Phuong Nguyen
Business Strategy – BAD 4013 – SUMMER 1999
Case Study
Southwest AirlinesI. Strategic Profile and Case Analysis Purpose
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. Twenty-seven years ago, Rolling King, owner of floundering commuter airline, and Herb Kelleher, King’s lawyer, got together and decided to start a different kind of airline that would provide a short-haul, low-fair, high-frequency, point-to-point service in the United States. The company began service on June 18, 1971 with flights between Dallas, Houston, and San Antonio (“The Golden Triangle” as Herb called it). Southwest Airlines is the fourth largest customer airline carrier in the United States. They use all Boeing 737 jets in order to save money on training and maintenance. The average age of company’s fleet is only 8.4 years. The average trip length is 451 miles with an average duration of about one hour and 23 minutes. Southwest Airlines averages more than 2,400 flights per day, almost twice the industry average. The average one-way airfare is $75. Southwest Airlines flies to 54 cities in 28 states. Southwest Airlines is recognized as the industry leader in focused low-cost airfare by introducing new strategic competencies such as ticketless travel and selling seats through Internet sites. Southwest Airlines is also known as “Southwest Spirit” which represents their unique organizational culture. The case questions whether Southwest Airlines should expand their operations to Northeast. Actually, they already began new services to Manchester in New Hampshire on June 7, 1998 and to Islip in New York on March 14, 1999. So, our critical question for Southwest Airlines is whether they should expand their operations overseas, especially to Europe since it is the second largest emerging market for the airline industry next to the United States, or whether it should remain focused on the domestic market.
II. Situation Analysis
A. General Environmental Analysis
1. Technology
Technology is expected to have s tremendous impact on the future of the airline industry in the future. In the future, business travels will not loose time when flying. Airlines will be able to offer satellite based telephone systems capable of handling calls to and from anywhere in the world, in-flight faxes, computer, and date transmission services. Technology in the design, development, and operation of the airplane itself will allow the plane to virtually fly itself. Hands-off piloting, navigation, and landing of aircraft have become routine. Computer technology will continue to refine the cockpit.
2. Demographic Trends
Although the percentage of change in predicted population from 1997 to 2005 is only 6.9%, the make up of the United States will change dramatically. The fastest growing age group will be 55 to 59 year olds, projected to increase by 43% between 1997 and 2005. The fifty something population is considered the biggest spenders. Growth is expected from 40 to 64 year olds with a decrease in population in the 25 to 39 year olds. What does this mean to the industry? Frequent flyer is defined as between 45 to 54, married, own their home, income level from $50,000 to $100,000 (median income = $65,143), two income earners in home, no children, and use credit card and bank cards for travel/entertainment. They travel for business but do travel on vacations. They travel in the United States but also to foreign countries. The West will be the fastest growing area in the United States between 1997 and 2005 at 17%. The Middle Atlantic area, which includes Pennsylvania, New Jersey, and New York, will be the slowest growing area in the United States. The Northeast is expected to grow 2%, the Midwest by 4%, the South by 9%, and the Pacific states by 9%. The West will surpass the Midwest in population by 2005. The South and the West will be home to 59% of the Americans in 2005.3. Economic Trends
Disposable personal income in the United States has been on the increase. Personal consumption expenditure also increased in 1998 compared to 1997. Because the aging population will decrease the labor force growth, this will reduce the economy’s potential to produce. This will increase the cost of labor for the airline industry. Households in the Northeast and West spent more than the Midwest and South in 1995. Because regional spending patterns are partly determined by climate, spending by region is not likely to change in the years ahead.4. Political/Legal Environment
With the deregulation of the airline industry came the advent of hypercompetition and also a decrease in wages for airline industry employees. Censuses show a 10% decline in the relative earning of airline workers after deregulation. Excess government intervention will be the only thing that will inhibit the rapid growth effects of deregulation both domestically and internationally.5. Global Environment
Growth in international travel will be determined on the successful application of Open Ski legislation and other agreements with foreign governments and carriers. On June 16, 1999, the United States and the United Kingdom were on the verge of a break through in their negotiations on an open-skies agreement between the two countries. This would create an open and competitive environment in one of the world’s largest international aviation market. The European Community has been working on its own version of Open Skies deregulation. European regulation is a national matter but you also have the overlay of European wide regulation over national regulation. Right now the focus is on cooperation and regulatory environments but there is a healthy trend toward deregulation in Europe. The airline industry in the Asia-Pacific region is expected to double in the next 15 years. There will be a continuous strong growth in the worldwide demand for air travel and passenger travel in the next millennium. Many of the firms in the industry have seen a healthier increase in the international market compared to the domestic market in the airline industry for the first quarter of 1999.B. Industry Analysis
1. Threats of New Entrants
With high barriers to entry, there is littler threat of new entrants. Capital required to enter this industry is a strong barrier. Also, there has been a trend fore fewer, but larger carriers in the industry
? More low-cost, high volume airlines
? More international airlines2. Threats of Substitute Products
The only firm that has come up with a close substitute product to challenge Southwest is Continental. Continental came up with the “Lite” only to have it grounded in 1995. Continental extended their Express after grounding Continental Lite. Many firms have regional airlines that offer frequent flyer miles for incentives to fly but they would not be considered substitutes for Southwest Airlines.
? Train
? Automobiles
? Buses
? Telecommunications and video conferencing are eliminating much of the need for business travel
? High speed and maglev train
? Smart road (future concept, higher automobile volume and speed, less need for flying short distances)
? Other leisure activities other than traveling3. Rivalry among Competing Firms
There is stiff competition between the major firms in the industry. Three major airlines hold 50% of the market share in the industry. The trend has been toward greater consolidation with fewer, but larger, carriers. This industry has high entry and exit barriers. Firms also are dealing with high fixed costs because there is little variable cost in the airline industry.
? Alaska, American America West, Continental, Delta, Northwest, Southwest, Trans World, United, US Airways, Aeroflot, Lufthanza, British Air
? Many other airlines in different countries4. Bargaining Power of Suppliers
Fuel prices have been on the decrease for the past few years which has helped the airline industry decrease their operating expenses.
? Airline suppliers such as Boeing and McDonal Douglas
? Employee suppliers, pilots and other fuel suppliers
? OPEC and oil price volatility
? Airports and limited number of gates and limited space for increasing number of airlines.5. Bargaining Power of Buyers
Change in traveling interests due to Baby Boomers maturing and wanting to use airlines for vacation purposes, not business purposes
? Individuals, personal
? Businesses and business travelers
? Family vacation travelers
? Travel agencies with bulk buying, package deals, and chartered flightsC. Competitive Environmental Analysis
British Airways is the largest airline in the world. Europe is the location of Virgin Express, who is going to strategically position itself as Europe’s premier no-frills, low-cost airline. British Airways will be one of their strongest competitors. Southwest’s strategy is basically the type of strategy that Virgin Express will develop in attempting to gain a little market share from British Airways.
British Airways is dominating in the net profit arena. Southwest is running the lowest out of these airlines. However, Southwest is the smallest of the airlines and is looking primarily for the lower end of the consumer scale, but for a higher volume per plane.
It is interesting that Southwest, the airline with the lowest load factor, has the highest net profit margin. This result is due to Southwest’s strategy to continually eliminate and reduce cost as much as possible. Even without a load factor as high as other airline, which it might want to include in its strategic planning in the future, it is able to pull out a high net profit margin.
Major recent occurrences and activities in the airline industry which affect competitiveness are:
1. E-Ticketing
The use of electronic ticketing has greatly reduced the costs of printing and distributing tickets to customers and is providing a good cost savings for companies who are already using the concept. For the companies who aren’t, if they do not at least have plans to develop similar system in the near future, they will be at a cost disadvantage to their rivals.2. Non-Assigned Seating
Another interesting offshoot from reducing ticketing costs is Southwest’s strategy on non-assigned seating. They operate on first come first served basis, therefore, reducing processing costs of computer systems determining which customers has which seats. This process also allows them to have faster turn-around times at the airport gates.3. Code Sharing
This concept allows different airlines to book their passengers or to buy seats on other airlines and share the flight as if it were one of its own. This is very helpful for low-volume routes that previously needed several small planes for the various airlines to accommodate their passengers. Now all of the passengers may be loaded onto one plane and its code shared by the various airlines offering that particular flight service. Companies who do not utilize this option several limit its distribution and asset potential by forcing it to offer its own flights in certain low-volume market.4. Decreasing Commissions
The major and most airlines are slowly but progressively reducing the amount of commissions that are offered to the travel agents. This is great for the airlines because it lowers their costs. However, the travel agent industry is in a state of sever turmoil with many companies forced to close and many others desperately trying to alter their strategies to find a niche where they might be able to survive now and in the future. An airline that keeps the higher travel agent commissions might win over many of the travel agents and increase their bookings in this way, but that strategy will most likely to be short term. The greater cost may not be worth swimming up stream against the industry.5. Internet Ticket Sales
Internet ticket sales are dramatically increasing and the amount information available to the consumer is continually growing. It is feared that airline travel may become more of commodity with lager numbers of competitors and with fewer areas of differentiation, This will force the airlines to compete primarily on price. Airlines are going to have to work harder trying to differentiate themselves and try to offer better and different service than the other airline competitors.6. Mergers
The largest US airlines have been undergoing plans to create a series of mergers or alliances to better utilize their economies of scale and synergies. The big three are:
? American Airline and US Airways
? Delta and United
? Northwest and ContinentalThis attempt to oligopolies the industry would most likely aid the large companies and especially prepare them much more for larger, more intnese, global competition. However, if this occurred, they would probably raise offering more of an incentive for low-cost startups to enter the market. Alternatively, the huge size of the airline alliances would present a much larger barrier to entry for those startups. These air alliances could simply become very aggressive in price competition when these new entrants arrive on the scene and just destroy them.
7. CRJ Increase
The number of Commuter Regional Jet flights have been increasing dramatically. Numerous stories of single propeller plane accidents have caused the public to view these planes as unsafe and, consequently, would rather pay a little more for a jet aircraft instead. This trend will continue in the foreseeable future offering a potential niche to small companies, unless the major airlines continue to develop strategies to move into and dominate these markets.8. Clean Service and Safety Records
As always, clean service and safety records are a must for an airline. With the way the media ridiculously attracts the few worthy news stories that it finds, if a major airline had a large-scale accident or incident, it could cause long term and potentially irreconcilable damage to their name and reputation. This is a competitive must for the airline industry.D. Internal Analysis
Southwest is the United States’ only major short haul, low fare, high frequency, point to point carrier. Southwest’s average one way airfare is $75 with an average passenger trip length of 441 miles. Southwest flies to 54 cities (55 airports) in 28 states.
1998 Consolidated Financial Statistics:
Net Income: $433.4 million
Total Passengers Carried: 52.6 million
Passenger Load Factor: 66.1 percent
Total Operating Revenue: $4.2 billionYear end results for 1998 marked Southwest Airlines’ 26th consecutive year of profitability. They also received the Triple Crown Award for the 7th consecutive year given by the U.S. Department of Transportation for having the best on-time performance, best luggage handling record, and fewest customer complaints.
III. Identification of Environmental Opportunities & Threats and Firm’s Strengths & Weaknesses (SWOT Analysis)
A. Strengths
1. Low operating costs which produces the lowest fares to customers
2. High customer satisfaction
3. Close labor relations and employee dedication
4. Top rankings in airline industry including on-time arrivals and departures, safety, baggage handling, customer complaints, and financial stability
5. Effective management of human resourcesB. Weaknesses
1. Management succession (future strategic leadership)
2. The company’s and their third parties’ systems and equipment may not be Y2K compliant and could result in reduction or suspension of the companies operation
3. Capital flexibility for new technological advances in aircraft
4. Ability to meet growth demandC. Opportunities
1. Globalization of the airline industry might enable Southwest to expand their services and profit bases abroad
2. Operating costs 48% lower than in foreign markets
3. Domestic expansion in the mid-west and heartland (37% of domestic market share to other carriers)
4. Open Skies agreement between the United States and the United Kingdom would create an open and competitive environment in one of the world’s largest international aviation market.D. Threats
1. Foreign investment in the United States airline industry
2. Less restrictive, more competitive bilateral agreements unacceptable to key bilateral partners will suspend growth in international markets.
3. Operating restrictions in foreign airports
4. Imitators in foreign and U.S. markets
5. Government regulations and policies
IV. Strategy FormulationA. Strategic Alternatives
1. Green-field venture into Mexico or Canada
2. Form equity strategic alliance with European airlines
3. Product diversification through creation of a logistics division
4. Downscope domestic market
5. Maintain focus on domestic marketB. Alternative evaluation
1. If Southwest Airlines (SWA) was to diversify its market, than the natural assumption would be that Canada or Mexico would be the future target market because it would be a gradual extension of the current market. However, both potential markets do not currently produce enough demand in the short haul, low-cost airline industry. Government regulation still plays a vital role in the affairs of the airline industry in Mexico, but less of a role in Canada. These few discouraging characteristics would not produce successful strategic results for SWA under the current conditions.2. The next strategic alternative for SWA would be to enter the second largest airline market through a strategic alliance with a fellow low-cost European airline. This would reduce Southwest’s market risk, and allow them to enter the new market quicker. Recent deregulation throughout the majority of Europe has established a hypercompetitive market for competing airlines around the world. All of the firms are trying to capture as much of the European market share as quickly as possible. American and United Airlines are two of the United States firms that have tried to enter this competitive market through mergers, acquisitions, and alliances, but have failed miserably. Perhaps their strategic scope was to broad. There are currently many low-cost airlines that are trying to implement SWA’s core competencies in Europe’s emerging airline industry. While no firm can completely imitate all Southwest’s core competencies perfectly, many of these low-cost replicas have successfully earned consistent above average returns. This could indicate a potential strategic opportunity for SWA to expand its market share. Currently the risks outweigh the returns, so Southwest is better off waiting for the European market to mature because even a mature market will not prohibit a culturally unique firm like Southwest from entering at will.
3. The creation of a logistics division to diversify its product base is a very realistic alternative that could bode well for SWA. While SWA currently does transport some commercial packages for customers, they have the potential to broaden their scope to individuals and small businesses as well. The average airplane in Southwest’s fleet makes eight departures per day. This means Southwest could gain a competitive advantage on other parcel carriers (UPS, Fed Ex) because they have the potential to decrease the average delivery time of their packages by three to four times that of their competitors due to their point to point airline strategy. They would not have to incur the cost of hubs and storing that the other parcel carriers do. This equates into quicker, cheaper, higher quality care of shipping than the industry standard can compete with. While this is definitely a future potential strategic advantage for the firm, it must gain access to more cities for this alternative to be successful in the United States.
4. Another alternative is for Southwest to downscope its current market segment, and focus on a specific region of the country that is most prosperous for the firm. The current competitive landscape for the airline industry is changing so rapidly that it is opening up more opportunities for firms to enter into new markets. Currently, the United States market is the most lucrative region for the airline industry, which literally invites hypercompetition. Due to the potential threat of international competition intense regionalization might discourage cannibalizing competitors. Herb Kelleher motto has always been, “Thing big and we will get smaller. Think small and we will get bigger.” This type of mentality is what Southwest was founded on, and will continue to survive on. However, such a significant reduction in market share could expose SWA to the potential risk of an acquisition or takeover.
5. The last alternative is almost too simple to work, but offers the most return for the least amount of risk. Southwest Airlines has been competing with the big dogs of the airline industry since its creation. It has consistently countered every attack by a competitor with a highly successful response. When the airline industry was going through its worst times financially, Southwest was the only airline that made a profit year after year. This is attributed to SWA’s strategic leadership and unique culture. Together these characteristics have provided a sustainable competitive advantage unable to be imitated by any of its competitors. Southwest Airlines is only currently established in 28 states in the United States. This will allow SWA to diversify their market domestically by continuing to do what they do best in a region that knows them best.
C. Alternative Choice
The most practical strategic alternative for Southwest Airlines under the current uncertain conditions of the airline industry is to remain focused on expanding its interests in the domestic market. This will more likely ensure future prosperity until international markets settle down. At that point, SWA can reassess their current strategic position to determine whether or not globalization is a feasible alternative. In terms of the prospect of launching a logistics division, Southwest would be better off waiting until it had a majority of the market saturated to meet the complete needs of its clients. SWA has historically been a very patient competitor with very innovative ideas. They are not going to let an opportunity pass them by, but they are not going to make any rash decisions either. Southwest needs to continue improving its core competencies to further separate itself from its competitors. This type of a strategy will open doors of opportunity for SWA, and allow them to take the strategic actions necessary to increase their strategic competitive advantage and earn above average profits.
V. Strategy Implementation
A. Corporate Governance
Internal Governance Mechanisms
Executive CompensationB. Organizational Structure and Controls
1. Business Level Strategy
Through Functional Structure
Competitive Advantage: Low Cost
Competitive Scope: Focused (Domestic leisure, business travelers, point to point system)
Low cost focused strategy: Requires a centralized functional structure
Maintain cost leadership through development of better logistics technique
Maintain Focus
Gain Market Share by expanding hubs/ destination2. Low Cost Structural Characteristics
? Specialized Divide firm into separate homogeneous subgroups
Functional areas
Reduce cost through the efficiencies achieved by
employees specializing in a narrow set of activities? Centralization – Quasi decentralized: Management strives to push some decision making authority lower in the organization while remaining focused on the more general need for activities to be coordinated and integrated through the efforts of a centralized staff.
? Formalization – Rules and procedures that govern organizational activities
? Using work tasks to increase production and distribution systemsC. Strategic Leadership
1. Foster managers to be next CEO
Internal Managerial Labor market
Internal CEO succession + Heterogeneous Top Management Team Composition = Stable Strategy with innovation
2. Determine Firms direction – Exploit and maintain core competencies
3. Develop human capital