Airlines remained profitable, maintaining full employment as the airline celebrated its 30th birthday. At the end of that year, Southwest Airlines had 29,274 employees and 344 aircraft. In the next few years Southwest Airlines incorporated many other useful ways to bring more business to their company. In 2004, Southwest Airlines enjoyed its 31st consecutive year of profitability by offering online boarding passes through its website, southwest.com. Southwest was the first ever airline to have its own website, and contributes a substantial amount of its success and profit to having that website. 4 In 2006 Southwest Airlines celebrated its 35 anniversary, launching its first ever corporate blog, “Nut’s about Southwest.” (Southwest, 2008) And it also had some good news the same year, as the Wright Amendment Reform Act became a law. This law permits Southwest Airlines to sell through tickets and to operate direct, one-stop (same plane) and connecting service between all parts of the country and Love Field. Airline Industry Information Southwest Airlines is interesting in regards to their strategy in their industry. It’s hard to compare them to other domestic, discount airlines in the United States. They primarily focus on offering discounted, domestic, short-haul routes with high frequencies in the United States. They fly to 64 cities in 32 states. According to Wikipedia.com (2007), the average Southwest trip is 629 miles, and the average trip takes around 1 hour and 45 minutes. They are currently tied with Northwest for the fourth-largest fleet of aircraft among all the world’s commercial airlines. According to finance.yahoo.com (2008), they are the largest airline in the United States by number of passengers carried domestically per year as well as the largest airline in the world by number of passengers carried. They fly 520 Boeing 737’s, serve 411 non-stop city pairs, and approximately 78% of the company’s customers fly non-stop. They also sell credits to business partners including credit card companies, hotels, telecommunication companies, and car rental agencies to raise profits. They are by far the biggest company in their specific industry. It’s easier to compare them to other major airlines in a financial sense. Some major airlines that are comparable financially include Northwest Airlines and Continental Airlines. These airlines focus on travel internationally unlike Southwest. As mentioned above, Southwest is hard to compare to other airlines in their industry of discount, domestic flights because of their size and financial condition. According to 5 independenttraveler.com (2007), other discount, domestic airlines include AirTran Airways, Frontier Airlines, Gulfstream International Air, JetBlue Airways, SkyBus Airlines, Sun Country Airlines, Spirit Airlines, TED Airlines, and Virgin America. Even while focusing on discounted, domestic flights, Southwest is one of the most profitable airlines in the world, which is why it makes more sense to compare Southwest to larger, major airlines. According to CNNMoney.com (2007), Southwest is the fifth most admired company in America. According to hoovers.com (2008), Southwest ranked #276 in the FORTUNE 500 for 2007. In comparison, Northwest ranked #213 and Continental ranked #186 in the FORTUNE 500. Hoovers.com also listed the number of employees for these companies. Southwest employs 34,378, Northwest employs 34,000 and Continental has 45,610 employees. Financially, Southwest compares very well to other major airlines. According to Wikipedia.com (2007), Southwest is the sixth largest airline in the United States in terms of revenue, and they posted a profit for an astonishing 35th consecutive year in January of 2008. According to finance.yahoo.com, the market cap for Southwest is $9.2 billion. In comparison Northwest has a market cap of $2.14 billion and Continental has a market cap of $2.03 billion. The sales of Southwest are also comparable to Northwest and Continental. Looking at a three year comparison from 2005 to 2007, Southwest had sales of $7.5 billion in 2005, $9.1 billion in 2006, and $9.8 billion in 2007. Northwest had revenues of $12.3 billion in 2005, $12.6 billion in 2006, and $12.5 billion in 2007. For Continental had revenues of $11.2 billion in 2005, $13.2 billion in 2006, and $14.2 billion in 2007. As for net income comparisons, Southwest had a net income of $548 million in 2005, $499 million in 2006, and $645 million in 2007. Northwest had a net loss of $2.5 billion in 2005, $2.8 billion in 2006, and a net income of $2.1 billion in 2007. Finally, Continental had a net loss of $68 million in 2005, a net income of $343 million in 2006, 6 and $459 million in 2007. Over the last year, Southwest has had a more stable stock price than Northwest and Continental. Southwest has also done well since 1980 when compared to the S&P 500. Southwest performed very evenly with the S&P 500 up until 1990. Since then Southwest has performed better than the S&P 500. Southwest has been a consistent force financially in the airline industry. Southwest’s Successful Strategies Know that you know a little about the history of Southwest and how its industry has developed over the years, it is important to know how it has sustained its success over the years. Southwest’s strategy is very unique because it profits off of low costs and great customer service. Southwest cuts costs by focusing on shorter-hauls, point-to-point routes, no-frills service, and by working out less-crowded airports. Southwest flies only domestic flights which keep the average flight times low along with the costs. Also, Southwest is a point-to-point transportation in which it works really hard to reduce connections in order to create non-stop flights. Southwest has major hubs throughout the nation that fly to hundreds of cities within the mainland. In order to keep costs even lower, Southwest offers a no-frills service. This means you won’t be getting any on flight meals, or special treatments like first class. By serving only peanuts, drinks, and other snacks, Southwest keeps their costs down tremendously. Customers are usually satisfied with this service because on-flight meals served by other airlines are appeared to be tasteless. Southwest selects less- crowded airports for its operations. In doing this, it minimizes turnaround times and keeps its planes in the air longer than competitors. Also between flights, Southwest planes only spend 20 to 25 minutes on the ground, compared with about 45 minutes for the other major hub-and-spoke carriers. (Pender, 2001) 7 Another technique used to speed up operations and lower costs is the use of online website. Southwest is the first airline to have an online website. This website allows customers to download the “Ding” service. The company introduced “Ding” service in February 2005. “Ding” brings even deeper discounts directly to the customers desktop. This service allows customers to choose up to ten airports of their choice and get live updates from their cities. In its first two years, the Ding application was downloaded by 2 million consumers and generated more than $150 million in ticket sales. The Southwest website also allows customers to check-in 24 hours before their scheduled flight by using the internet. Southwest only uses one type of aircraft, the Boeing 737, which heavily reduces training and maintenance costs. Southwest has been able to successfully implement a fuel-hedging program. It has used contracts to lock in future fuel prices which has saved the company hundreds of million of dollars per year since its agreement. This program is quite a big deal, and has help bring Southwest to the top of the industry. To see how big of an impact it plays, a quick past example will be used. The step down in hedging in 2005, when it paid $26 a barrel for 83% of its fuel, and in 2006 where is paid $36 a barrel for 73% of its fuel, adds more than $600 million to costs. (Reed, 2006) This increase is ridiculous and painful to Southwest’s profitability. The airline reported in this year’s first quarter report that it spent $753 million on fuel which is a 33.5% increase from a year ago. Southwest is very employee-oriented. They have an open-door policy. As a result, no outside consultants are needed to tell them what they’re doing wrong; the employees will tell them to their face. Also, they have strength within their employees. They hire based on personality and train accordingly. Southwest encourages employee development and movement within the company. Building strong leaders who care about the employees is the foundation of 8 their employee-retention strategy. (Bryant, 2007) After the attacks of 9/11, Southwest employees began asking how they could save the company money and avoid the layoffs that all other airlines were seeing. To avoid those troubles, some employees donated their tax-rebate checks while others joined a voluntary program. With this program, employees worked without pay for as many as 32 hours in the following eight weeks after 9/11. (Pender, 2001) Strategic Challenges Southwest Airlines is facing many strategic challenges currently and many more in the near future. These strategic challenges may affect the success and profitability that this company has been striving on for many years. Profitability could be hurt in near future due to the lack of international flights, expiring fuel-hedging program, unsatisfied customer seating, recent unfortunate customer relations, and the advancement of competition through innovation. (Reed, 2006) Southwest Airlines may have to expand internationally in the future in order to remain number one. The benefits of this option would be the pursuit of new markets which ultimately should bring higher revenues. Because Southwest is so great at lower costs, they might be able to offer lower prices for international flights better than their competitors. This lowered price in international flights may ultimately segment new markets like businesspeople and family overseas. The decision would come at a cost and an expensive one! The airline says it doesn't yet have the technological capacity in its reservations and operations systems to handle flights that go outside the U.S. (Maxon, 2007) Also, there will be an increase in costs due to fuel prices and international taxes. Also, Southwest’s international venture might fail because of lack of recognition in foreign countries. Ultimately, more training would be needed to cope with the bigger planes, more diverse clientele, and new operations. 9 Southwest’s success in the past years is heavily influenced by its successful hedging program. But, guess what, it expires in less than two years. So, what do they do? Entering into a new hedging contract has become an option. The benefits for this are that they will know the oil prices they will be paying in the future. Oil prices are rising by the hour at an unforeseen rate. Southwest can cope with these increases by hedging its oil prices. But, they are also potentially taking on risk that the prices will not decrease in the future. What happens if they do? Then, their hedging program would be pointless and costly. Southwest also has been burned recently by loyal customers about the lack of assigned seating. This has been the number one complaint by customers since it began flying in 1971. The airline could assign all seats. It could let passengers pay extra to get priority seating—the right to get on before any passengers who didn't pay for assigned seating. The priority seating could be for an assigned seat or the first choice in open seating. This would increase customer comfort and also increase revenue. Also, by implementing the priority seating, they may appeal to new customers like businesspeople. But, this also may hurt sales because people would have to pay for the option to have an open seat not relying on the first-come, first-served system. It would also lose the Southwest “touch” and be like every other airline. Finally, Southwest will have to be more innovative in the future in order to keep up with the competitors. Southwest must decide if it wants to respond to onboard TV and music offered by JetBlue, Virgin America and others. These carriers had the advantage of ordering new fleets with TVs from the beginning; Southwest has to consider a solution that works with its 500 existing airplanes. But, there is potential because Southwest is readying a test of wireless Internet on some planes. (Maxon, 2007) If this service works, then it’s possible that the onboard TV could be successful and not far behind. Problems with this choice are the increase in costs to 10 install them and to keep them maintained. Also, additional training would need to be implemented in order to operate these devices on board. Recommendations The recommendations the group made for Southwest based on their current strategic challenges goes as follows: • Expand internationally by starting with flights to Mexico and the Caribbean region. • Forget the Fuel Hedging program because negotiations will be impossible. • Stick with original seating situation that has “Southwest Touch.” • Place TV’s, power outlets, and wireless network on flights. Innovation always wins. 11 Works Cited Bryant, Elizabeth. "Leadership, Southwest Style." T & D 61 (2007): 36-39. CNN Money. 3 Mar. 2008 <http://money.cnn.com>. "Domestic Airlines." Independentraveler. 2007. 15 Apr. 2008 <www.independenttraveler.com>. Maxon, Terry. "Southwest Airlines Plotting New Strategic Course." Dallas News. 7 Aug. 2007. 12 Apr. 2008 <http://www.dallasnews.com/sharedcontent/dws/bus/stories/080207 dnbussouthwest.d3f1979c.html>. McCaffery, Richard. "Southwest Airlines' Competitive Edge." 20 Sept. 2000. 3 Mar. 2008 <http://www.fool.com/news/foth/2000/foth000928.htm>. "Oil and Hedge Funds." A Networked World. 9 Aug. 2005. 3 Mar. 2008 <http://www.kn.com.au/networks/2005/08/oil_and_hedge_f.html>. Pender, Kathleen. "Southwest Sets Standard for Success in Depressed Airline Industry." SFGate. 4 Oct. 2001. San Francisco Chronicle. 2 Mar. 2008 <http://www.sfgate.com/cgi- bin/article.cgi?file=/c/a/2001/10/04BU196238.DTL> Reed, Dan. "At 35, Southwest's Strategy Gets More Complicated." USA Today. 11 July 2006. 3 Mar. 2008 <http://www.usatoday.com/money/biztravel/2006-07-11-southwest- usat_x.htm>. "Southwest Airlines." Wikipedia. 21 Apr. 2008 <http://en.wikipedia.org/wiki/Southwest_Airlines>. 12 "Southwest Airlines Co." 23 Apr. 2008. Business Week. 10 Apr. 2008 <http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?capid=31726 >. "Southwest Airlines Co. (LUV)." Yahoo. 15 Apr. 2008. 15 Apr. 2008 <http://finance.yahoo.com/q?s=luv>. "Southwest Airlines Co." Hoovers. 2008. 15 Apr. 2008 <http://www.hoovers.com/southwest- airlines/--ID__11377--/free-co-factsheet.xhtml>. Southwest Airlines Homepage. 3 Mar. 2008 <www.southwest.com>. Taylor, Sandy. "To Provide the Best Customer Service, Put Customers Second." 18 Apr. 2005. 3 Mar. 2008 <http://www.mccombs.utexas.edu/news/pressreleases/barrett_wrap.asp>. "We Weren't Just Airborne Yesterday." Southwest.Com. 20 Apr. 2008 <http://www.southwest.com/about_swa/airborne.html>. Yahoo Finance. 3 Mar. 2008 <http://finance.yahoo.com/>. 13 Supplemental Reading (Appendix) 14 SWOT Analysis After performing a detailed SWOT analysis on Southwest Airlines industry we came up with several important key topics in each area. Southwest has a great employee and management relationship. The employees are all treated like customers. Southwest operates under an open-door policy, as a result, no outside consultants are needed to tell them what they’re doing wrong, and the employees will tell them to their face. The relationship between the employees and the management at Southwest is a great internal strength for the company. A further strength in the Southwest business is the overall operation of the airline; they offer a cheap air-fare ticket to customers who want to travel with in the domestic United States. This is a great competitive advantage for Southwest as there is not another company who can offer such low prices. Due to the low prices and overall great employee/management relationships it has built great customer satisfaction. Employees are happy, productive and are getting the work done both economically and efficiently. This in turn is shown through the overall customer satisfaction the airline. Southwest has also seen a great strength in the profits that it has been receiving. It has seen 60 consecutive quarterly profits. This is a great strength in this industry as it has recently been going through a tough time since the 9/11 attacks. Southwest only operates Boeing 737 planes; this is a great strength as it reduces operating costs significantly. With the operation of only one model of plane, the cost for training, fuel, maintenance and storage are all reduced providing Southwest with more money to finance other things. Southwest Airlines is a very successful business and it was a lot harder to locate any weaknesses in the industry than it was to find strengths. What we came up with was even though 15 offering domestic flights could be seen as a positive, it could also be seen a negative and weakness to the business. Not offering an international schedule could be seen as a loss in a potential market. Furthermore, Southwest only offers flights from less popular airports such as Chicago Midway. This is definitely a weakness in the business as the less popular airports tend to be further away from the higher demand for flights. Southwest has plenty of opportunity for growth and further success in the industry. Offering an international flight schedule would be a great opportunity for southwest to gain a greater market share. By offering the international flight schedule they will have to offer flights from more popular airports such as Chicago O’Hare. With the increase in technology, southwest has a great opportunity to offer some sort of in flight entertainment. By offering this, it might increase interest and demand in Southwest. There are a few threats that Southwest is currently facing, and will be facing in the future. The competition that southwest faces is gradually increasing. With new airlines constantly entering the market and wanting to compete with low prices. The increase in fuel prices is a great threat to Southwest, as their fuel hedging contract is coming to an end in 2009; they will have to face the fuel prices like the other airlines are doing right now. This may cause them to increase their ticket prices because they will not be able to offer such low prices and pay top dollar for fuel. 16 Porters Approach to Industry Analysis Southwest Airlines has several substitutes that could be used instead of flying with Southwest. We came up with substitutes such as their current competitors like Jet Blue, United and Continental. These airlines also offer cheap air fare, however not quite as cheap as southwest. A further substitute for a southwest airline flight could be other forms of transportation such as train or car that could be used instead of a flight for the short distance travelers that do not want to get caught up with the hassle of airport security. Business travelers for example may want take to the roads instead of a flight if they are only traveling a short distance. The demand for flights in the Southwest industry is elastic. People will always try to find the cheapest flight as there are there are not many people that will only choose southwest they; they will purchase the cheapest flight they can find. Therefore there does not seem to be much bargaining power for the buyers in this business. The bargaining power for the suppliers is different however, Southwest has a service that is relatively unique and therefore can offer prices that other airlines cannot offer. There are substitutes that are available to consumers, however there is not all that many options so Southwest can offer a low fare and the competitors will have to beat it in order for a consumer to utilize a substitute and with fuel hedging contract that Southwest is currently on it is very hard for a airline company to offer a lower price than Southwest. This creates a good bargaining power for the suppliers in the Southwest business. There exists a rivalry amongst the rival firms such as Jet Blue, Continental, Delta and United. Southwest offers prices that the other firms cannot compete against by eliminating 17 several amenities from their airline and having a bare minimum on board. This creates a differentiation and makes southwest able to charge a lower price than many of the competitors. Some of the companies have tried to offer fewer amenities however have failed to succeed and watched their sales drop significantly. Southwest airlines operates on a reduced amenity airline, therefore the fixed costs are reduced. However, because the airline must fly their planes on a schedule, regardless of the number of people flying on any one flight, they offer cheaper standby fares whenever a plane has empty seats. The threat of new entrants into the discount air fare industry is apparent as we recently saw in the news that a new entrant was very unsuccessful and ended up going bankrupt. Southwest Airlines Economies of scale create a cost advantage over any new rival in the industry by offering little amenities and the use of the fuel hedging program. Southwest has product/service differentiation makes it possible to offer prices and services that other airlines cannot. In the airline industry the relevant power of the stake holders is apparent in the fact that there are so many government regulations and security issues currently since the attacks of 9/11.