Business overview of Southwest Airlines Company

Southwest Airlines Company is an American low cost airline. Although the airline industry is no longer experiencing the rapid growth it exhibited during the 1990’s; commercial air travel in the U.S. remains the preferred method of transportation for a majority of Americans due to cost-effectiveness and timesaving characteristics. Southwest is the largest airline in the world by number of passengers carried per year (as of 2009). Southwest maintains the third largest passenger fleet among all of the world’s commercial airlines. As of May 3, 2009, Southwest operates approximately 3,510 flights daily. Southwest has its headquarters on the grounds of Love Field in Dallas, Texas. Southwest Airlines has carried more customers than any other U.S. airline since August 2006 for combined domestic and international passengers according to the U.S. Department of Transportation’s Bureau of Transportation Statistics. Southwest Airlines is one of the world’s most profitable airlines, posting a profit for the 37th consecutive year in January 2010. Southwest’s successful business model involves flying multiple short, quick trips into the secondary (more efficient and less costly) airports of major markets, and using only one aircraft type, the Boeing 737.

Key Issues

Southwest’s most visible problem, as with all airlines, is the drop in demand for air travel the past 18 months. While fallout from the terror attacks gets part of the blame, Kelly (Southwest CEO) says more of it goes to general economic weakness and specifically the collapse of the late ’90s technology and telecom bubble. Environmental changes are also having effects on the Industry. Budget conscious business travelers used to love Southwest, not only for its prices, but because it was so easy to buy a ticket at the last moment, move from curb to gate in minutes and be on their way. New security procedures have taken away this added convenience and have even lengthened the lines. Southwest operates on a first come, first serve basis and the random gate screenings, which tends to target last-minute, one-way flight passengers (a description of most of Southwest’s passengers) places fliers in the position to have to fly in the much dreaded middle seat.

Analysis Models

The analysis of Southwest will cover an external analysis, an internal analysis, and a SWOT analysis. External models utilized will be The Five Forces Model of Competition, Driving Forces, and Industry Key Success Factors. Internal models utilized will be a Financial Analysis, and a Competitive Strength Assessment or SWOT Analysis.

The Five-Forces Model of Competition

Rivalry among firms (High) The extent to which rivalry exists will influence the overall profitability of the industry. Market concentration remains a significant factor affecting rivalry. In 1989, no single airline solely dominated the industry, but the eight largest carriers retained a total market share of 92 high traffic cities with high demand. In order to gain profits, airlines must beat out the competition by offering as much or more flights with time flexibility to a variety of destinations.

Other factors contributing to rivalry include high fixed costs, excess capacity, low differentiation, price wars, and readily available prices via the Internet. Due to the nature of the industry, high fixed costs are expected. Contributions to fixed costs in the airline industry include the costs of planes, fuel, pilots, flight attendants, and additional staff for baggage and customer service. The need to meet government regulations and hire experienced employees can cost an airline company millions of dollars. Currently there has been excess capacity on many routes; as a result, airlines have been participating in price wars in order to attract customers at all costs. Minimal differentiation among airlines and switching costs for passengers also magnifies rivalry.

Rivalry has also increased greatly due to prices being readily available for comparison through the Internet. For instance, “Delta Air Lines, like most major carriers, distributes about 70% of its tickets through travel agents. Each one of those round-trips costs the airline $10 in fees,” therefore increasing prices for consumers. One of Southwest’s strong contributions to profit emerges from accepting online reservations and processing e-ticket for reduced prices by ticket-less travel. Many major carriers are challenging Southwest’s online business through building alliances with e-Travel and using travel websites in order to create larger amounts of sales from smaller business or leisure travelers. By 2003, airlines expect a 20% increase in ticket sales by online purchases and sales from online agencies to add another 15% to 20% to the total number of tickets purchased.

Threat of substitute products (High) Substitutes to air travel include cars, buses, and trains. The importance of buses and trains as substitutes has declined drastically over time. Switching costs between air travel and its substitutes are fairly low; however, the relevant importance of substitutes will change according to the route, reason for travel and the customer-type. For example, longer journeys, such as traveling across the U.S. or overseas, will depress the use of

ground transportation. Traveling for a business trip can encourage flying whereas traveling for a family vacation can encourage driving. Since leisure travelers are more price-sensitive than business travelers, they are more likely to utilize substitutes, given that opportunity costs are taken into consideration.

Threat of new entrants (Low) The wave of new airlines suggested that the airline industry has inefficient economies of scales and could support many new entrants. Even though economists predicted that barriers to entry were low and new firms could easily deploy airlines and other assets to new routes in response to demand, later observations suggest however, that there was

only room for 8 major carriers. Beginning in 1993, startups were eventually consolidated

and incorporated into the major airline companies. Eight of the 11 major airlines dominating the industry in 1978 ended up filing for bankruptcy, merging with other carriers, or simply disappearing from the radar screen, therefore proving that there was little threat of new entrants surviving in the airline industry.

Power of buyers (very Low) The inability of the majority of airline customers to coordinate and organize lessens the power of individual buyers. The extent to which airlines can engage in price discrimination will differ depending on the route and type of customer. Routes heavily flown by multiple airlines increase the availability of substitutes and therefore, are more likely to offer competitive prices. In contrast, flights with farther distances and a limited schedule and hubs, can often be dominated by one or two airlines, which tend to overcharge customers. Corporate discounting, which involves negotiations between corporations and airlines, has been a valuable strategy for larger corporations in lowering airfare and waiver fees. Nevertheless, corporation bargaining power still remains low due to the need for corporations to negotiate well in advance and the fact that discounts depend on airline offers, decisions and demand forecasts.

Power of Suppliers (Lowest) The last force, bargaining position of suppliers, is strong in favor of Southwest, since they are concentrated and this limits the control airlines have over suppliers to reduce prices and earn higher profits. The airlines have no control over the cost of fuel and this is one of the primary expenses of all airline industries. Since all airlines have to pay the same prices for fuel this contributes to supplier power being the lowest of the of Porters five forces.

Findings:

Porter’s Five Forces model helps paint a picture of the airline industry. The rivalrous nature of the industry has become obvious through intense price wars, strong supplier bargaining power, and high substitutability between products offered. These factors continually contribute to the industry’s struggle to sustain profitability. The five-forces model of competition reveals that the strongest force of competition is rivalry among firms; this is an extremely strong force. Thereafter is the threat of substitute products which is a strong force of competition. Next in the model is the threat of new entrants, followed by the power of buyers, both of these forces are weak in this industry. The lowest and weakest force is the power of suppliers.

Industry’s Dominant Economic Features

Market size and growth rate. At the conclusion of the 2009 fiscal year Southwest airlines was the third largest airline in the United States. Delta Airlines and US Airways (which merged with United) were ranked just behind them. The interesting thing is that these other airlines offer international travel and Southwest only offers fares in the United States. The company operates out of 35 major cities and utilizes over 500 Boeing 737 aircraft. Southwest revenues for 2009 were $10.4 billion and there was a net profit of $99 million. The company has been the most profitable airline in the US and has posted a profit for 37 consecutive years.

Number of rivals. The airline industry is saturated with different airlines ranging from the large companies to the smaller ones trying to make their mark. The biggest rivals of Southwest are Delta and US Airways.

Scope of competitive rivalry. Competition has become increasingly more international with it becoming significant for companies in this industry to have a presence in foreign markets.

Number of buyers. Southwest has a loyal customer base due to the fact they provide the lowest fares available for flight. One of Southwest’s goals is to never inconvenience their customers. Southwest tells their employees that they are in the customer service business and they just happen to provide airline service.

Product innovation. Some of the things that Southwest has done is create better ways to order tickets for flight. They were one of the first airline companies to use e-tickets reducing lines at the kiosk by as much as 90% which also contributed their low percentage of late arrival/departure flights.

Supply/demand conditions. The demand for flight is on somewhat of a downfall due to the economic downfall the US has been experiencing. This shouldn’t allow any of the other airlines to get an advantage over Southwest, since the competition is facing the same issues.

Economies of scale. Southwest’s entire mission is centered on offering cheaper flights than competitors, without shirking on service. By keeping costs down, it has been able to thrive in an environment that forces many other airlines to take large losses or declare bankruptcy. Southwest has been able to dramatically increase its profits and, subsequently, its stock price.

Findings:

As more foreign markets become available the market size and growth rate have grown significantly. This has led to additional competition for the larger companies that have succeeded in the industry for many years. Although the degree of product differentiation is low, Southwest has firmly entrenched itself in the airline industry with the managerial strategies the company has implemented.

Driving Forces

Entry/exit of major firms. The airline industry has many entry barriers so the dangers associated incoming airlines are low. Lately, however, there have been many airlines exiting which causes fierce competition to gain their customers.

Changes in cost and efficiency. Cost of fuel, increasing inflation, increasing interest rates, maintenance costs, safe flights, and timely arrival and departures all play a major role in the airline industry

The internet. The internet enables flyers to go online and do more comparative shopping for good prices, flight schedules, and flight destinations. It is also more user friendly for businesses..

Industry Key Success Factors

Targeting the niche market. Southwest Airlines’ secret to its success is very straightforward. Southwest clearly defines its existing purposes, which is to provide the lowest fares for business and leisure travelers traveling between states. Instead of competing with large-scale airlines to fly international routes, Southwest focuses on “point-to-point” interstate short trips, and more on maximizing the profitability than focusing on market share. This strong vision outweighs the allurement of international flight market, keeping Southwest airline concentrated on its own niche to gain profit.

Cost-consciousness. Since low fares have become its selling point, decreasing the cost becomes very important. Southwest Airlines tries to save money by simplifying its operating process. Utilizing strategies such as having “One type of aircraft”, “cash-register receipts as tickets”, “no computer reservation system” and “no meal service” are some examples of its low cost strategies.

High Service Quality. Furthermore, Southwest understands that its “low fares” strategy cannot be achieved at the sacrifice of good service. Southwest defines the essence of its business as service, stating, “We are not an airline with great customer service. We are a great customer service organization that happens to be in the airline business.” According to the five dimensions in SERVQUAL, Southwest has great performance in the dimensions of reliability, responsiveness, assurance, and empathy.

Successful Internal Marketing. The Southwest culture is to serve people in a fun and innovative way, but at the same time, make profits. Southwest believes that it should satisfy its employees first and then they would satisfy its customers. The secret for the success of Southwest Airlines is that it never sacrifices happy employees in order to satisfy customers. It believes that the company should trust and stand on its employees’ side because sometimes customers might be wrong. Southwest tries to let employees know that it is not a company but a big family.

Internal Analysis

Financial Analysis

Net income for fiscal 2009 was $99 million compared to that of $178 million in 2008

Net income, excluding special items: $143 million

Total passengers carried: 86 million

Total RPMs: 74.5 billion

Average passenger load factor: 76 percent

Total operating revenue: $10.4 billion

See Appendix A for Southwest Airlines Income Statements for 2007-09, Appendix B depicts Southwest Airlines Balance Sheet from 2007-09, and Appendix C depicts Southwest Airlines cash flow from 2007-09.

SWOT Analysis

Strengths

Low cost carrier.

Diversified management team.

Financial strength.

Marketing and distribution.

Weaknesses

No business class or first class seating section

Employees are members of the employee union.

One type of aircraft/insignificant amount of cargo/freight

Opportunities

Global growth joint ventures.

Movement into open free markets.

Expand product line to meet a broader range of customer needs.

Threats

Online ticket reservation system by competitors.

Decrease in the air travel demand.

Fluctuations in fuel price.

Terrorism

Legal limitations.

Findings:

The strength of Southwest is its ability to offer low cost airline fares to over thirty-five states in 69 locations. Low cost fares are offered as a result of the airline not operating out of a hub like most other airlines, instead Southwest focuses on short-haul trips to several different cities. Southwest has a very unique management style, it is considered more of an employee driven management. The leadership of Southwest strives to make every employee feel as though they are running their own small business. This is important to the company because it knows that employee satisfaction drives customer loyalty. Financially, Southwest Airlines had a profit of $99 million last year and has been able to post profits each of the thirty-eight years they have been in existence. Nucor provides customer with a broad range of high quality products at prices consistently lower than the competition. However, Nucor’s weakness is their ability to keep up with the supply/demand globally and its utilization of e-commerce. Nucor has many opportunities to fast forward its operations such as moving swiftly to capitalize on joint ventures globally. Also Nucor has exploring opportunities in the free market. The company faces many threats due to strong competition from domestic and international steel producers as well as economic factors such as higher interest rates and inflation.

Conclusion

Southwest Airline has developed a great low cost model for the past thirty years that fits today’s economy the best. It has expanded from a tiny company with merely three aircraft to one of today’s major airliners that flies between 58 cities carrying over 60 million customers each year. As everyone can see, Southwest Airline has been a big success. Now, it is given an opportunity to grow even bigger at this extremely hard and critical time for the airline industry. Southwest offers a low cost, friendly and simple service that distinguishes itself from its competitors and will allow it to sustain profitability in the airline industry. Southwest has been able to a build a loyal customer base with its genuine customer service and its employee’s love of their job. Southwest always remembers that in order to succeed in an industry, it is often not the case of having a strategy of “doing it better”, but rather one of “doing it differently.” “Southwest has had more opportunities for growth than it has airplanes. Yet, unlike other airlines, it has avoided the trap of growing beyond its means. Whether you are talking with an officer or a ramp agent, employees just don’t seem to be enamored of the idea that bigger is better.” Since its initiation, Southwest has managed to grow in a controlled fashion by adding only a few new cities each year. Southwest has proven itself to be successful and we believe it will continue to be profitable as long as it never ceases to offer customers efficient and low cost air transportation. With continuous aggressive promotion and strong commitment, Southwest will remain the preferred airline for providing low fares.

Jan 02

2007

Reclassified

Dec 31

2007

Reclassified

Dec 31

2008

Restated

Dec 31

2009

4-Year

Trend

Assets

Cash and Equivalents

1,390.0

2,213.0

1,368.0

1,114.0

Short-Term Investments

369.0

566.0

435.0

1,479.0

TOTAL CASH AND SHORT TERM INVESTMENTS

1,759.0

2,779.0

1,803.0

2,593.0

Accounts Receivable

199.0

279.0

209.0

169.0

TOTAL RECEIVABLES

199.0

279.0

209.0

169.0

Inventory

181.0

259.0

203.0

221.0

Prepaid Expenses

51.0

57.0

73.0

84.0

Deferred Tax Assets, Current

—

365.0

291.0

Other Current Assets

411.0

1,069.0

—

TOTAL CURRENT ASSETS

2,601.0

4,443.0

2,653.0

3,358.0

Gross Property Plant and Equipment

13,125.0

14,534.0

15,491.0

15,641.0

Accumulated Depreciation

-3,765.0

-4,286.0

-4,831.0

-5,254.0

NET PROPERTY PLANT AND EQUIPMENT

9,360.0

10,248.0

10,660.0

10,387.0

Long-Term Investments

—

162.0

99.0

Other Long-Term Assets

1,499.0

2,081.0

593.0

425.0

TOTAL ASSETS

13,460.0

16,772.0

14,068.0

14,269.0

LIABILITIES & EQUITY

Accounts Payable

643.0

759.0

668.0

746.0

Accrued Expenses

699.0

717.0

743.0

632.0

Current Portion of Long-Term Debt/Capital Lease

122.0

41.0

163.0

190.0

Current Portion of Capital Lease Obligations

—

14.0

Other Current Liabilities, Total

546.0

2,020.0

269.0

64.0

Unearned Revenue, Current

799.0

931.0

963.0

1,044.0

TOTAL CURRENT LIABILITIES

2,887.0

4,838.0

2,806.0

2,676.0

Long-Term Debt

1,567.0

2,050.0

3,506.0

3,324.0

Capital Leases

—

11.0

Unearned Revenue, Non-Current

120.0

106.0

105.0

102.0

Pension & Other Post-Retirement Benefits

111.0

88.0

101.0

86.0

Deferred Tax Liability Non-Current

2,104.0

2,535.0

1,904.0

2,207.0

Other Non-Current Liabilities

222.0

214.0

693.0

397.0

TOTAL LIABILITIES

7,011.0

9,831.0

9,115.0

8,803.0

Common Stock

808.0

Additional Paid in Capital

1,142.0

1,207.0

1,215.0

1,216.0

Retained Earnings

4,307.0

4,788.0

4,919.0

4,983.0

Treasury Stock

-390.0

-1,103.0

-1,005.0

-963.0

Comprehensive Income and Other

582.0

1,241.0

-984.0

-578.0

TOTAL COMMON EQUITY

6,449.0

6,941.0

4,953.0

5,466.0

TOTAL EQUITY

6,449.0

6,941.0

4,953.0

5,466.0

TOTAL LIABILITIES AND EQUITY

13,460.0

16,772.0

14,068.0

14,269.0

Appendix C

Southwest Airlines Cash Flow

Currency in

Millions of U.S. Dollars

As of:

Jan 02

2007

Reclassified

Dec 31

2007

Reclassified

Dec 31

2008

Restated

Dec 31

2009

4-Year

Trend

NET INCOME

499.0

645.0

178.0

99.0

Depreciation & Amortization

515.0

555.0

599.0

616.0

DEPRECIATION & AMORTIZATION, TOTAL

515.0

555.0

599.0

616.0

(Gain) Loss from Sale of Asset

-16.0

-14.0

-12.0

Other Operating Activities

379.0

1,481.0

-2,288.0

117.0

Tax Benefit from Stock Options

-60.0

-28.0

—

-1.0

Change in Accounts Receivable

-5.0

-38.0

71.0

40.0

Change in Accounts Payable

-223.0

149.0

-98.0

59.0

Change in Unearned Revenues

150.0

131.0

32.0

81.0

Change in Other Working Capital

87.0

-73.0

-21.0

-27.0

CASH FROM OPERATIONS

1,406.0

2,845.0

-1,521.0

985.0

Capital Expenditure

-1,399.0

-1,331.0

-923.0

-585.0

Investments in Marketable & Equity Securities

-117.0

-198.0

-55.0

-986.0

CASH FROM INVESTING

-1,495.0

-1,529.0

-978.0

-1,569.0

Long-Term Debt Issued

300.0

500.0

1,664.0

919.0

TOTAL DEBT ISSUED

300.0

500.0

1,664.0

919.0

Long Term Debt Repaid

-607.0

-122.0

-55.0

-583.0

TOTAL DEBT REPAID

-607.0

-122.0

-55.0

-583.0

Issuance of Common Stock

260.0

139.0

117.0

20.0

Repurchase of Common Stock

-800.0

-1,001.0

-54.0

—

Common Dividends Paid

-14.0

-13.0

TOTAL DIVIDEND PAID

-14.0

-13.0

Other Financing Activities

60.0

5.0

-5.0

-13.0

CASH FROM FINANCING

-801.0

-493.0

1,654.0

330.0

NET CHANGE IN CASH

-890.0

823.0

-845.0

-254.0

Source of Financial Statements: Business Week 04/23/2010

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