Southwest Airlines - Unfurling Wings of Transformation

Case Studies and Resources Aug 17, 2017

Case Type: Industry and Competitive Strategy, General Management, Service Management, Organizational Behavior, Company Life-Cycle

Case Source: Thunderbird School of Global Management (2005 Version)

Industry Coverage: Commercial Aviation

Original Case Abstract

Through three generations of leadership, conservative management and aggressive expansion have guided Southwest Airline’s legendary growth. Herb Keheller, founder and industry revolutionary, introduced a business model that transformed the airline industry; Keheller passed the baton to James Parker and Coleen Barrett, the first man-and-woman team to run an airline, who maintained direction and focus. The company soon experienced cracks in its façade, especially in the wake of 9/11 terrorism, spiraling fuel prices, labor unrest, and new entrants like JetBlue. After reorganization, former CFO Gary Kelly took the helm and gave a speech in which he told employees that the Southwest brand was under attack. Kelly had to weigh many issues if he was to continue the 33-year profitable operation track record. Could Southwest preserve the Herb-centric culture, and was this culture critical to their future success? Would Southwest lose its leadership position to copycats, or, worse, have to copy the copycats to meet customer expectations” What would Southwest do to maintain their cost advantage in light of spiraling fuel costs, costly labor concessions, and intense competition? Finally, was it time to reinvent the 40-year-old company?

Pointers Addressed in Final Composition:

  1. Comparison of Southwest Airlines’ performance to the U.S. airline industry’s overall performance.
  2. Overall competitiveness of the U.S. airline industry.
  3. Southwest Airlines’ strategy (operational factors, non-financial performance indicators, link between corporate culture and strategic choices).
  4. Whether Southwest Airlines’ competitive advantage is based on differentiation or low cost.
  5. Main reasons for imitators to fail where Southwest Airlines has succeeded.

Final Composition:

Since long, the U.S. airline industry has been plagued with high operating costs, recessions, labor strikes, fuel crisis, air-traffic delays, security issues and lower profits often leading to the filing of bankruptcy by major aircraft carriers. Through such times, Southwest Airlines shot up the charts with its futuristic management policies and marketing strategy prowess. In an oligopoly of major players, where fares were determined by the cost incurred by company rather than the customer demands, and where price competition was unheard of, Airline Deregulation Act of 1978 ensured that the market opened up to new entrants bringing about a much needed change in the industry and challenged the already existing giants, further, forcing them to review and revise their business models and to cater to a larger group of stakeholders.

Southwest Airlines is a success story of an airline service that launched itself as a low cost carrier and managed to maintain a steady growth rate and profit margins during a decade when 8 out of 11 major and more than 150 small carriers either went bankrupt or merged into other airlines challenging the pre-set norms of the airline industry. The strategies and policies used by Southwest did not just give a fierce competition to the already established giants but also inspired many to launch their own carriers on the terms of Southwest’s business model. The only two airlines that successfully managed to thrive on Southwest Airlines’ business model were Morris Air and JetBlue – both headed by David Neeleman. Morris Air was acquired by Southwest as part of their expansion plans leaving JetBlue as the only airline inspired by Southwest’s model, by the year 2005. While JetBlue successfully managed through the tough times, many of Southwest’s competitors, big or small, were unable to identify the distinguishing factors to Southwest’s success. As such, within the first 34 years of its operations, Southwest’s small fleet of four Boeing 737 air crafts serving three cities in the state of Texas with annual customer base of a mere 108,554 passengers, in 1971, grew to a whopping 417 aircraft serving 70 million passengers throughout the nation, in the year 2004, ranking it among the top 8 airlines in the US industry in 2004.

Before the Airlines Deregulation Act, the US airlines industry did not have varied pricing strategies to appeal to the customers and all the operating costs were passed along to them as increased fare prices. Each market had between two to three aircraft carrier services that formed the oligopoly which ensured that the prices were regulated as per the industry demands with no competition among them. Due to this, every market was segmented into two segments – people who could afford to fly and people who could not. In 1978, after the government policy change and entry of new players in the markets, the industry giants, that once formed the oligopolies, were forced to cut down on fare prices, that were mostly composed of fixed costs (nearly 80% fixed costs), bringing down the average fare price from 10 cents per domestic air mile in 1975 to 4 cents per domestic air mile in 2003. To cover up for the revised fare prices and to sustain in the competitive market, the major airlines took severe measures in their business operating model. As many as 20,000 airline industry employees were laid off throughout the industry in early 1980s, while the productivity of the remaining employees rose 43% during the same period whereas the average employee wages dropped sharply leading to massive distrust, job insecurity and dissatisfaction among the airline industry unions. Major airlines like United, American and Delta tried maximizing capacity utilization by trying to increase the revenue earned per available passenger seat. To do so, a hub-and-spoke patterned network was identified as a suitable fit, in which, passengers were redirected to major hubs from outlying airports from where they were redirected to their final destination. Such a network would often result in delayed flights caused by yet-to-arrive passengers leading to additional costs of rescheduling for these carriers alongside additional flight time for their passengers. Establishing a hub was, in itself, a costly affair with terminal construction and gate acquisition charges reaching as high as $150 million for a single terminal on a major hub. Increasing fuel prices, additional aircraft maintenance costs due to new government norms post multiple aircraft accidents and increasing debt added to the woes of these major aircraft carriers and adversely affected their already low profitability.

Southwest Airlines began its humble and unconventional journey with four Boeing 747s providing services to three cities in late 1970. Herb Kelleher along with Rollin King established Southwest Airlines as a low cost, short-haul, point-to-point high frequency flights’ airline. Southwest segmented its market into business travellers (people who valued time efficiency) and leisure travellers (people who valued price efficiency). To cater to these two segments, Southwest introduced $13 fare for leisure travellers after 7PM and on weekends and $26 fare for business travellers until 7PM on weekdays. This was a perfect example of their impeccable pricing strategy. While Braniff Airlines tried to imitate their pricing strategy, Southwest further showed its brilliance at marketing mix by offering its customers a bottle of Chivas Regal scotch whiskey for an additional $13 making it a win-win situation for all its stakeholders. As such, Braniff Airlines was forced to abandon their oldest route ensuring that it no longer acted as a threat to Southwest’s low fare business model.

Southwest Airlines had a much deeper understanding of the operations of the airlines industry than its competitors. In general, the hub-and-spoke approach was a cost-saving approach due to its operational efficiencies whereas the point-to-point approach was considered cost-ineffective, in case of insufficient demand. Southwest used the short-haul flights approach to its advantage by flying each airplane for an additional 3.4 hours each day, making 8 trips daily – twice the industry average, making Southwest Airline’s cost per available seat mile as the lowest in industry, at a time when other airlines’ planes spent most of their time on ground, waiting for their passengers to arrive from different spokes to the hub. In addition to this, Southwest also ensured that the turn-around time for each flight was reduced to the bare minimum by asking its employees to work on additional tasks. Southwest’s no frills approach of not offering fixed seats or meals to its customers further saved on flight boarding time helping in keeping up with the schedules. Such an approach saved Southwest on any rescheduling costs that could have incurred. Their ticketing policies saved them a lot of money (costs dropped nearly 66%) helping them pass on this benefit to the customers in terms of further reduced fares. Additionally, where each airline carrier formed its own hub, Southwest leased already developed terminals or secondary airports; that were usually closer to the downtown, for their everyday functions, making it more favorable for the passengers to opt for Southwest’s services.

Southwest’s futuristic people policies and its ability to brand itself as a people’s airlines added as a distinguishing factor among its many imitators. Catering to its internal stakeholders and keeping them content with good pay, job security and their unorthodox people programs ensured that a cheerful corporate culture was formed and maintained. At a time when airline industry employees were unsure of their future and airline labor unions were unhappy, Southwest formed its own labor union to assess and understand its employees and to further improvise on their quality of life. The CEO – Herb Kelleher lead the team by example by freezing his salary for five years when there was a need to bootstrap their finances rather than acting as a corporate boss at a time when airline industry employees were being laid off due to bankruptcy or were being forced to accept lower pay. The trust factor of the employees in their management and a sense of belonging clearly showed how Southwest was ahead of time in their people’s policy from the rest of the industry. From the point of view of a customer, the frequent flyer program, their over-the-top services, good nature and good humored flight staff and the freedom to choose their seats as part of first-come-first-serve basis became the perfect blend to make Southwest became the most desired airline for 7 straight years. None of the imitators and competitors took notice or considered of value of this Southwest culture that Southwest took pride in and gained heavily from.

From being knocked off the charts even before it started, to the top 8 airlines in the US industry, Southwest’s journey has been nothing more than phenomenal. With cost control methods to brilliant people’s policy of esprit-de-corps, Southwest did everything by the books, if one refers to Fayol’s principles. The good use of extended marketing mix and the tendency to stay conservative in an otherwise risky industry is the reason why Southwest Airlines was counted among the top 8 airlines in the US commercial airlines industry, where its competitors failed to learn from Southwest’s success stories. While some of the airlines did try to imitate Southwest’s operational model, many lagged the spirit that Southwest and its employees carried with them. Indeed, Southwest unfurled the wings of transformation in the airline industry and set and example of the need to have good people’s policy alongside an optimal operational policy, by staying profitable while taking care of its own employees.