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  • Subject area(s): Marketing
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  • Published on: 14th September 2019
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Executive Summary

Southwest Airlines entered the airline industry with the strategy as a low cost airline provider in 1971.  Southwest has focused on low fares within the domestic United States, and they have just recently added a few international flights to Mexico and the Caribbean in 2015.  Southwest's low cost strategies fixated reducing input costs that other large airlines charge heavily for like seat selection, business class, and baggage fees.  Their “Transfarency” program where two checked bags fly free has made Southwest a very popular airline.  

The customers of Southwest Airlines acknowledge that they may not receive the same luxury amenities that other airlines offer, and that shows in Southwest's profitability year after year.  Along with being one of the top airlines in the United States for their low costs, they are also known for their outstanding customer service compared to other airlines in the industry.

In this analysis of Southwest Airlines, we have concluded that they are a low-cost player, and that they should continue this strategy.  With the intense competition in the domestic United States airline industry, many airlines have to operate with low profit margins to remain in operation.  Southwest Airlines has differentiated themselves as a company with low cost and very few embellishments.  Through this strategy, they have been able to remain profitable in this aggressive airline industry.

Strategic Analysis of Southwest Airlines

Introduction

Southwest Airlines (LUV) has become known over the past two decades as a thriving airline company operating in a time when most airlines have been struggling.  Whether it is due to fluctuating demand based on the luxury service or due to rising oil prices, a company operating in the airline industry must maintain and strengthen a set of competitive advantages that differentiates it from its competitors.  Southwest Airlines' business model leverages extremely efficient operations, deep focus on the customer experience, low-cost pricing and logistics solutions, active forward thinking, and a motivated team of employees and associates.  Through this sound strategy, Southwest Airlines has achieved multiple competitive advantages that have allowed it to stay relevant in the face of an evolving landscape.

Current Situation

Performance: Southwest Airlines Co. (the “Company” or “Southwest”) operates Southwest Airlines, a major passenger airline that provides scheduled air transportation in the United States and near-international markets.  For the 43rd consecutive year, the company was profitable, earning $2.2 billion in net income.

Southwest Airlines currently has a strong financial position for the years of 2011 to 2016.  All of the performance ratios would agree with this statement.  Return on assets is almost a 1 to 1 ratio, which concludes that they are using their assets effectively.  Net income has almost doubled from year to year in 2013 and 2014, despite the increase in expenses.  The only down turn they had in the last 10 years, was in 2008 during the economic crisis.  In the years of 2011 to 2015, they have made investments to grow the company as the statement of cash flows under investing activities.

Financial Objectives: Net income for the year ended December 31, 2015, was a company record $2.2 billion, or $3.27 per diluted share, a 92.0 percent increase in net income year-over-year. This increase primarily was due to a 6.5 percent increase in operating revenues, driven by strong demand for low-fare air travel, a 7.2 percent year-over-year capacity growth, the impact of the July 2015 amended Agreement with Chase, and the resulting change in accounting methodology.  Also, operating expenses decreased 4.1 percent, primarily as a result of lower fuel prices, which more than offset increases in certain cost categories including salaries, wages, and benefits expense.

The Company flew 10.9 billion revenue passenger miles (RPMs) in March 2016, an increase of 6.2 percent from the 10.2 billion RPMs flown in March 2015.  Available seat miles (ASMs) increased 6.1 percent to 12.9 billion in March 2016, compared with March 2015 ASMs of 12.1 billion.  The March 2016 load factor was a record for the month of March at 84.6 percent, compared with 84.5 percent in March 2015.  The Company continues to estimate its first quarter 2016 operating revenue per ASM (RASM) will be in line with the first quarter of 2015.

Southwest Airlines also generated to a net change in operating cash flows of $3.238 million in 2015.  This amount as only enough to cover 43.72% of current debt based on the operating cash flow ratio.  However, further analysis made on one of its competitor Delta Airlines, they are only able to pay about 45.23%.  An increase in revenue, net income, and one of the most important assets as cash; we have concluded that management has allocated and used resources efficiently.

Strategic: Strategies is an area that is hard to analyze.  Most companies will not inform the public of the current strategies, and we believe the reason being is to not let your competitor know what your plans are for the future.  This would give them an opportunity to react, and either make a defensive move or an even more offensive move than your own.  From the time the company started back in 1971, their main goal has been to offer low-fare transportation.  With this strategy, Southwest has managed to be profitable for 42 years and counting.   

It is clear that one of the main strategies for Southwest Airlines was to expand internationally in 2014.  They began to offer new routes to Mexico, Costa Rica, and countries in the Caribbean. They have also fully integrated AirTran Airways, in which CEO Gary C. Kelly described as “…arguably the biggest project in our Company's history.”  This was a strategic plan that was started in 2010.

With strategic initiatives complete and moving forward, CEO Kelly said, “Beyond 2015, our objectives are to sustain the strong earnings momentum, grow Southwest Airlines at a sensible rate, and continue to enhance our Customer Service and Experience.”

In March of 2016, they promoted Justin Jones to Vice President Operational Strategies and Performance.  He is responsible for developing new strategies that align with the current operations.

Strategic Posture

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.”

Our Purpose: Connect people to what's important in their lives through friendly, reliable, low-cost air travel.

Our Vision: To become the World's Most Loved, Most Flown, and Most Profitable Airline.

With their mission, purpose, and vision as stated above; we conclude that they have stayed true to their word.  They have high quality service, otherwise they would not be the most used airline industry in the U.S.  They continue to be a low-cost provider in the industry, while also being profitable.

Objectives: With their main objective being completed in 2014, they have continued growth in sales into 2015.  Their objective is to potentially add 50 more domestic U.S. and international destinations in the future.  These destinations could possibly be from Hawaii in the west, to Canada in the north, and stretching to the northern reaches of South America, which is great news for shareholders.  This means that they are looking at ways to grow the company, which means it will grow the value of their stock.  

Corporate: Southwest Airlines is a business level corporation with one portfolio.  As stated earlier they made an acquisition of AirTran Airways.  They have not shown any intentions to grow the portfolio by other means.  They have and continue to use these four strategies to grow the company.

1) They have established themselves as a low-cost provider.  This makes it difficult for new entrants and difficult for current competitors to lower their prices to overtake them.

2) They engaged in fuel hedged derivatives.  This lowers their chance of suffering losses to the potential of jet fuel price increase.

3) They have expanded internationally to capture different markets.

4) They also have a frequent flyer rewards program to retain customers to keep flying with them.

Governance

The board consists of 11 members, with the current Chief Executive Officer (CEO), Gary Kelly, as the Chairman of the Board, and Ron Ricks, who is a member of the executive committee of Southwest Airlines and the Vice Chairman of the Board.

Evaluating the CEO's performance in light of those goals and objectives, and together with the other independent members of the Board, (as directed by the Board and to the extent consistent with any applicable plan documents or law), determine and approve the CEO's compensation level based on this evaluation.  In determining the long-term incentive component of CEO compensation, the Committee will consider Southwest Airlines' performance and relative shareholder return, the value of similar incentive awards to CEOs at comparable companies, and the awards given to the Company's CEO in recent years.

External Environment: Opportunities and Threats

Opportunities: The acquisition of AirTran allows Southwest Airlines immediate growth and development in bigger markets, such as the international airports in Boston and Baltimore, while also diversifying their routes as well, with new destinations such as the international airport in Atlanta.  The acquisition also provides Southwest access to slot-controlled markets such as LaGuardia airport in New York and the Ronald Reagan Washington airport in D.C., where Southwest Airlines formerly had little or no presence.

In addition, with the acquisition of AirTran in 2015, Southwest Airlines has begun operations in near-international destinations, such parts of Mexico and the Caribbean.  With the acquisition of AirTran, they ended in 2011 after serving 68 U.S. and near-international destinations. Southwest Airlines will takeover these routes through the acquisition process.

With the completion of their reservation system overhaul expected in the next year, Southwest can begin considering these routes.  They are currently involved in litigation to internationalize the Hobby Airport in Houston, where they have dedicated much infrastructure investment and hold a significant presence, which would facilitate their move into these new markets.

Further opportunities involved varied methods of generating additional revenue, such as by adding in-flight WiFi (wireless internet) through the in-flight internet provider, Row 44.  All flights equipped with the service charge $5, regardless of duration.  As of February 2015, 165 of the fleet's 610 Boeing 737s had been equipped with WiFi.  Row 44 has also signed deals with the NFL and MLB to stream live basketball, baseball, and football games during flights.

Threats: There are a number of potential threats to Southwest's success in the highly competitive American airline industry.  If they are unable to compete as they grow into busier, more congested markets, or internationally, Southwest will witness diminishing growth.  Additionally, as many legacy carriers enter bankruptcy or realign themselves, Southwest loses some its supply advantages, most notably in labor costs.  Southwest has been seeing increasing operating costs over the past few years, which if unchecked or allowed to grow faster than the competition, could force higher prices, and diminish market share.

There are also a number of industry-wide threats that could impact Southwest's profit margin. Any new regulation – via aviation or environmentally – would hurt Southwest's pricing ability. Furthermore, since air travel is fairly elastic, in times of economic downturn both leisure and business air travel decrease substantially.  As such, the whole industry suffered through late 2008 and 2009, and another dip into recession would hurt Southwest's operations.

Just like other airlines, Southwest Airlines fuel and transportation costs is a major weakness towards their profit margin.  Fuel prices are notoriously volatile, with the price of jet fuel fluctuating sometimes with or independently from the price of crude oil.  The airline as a whole industry is vulnerable to these swings, on the positive side, but it still negatively affects Southwest's bottom line.  Last year, fuel constituted 38% of Southwest's operating costs.  Thus, despite the hedging Southwest actively engages in, any serious upswing still has negative ramifications.

Internal Environment: Strengths and Weaknesses

Strengths: Southwest has traditionally been a low-cost airline carrier, which is how they were able to establish a position in the airline industry.  Southwest Airlines operates on point-to-point routes, rather than the customary hub-and-spoke tactic like many other airlines, which allows more flexibility in selecting cost-effective routes.  Also, Southwest Airlines relies on secondary and smaller airports in larger cities, such as Midway (rather than the Chicago O'Hare airport) and LaGuardia (rather than JFK in New York) to improve on-time consistency, which is an important aspect of customer satisfaction and customer relations.

Southwest Airlines has always aimed for a maximum of 20 minute turnarounds at the gate – another consistent part of their renown customer service – which is facilitated by its use almost exclusively of Boeing 737-700 planes.  This allows for standardize maintenance procedures, and in turn, quicker service.  Along with purchasing and renting exclusively Boeing planes, Southwest receives a bulk discount.  They have also historically had very good customer relations.  This has been aided by successful marketing campaigns, such as‚ “Transfarency”.  Southwest captured attention from this point of differentiation from nearly all of their competitors, a passenger's first and second checked bags are both free.  This strong customer reputation has been important in their continual growth.

Weaknesses: Southwest's significant growth after the acquisition of AirTran has proved to be somewhat problematic in maintaining the reliable service they have always been known for.  In 2010, their on-time arrival percentage dipped below 80% for the first time in company history to 79.5% (even though was still higher than all of their major competitors), but has since risen back to 83.5% in 2011.  With the integration of AirTran, Southwest's network will grow almost 20%, which brings up the question of whether or not this will further worsen their service.

Additionally, AirTran's fleet consists of 88 Boeing 717-200s (along with a number of 737s), which pose new challenges for Southwest's operations, since they did not previously operated planes other than the various 737's.  AirTran also brings a number of congested markets, such as Atlanta, to Southwest's operations, which pose both opportunities for growth and potential challenges.  There are also always possible challenges when expanding operations internationally, such as compliance with international laws.  The integration of AirTran poses a number of other possible weaknesses as well.  Though all has been smooth thus far, the integration of the various airline unions (Pilots, Maintenance, etc.) could pose problems to a smooth transition.

Any combination of these factors could force Southwest to revise its low-cost strategy.

Strategic Alternatives & Recommendations

Strategic Alternatives

The first option to continue to grow and becoming aggressive again.

Growth usually puts pressure on an airline's profitability in the short run.  It can take a couple of years for demand to fully ramp up as customers discover the new flights and change their travel patterns.

However, due to the massive drop in fuel prices, this dropped Southwest Airlines' operating costs by billions.  These funds can be spent on the progression of the company without a significant loss in profits.

There are international growth opportunities abroad.  Southwest Airlines carries more domestic passengers than any other U.S. airline, and it has more or less saturated the continental U.S. airline market.  On the other hand, it has a very small presence outside the continental U.S. Southwest Airlines will operate more than 100 international flights on Saturdays this summer of 2016: the first time it has operated 100 or more international flights in a day.

That number is likely to grow significantly in the next five to ten years.  Southwest is opening a new international terminal in Houston in October, which will allow it to make Houston a major international gateway. Southwest is also managing an expansion project on its terminal in Fort Lauderdale, Florida, which will allow it to add 25 to 30 daily international departures beginning in 2017.

Southwest also has major operations in numerous cities with ample room for international growth, such as Los Angeles, Las Vegas, Phoenix, Denver, Baltimore, and Orlando, Florida.

Southwest has stated that it could eventually add 50 cities outside of the continental U.S. to its route network. Considering that it has so many potential international gateways in the U.S., this means the long-term opportunity could consist of hundreds and hundreds of new daily flights.

The second option is to strengthen our position as a low-cost provider.

Larger planes mean lower costs for Southwest Airlines.  Having growth opportunities is nice, but it only makes sense to pursue them if they are profitable.  This means that keeping costs down is absolutely essential.

Southwest's biggest weapon in this regard is the ongoing shift in its fleet toward the Boeing 737-800.  This plane has 175 seats in Southwest's configuration, compared to at most 143 seats for Southwest's other Boeing 737s.  As a result of having more seats, the 737-800 has significantly lower unit costs than smaller 737 versions like the 737-700.

Southwest Airlines announced last month that it had converted all of its 31 orders with Boeing for 2016 from the 737-700 to the 737-800.  It is also likely to convert its last twenty-five Boeing 737-700 orders to the 737-800.  Furthermore, it has 170 firm orders for the even more fuel-efficient 737 MAX 8, which will begin arriving in 2017.  Altogether, this will more than triple the number of larger, lower-cost aircraft in Southwest's fleet.

This change is already benefiting Southwest's cost structure.  Last quarter, Southwest's adjusted unit costs, excluding fuel, special items, and profit sharing, declined 3.6% year after year.  For the full year, Southwest expects a more modest 2% decline in adjusted unit costs.  Continuing to add larger aircrafts will help Southwest Airlines manage other areas of cost pressure going forward.

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