2009

CASE ANALYSIS
TEAM
AKRITI SINHA
ARAVIND KUMAR
LIPIKA BRAHMA
NIKHILESH BHATTI
TARUN AGRAWAL
KOWSHIK YAKKALA
EXECUTIVE SUMMARY
Southwest Airlines entered the airlines market and within a few years was known amongst the market leaders by following a low cost
differentiation strategy. Not only did the airlines win numerous price wars by just religiously following its set of coherent activities but it also
gained many loyal customers who wanted to fly in South West and wrote to them for setting up new flight routes.
Southwest now had two major issues at hand, one was how would they continue to be the low cost leaders in the industry by making their
strategy sustainable. The other was they wanted to foray into new markets or establish new routes to expend their reach in the industry.
There were many activities that lead the strategy to be successful including low operating costs, low turnaround time, committed and efficient
employees etc. Their strengths seemed to be how well they managed time. They saved a lot of time on flight and in the airport which led to
cost savings later. They now were on cross roads and wanted to make their strategy sustainable.
The second dilemma was about their expansion strategy. South west had always followed a controlled expansion strategy and always was
known for its deliberate and cautious moves to expand. Now they had three options at hand
a) Expand within system, add a new segment between Detroit and Phoenix- where the airport gate and landing fee would be higher than
the average Southwest Standards
b) Grow in Chicago by adding a route from Chicago to Dayton- the fee per passenger would be lower than their average in other
airports, the airport was fairly uncongested and had room for further expansion
c) Establish base in east coast- kick off service from Baltimore- airport fees was in line with the system
In assessing the best option we evaluated all the three options both qualitatively and quantitatively. We evaluated the risks as well as the
returns in each of the three options separately and determined the best option. We forecasted the demand based on past growth rate. NPV
and an calculation of the payback period for each of the options gave us an understanding of the returns that each project would provide us
with. Risks are always based on the best case, worst case and expected case scenarios of the prices to be offered to the customers since
Southwest had to maintain a cost lower than almost 60% of the industry average to be competitive in the industry. They could maintain their
low prices only through their low operating costs. In the sensitivity analysis the final option seemed to go very well with the statement higher
the risk higher the return which does not go very well with Southwests controlled expansion theory. The second option seemed to turn very
bad in the worst case scenario in which southwest could operate due to entry of new competitors. The first option of expanding within the
system was moderate and fared well in both the worst and best case scenario.
Looking at it qualitatively the first option seemed lucrative since there were a lot of passengers already asking for the particular route to be
established and this would improve the brand image of Southwest since they would be responding to customer.

Contents
EXECUTIVE SUMMARY .............................................................................................................................................................................................................................................................................. 2
THE MAJOR ISSUES FACED BY THE COMPANY ................................................................................................................................................................................................................................ 4
PROBLEM STATEMENT:........................................................................................................................................................................................................................................................................ 4
THE AIRLINES INDUSTRY IN THE 1990s ........................................................................................................................................................................................................................................... 4
Changing Consumer Perception: ...................................................................................................................................................................................................................................................... 4
ANALYSIS OF PROBLEM 1: SUSTAINING LOW COST DIFFERENTIATION STRATEGY ........................................................................................................................................................ 5
ANALYSIS OF ACTIVITIES THAT ARE CRITICAL FOR MAINTAINING THEIR STRATEGIC COHERENCE ....................................................................................................................... 5
ANALYSIS OF PROBLEM 2: EXPANSION AND GROWTH INTO NEW MARKETS ..................................................................................................................................................................... 6
SITUATION 1: DETROIT AND PHOENIX EXPAND WITHIN THE SYSTEM ......................................................................................................................................................................... 6
SITUATION 2: GROW IN CHICAGO BY ADDING CHICAGO-DAYTON .................................................................................................................................................................................. 6
SITUATION 3: ESTABLISH BASE IN EAST COAST: KICK OFF FROM BALTIMORE .......................................................................................................................................................... 6
NPV and Payback period.......................................................................................................................................................................................................................................................................... 7
ANALYSING THE RISKS: SENSITIVITY ANALYSIS .......................................................................................................................................................................................................................... 7
ANALYSIS OF RETURNS ........................................................................................................................................................................................................................................................................... 8
QUANTITATIVELY: ................................................................................................................................................................................................................................................................................. 8
QUALITATIVELY ...................................................................................................................................................................................................................................................................................... 8
SENSITIVITY ANALYSIS ...................................................................................................................................................................................................................................................................... 8
RECOMMENDATION ................................................................................................................................................................................................................................................................................... 9
APPENDIX 1: ASSUMPTIONS: .............................................................................................................................................................................................................................................................. 10
APPENDIX 2: RETURN ANALYSIS ........................................................................................................................................................................................................................................................ 11
APPENDIX 3: SENSITIVITY ANALYSIS .............................................................................................................................................................................................................................................. 13
APPENDIX 4: WACC CALCULATION ................................................................................................................................................................................................................................................... 13
APPENDIX 5: PORTERS FIVE FORCES ANALYSIS ........................................................................................................................................................................................................................ 14
Appendix 6: HOW DOES SOUTHWEST ACHIEVE STRATEGIC COHERENCE ........................................................................................................................................................................................................ 15

THE MAJOR ISSUES FACED BY THE COMPANY
PROBLEM STATEMENT:
Southwest Airlines has two problems at hand now:
a) How to maintain the strategic coherence that it currently has and how to make them sustainable in the long term
b) Find the best possible expansion strategy amongst the three options of routes

Expand within the system, add a new segment between Detroit and Phoenix
Grow in Chicago by adding a route from Chicago to Dayton
Establish base in east coast- kick off service from Baltimore
THE AIRLINES INDUSTRY IN THE 1990s
Airlines Industry in the 1990s was one of the largest and growing industries. It remained the core for globalization due to its involvement in
international investments and world trade. But during the early years of 1990s the industry was hit with recession, Gulf war and the effects of
deregulation in 1978. In 1991 the number of passengers decreased with an effect on the financial results which were already at war with the
excess capacity losses due to overbuying of aircrafts in the 1980s. According to the reports airlines industry suffered a total loss of around
$20 billion from 1990-1994.
Changing Consumer Perception:
Several low fare airlines were introduced during those times that changed the whole perception of people towards air-travel. As, they were
low priced due to which there was a fear in their minds that the airlines might have lower safety standards which proved to be wrong. The
deregulation also had some negative effects as well:
Cost cutting in the operations
Mergers of airlines to prevent bankruptcy
Lower wages and job losses
The airlines operating strategies also got changed as a result of deregulation, liberalization and increase in the competition. Rather than
focusing on increasing the load factor, the airlines started to work towards increasing the overall productivity with increased profitability
through economies of scale.

ANALYSIS OF PROBLEM 1: SUSTAINING LOW COST DIFFERENTIATION STRATEGY
Southwest Airlines strongly follows the strategy of low cost/differentiation strategy. They provide the lowest possible fare in the industry.
This leaves South West with not much competition in the industry. At the same time South West focuses on differentiating itself on the basis
of the service, operations, cost control, marketing, its people and corporate culture. They believe in providing customer focused services.
They believe in adding fun element to their services. Their main aim is to offer great service at the lowest cost.
ANALYSIS OF ACTIVITIES THAT ARE CRITICAL FOR MAINTAINING THEIR STRATEGIC COHERENCE
MAINTAIN MOTIVATED PEOPLE FORCE
Southwest Airlines always banked upon their people for carrying out most of their time saving and cost saving activities. None of them would
be possible if the ground staff is not dedicated. To maintain the same amount of enthusiasm amongst the workforce to work efficiently even
with wages lower than the industry average
Selection procedure of employees they should always look out for people who crave psychological satisfaction more out of a job than
monetary satisfaction
Most of the times it was the employees who gave them new ways of saving time and money, so always keep up the org culture of
openness and employee involvement in major decisions
Recognitions and awards should continue to make employees happy and more self confident
TARGET ONLY SMALL CITIES AND CONTINUE WITH THE CITY TO CITY HOPPING ROUTE
Save up time by selecting less congested airports
Save up on costs by not following the hub and spoke model, saving fuel and time
TARGET CUSTOMERS: Their target customers mostly would be families who would be in the middle and lower middle class income range
who would not mind a little fun while travelling
BRANDING THEMSELVES AS THE OFFICIAL HOLIDAY CARRIER: Since they attract a lot of people during the vacations they should
market themselves as the carrier that brings together the whole family during a vacation at a very low cost. They should start hitting on the
emotional side
CONTROLLED EXPANSION: They should never go for any city that offers them a lot on revenue but where they might lose out due to bad
weather conditions or simply because of culture mismatch. They should foray into markets only after a study of their passengers
Why Chose this option?
Establish base in the East Coast
High Population 2.4 million
Flight timings more than 3 hours resulted in fuel savings
by 20-25%

Why not chose this option
Bad Weather conditions might result in flight delays
Average Flight Distance more than southwest standards
Luv Cuture cannot be retained
ANALYSIS OF PROBLEM 2: EXPANSION AND GROWTH INTO NEW MARKETS
For assumptions: See Appendix 1: Calculations: Refer Appendix 2
SITUATION 1: DETROIT AND PHOENIX EXPAND WITHIN THE SYSTEM





SITUATION 2: GROW IN CHICAGO BY ADDING CHICAGO-DAYTON





SITUATION 3: ESTABLISH BASE IN EAST COAST: KICK OFF FROM BALTIMORE





REVENUE 22158988.89
NET MARGIN 2740714.334
NUMBER OF
PASSENGERS
194377.0955
NPV 34251498.4
PAY BACK
PERIOD
1.576573362
REVENUE 31463996.68
NET MARGIN 570905.1022
NUMBER OF
PASSENGERS
642122.3813
NPV 6,634,766
PAY BACK
PERIOD
8.214306391
REVENUE 64719812.43
NET MARGIN 4146612.767
NUMBER OF
PASSENGERS
743905.89
NPV 51,321,417
PAY BACK PERIOD 1.051688724
Very high business connection
Many customers have been writing to Southwest to introduce a new Detroit-Phoenix Flight
Lots of retired individuals travel in this route and there are a number of passengers who would
stop by Phoenix and later stay on the flights till they reach their final destination
Easier to draw customers to this route
The only problem would be that the landing fees would be slightly higher than average Southwest
standards

Why Chose this Option?
Growth in Chicago
The Airport was in line with South west strategies of using uncongested airports
Room for expansion in future
Airport fees would be lower than Southwest as well as industry average

NPV and Payback period
The NPV for the third option is $51321417 and Payback period is 1.05 years and for the first option it is $34251498 and the Payback period is
1.57 years. So, in considering the risk and return factors, we chose the first option as best for south west airlines
ANALYSING THE RISKS: SENSITIVITY ANALYSIS


0
500000
1000000
1500000
2000000
2500000
3000000
3500000
4000000
Detroit- Phoenix
Worse
Detroit- Phoenix
Expected
Detroit- Phoenix
Best
0
1000000
2000000
3000000
4000000
5000000
6000000
7000000
Baltimore Worse
Baltimore
Expected
Baltimore Best
0
1000000
2000000
3000000
4000000
5000000
6000000
7000000
Baltimore Worse
Baltimore Expected
Baltimore Best
ANALYSIS OF RETURNS
QUANTITATIVELY:
As per our expectation Southwest can get a profit of $2740714 for Detroit route, $570905 for Dayton route and $4146613 for Baltimore
route. Though the expected profit is most for the third option but if we would see the range of worst to best situation; in the first option the
possible revenue outcomes would be between $18, 59,289 net Profits in the worse situation and in the best case it is $37, 56, 708. For
Dayton route, the Company can earn ($1, 92, 529) net profits in the worse situation and in the best case it is $15, 96, 325. For Baltimore
route, the Company can earn $22, 55, 947 net profits in the worst situation and in the best case it is $63, 94, 353.
Hence It is clear that range is highest in third option so instead of highest expected revenue it has the highest risk. While second option has
the least variation but the chances of giving negative returns in worst conditions is high. Hence first option seems to be best option.
QUALITATIVELY
They respond to customer requests and also keep up the Luv Culture Better Brand image and better connect with customers
SENSITIVITY ANALYSIS
South wests competitive advantage rests with pricing or providing services at low fares. From the sensitivity analysis, we come to know that
southwest can get the profit of $2740714 for Detroit route, $570905 for Dayton route and $4146613 for Baltimore route where the prices are
quoted at $114, $49 and $87. If the price war occurs in these places by the competitors of south west, the company can go for worse fares
and increase the revenue still in competing with their competitors. The reasons being:
Cost control activities adopted by South west such as- Cost cutting- Pilots contributing new ideas to save fuels, Fuel costs- Buying fuel
from vendors who offer best prices by carrying inventory if possible, Gate costs and landing fees- Average fee in small airports is $2.50, and
in small airports it is $2.00, No of departures- Maximum productivity of passengers through 20 departures a day, Low cost service- Offering
services at low cost as it was 7.3 cents per passenger
Risk analysis:-
From NPV and break even analysis we get the third option as the best as it has least period for break even and highest NPV. The first option
comes second and then the second at last. But this does not give us a holistic picture to make any suggestions right away. We should also
analyse the risk in a certain investment along with the returns. Some factors which would arise as risk factors are follows:
Operating cost
Fuel cost
Employee cost
Weather conditions
Choosing the best option:-
After going through the risk and return part will choose the best option. From return point of view it is very clear that third option we should
choose. It has $3.2 million NPV while first option has $2.4 million. Third option has only one major risk which is weather condition. Let see
how significant it is. Normal in and out time is 15 minutes for southwest airlines. It helps to reduce cost and save time also. This is a big
differentiating factor for them. In our options it is same expect for the last option which have 90 minutes time for in and out. This delay in
time by 6 times is very significant from cost as well as revenue point of view. Taking 10 O&D in place for one day, if 15 minutes is in and out
time then time for total 10 O&D would be 15*10*2= 300 minutes. If it increases to 90 minutes because of bad weather condition, then it
means in same day and same time we have only 300/90= 3 O&D is possible. It means decline of revenue to 1/3
rd
.
Due to more time for in and out there would be more fuel consumption which will lead to increase in cost. A flight from Detroit to phoenix,
which is around 1000miles, takes 3 hours to cover. It means a flight covers around 5 miles in one minute. So if flight has to wait for 90-
15=75 minutes more it means it will lost fuel equalling t0 75*5=375 miles.
It has given that per hour cost of operation of airline is $4000. So due to delay by 75 minutes operating cost will increase by
4000/60*75=$5000.
So after considering the risk part, third option gives negative returns as the revenue is declining and cost is increasing. So we will eliminate
the third option
RECOMMENDATION

Southwest should Chose the first option of expanding within the system since this options gives positive return, is less risky and also will help
the organization maintain its Luv Culture. This option will also improve their brand image as an airline carrier that cares not only for its
employees but its passengers as well.
This strategy also falls in line with their idea of controlled expansion.




APPENDIX 1: ASSUMPTIONS:
The loading factor is assumed to be 65% for expected demand and 55% for worst case and 75% for best case.
Growth rate for the trip is taken as average of last years quarter growth rate.
No of trips per day are 3 for Detroit phoenix route and 10 for other two routes.
The price ranges are taken from $99-$129 where the expected case is priced at $114 for Detroit phoenix route. The price ranges
are taken from $46.2-$54 where the expected case is priced at $49 for Dayton-Chicago route. The price ranges are taken from $74-
$100 where the expected case is priced at $87 for Baltimore- Chicago route
Operating cost excluding fuel and salary & wages are taken 43% of total revenue following last year proportion. Fuel cost would be
15% of total revenue and it would be reduced for first option as it is a more than 3 hour route.
To calculate salary & wages, total salary is divided by total employees to get salary per employee and then added for the additional
required route. Airport charges are charged by multiplying the number of charges to the no of passengers expected by its given rate
for the airport.
The expenses which are fixed and are common not considered for calculation. As the investment of two aeroplanes is common for all
options hence it was not considered to calculate cash flows.
For NPV, WACC is calculated on the basis of last year data. Tax rate, debt rate has taken from income statement while to find out cost
of equity we use dividend discount model (DDM). For DDM
The life of the project is taken as infinite because of investment done in airport which has the infinite life.
It is assumed that next year also expenses would be in same proportion.





Q1 Q2 Q3 Q4 Total
Demand(trips) 900 900.9 901.8009 902.703 3605.403601
No.of passengers 178.1 642122.3813
Revenue(price@49) 31463996.68
Operating cost
(Excludg Sal & Fuel) 13529518.57
Fuel costs 4719599.503
Sal & wages 11199199.01
Airport charges 1444774.5
Net Margin 570905.1022
Initial investment 54,500,000
PV of cash flow 7134765.908
NPV 6,634,766
Pay back period 8.214306391
Dayton
Q1 Q2 Q3 Q4 Total
Demand(trips) 270 271.89 273.793 275.71 1091.393013
No.of passengers 178.1 194377.0955
Revenue (Price@114) 22158988.89
Operating cost
(Excluding Sal , Fuel, Dep & land charges) 9528365.224
Fuel costs 2659078.667
Sal & wages 6647696.668
Airport charges 583134
Net Margin 2740714.334
Initial investment 54000000
PV of cash flow 34251498.4
NPV 34251498.4
Pay back period 1.576573362
Detroit-phoenix
APPENDIX 2: RETURN ANALYSIS




Q1 Q2 Q3 Q4 Total
Demand(trips) 900 990 1089 1197.9 4176.9
No.of passengers 178.1 743905.89
Revenue(price@87) 64719812.43
Operating cost
(Excludg Sal & Fuel) 27829519.34
Fuel costs 9707971.865
Sal & wages 21175943.73
Airport charges 1859764.725
Net Margin 4146612.767
initial investment 54,500,000
PV of cash flow 51821417.06
NPV 51,321,417
Pay back period 1.051688724
Baltimore



















Worse Expected Best
price/demand 543334 642122 740910
46.2 -192529 355152 902833
49 -9968.7 570905 1151779
54 316032 956179 1596325
Dayton
Worse Expected Best
Price/demand 629459 743905 858353
74 2255947 2986120 3716292
87 3237903 4146613 5055322
100 4219859 5307106 6394353
Baltimore
Worse Expected Best
Price/demand 164473 194377 224281
99 1859289 2303366 2747443
114 2229353 2740714 3252076
129 2599417 3178063 3756708
Detroit
Calculation of WACC
Income tax (given) 55816
revenue 146837
income tax rate 0.380122176
Percentage 38.01221763
Interest expenses 58941
Int exp(after tax) 36543.42
Debt capital 699123
Cost of debt 0.052270373 5.22704
Cash Dividend (per share) 0.053 calculation of growth
ROE*Retention ratio
Shares 92,472,755 0.09698
Total dividends 4901056.015
Equity capital 854253000
Cost of equity 0.102719433
WACC
wd*rd + we*re = 0.08002
Dividend discount model
APPENDIX 3: SENSITIVITY ANALYSIS

APPENDIX 4: WACC CALCULATION












APPENDIX 5: PORTERS FIVE FORCES ANALYSIS




















Supplier Power Balanced
The aircrafts were being
provided by Boeing that could
negotiate with the airlines at
higher prices
The power of the staff employees
which form a major portion of
the expenses varied according to
the type of person being
employed or presence of the
union.
Competitive Rivalry - High
The demand was inadequate to support the large number
of aircraft carriers
The airlines competed for the high traffic routes , hubs and
the airports
The presence of high fixed costs, high switching costs,
ability to differentiate and keep lower prices than others
also contributed to the high rivalry among the carriers

Customer Power High

Customers exercised high
bargaining power as he could
have easily switched to other
airline offering him a better
service at lower costs due to the
presence of a large number of
carriers at that point of time.
Substitutes - Low
The substitutes such as automobiles and railroads were present but could not affect southwest
airlines to a greater extent because the airlines was so positioned that the prices charged by the
airline were lower as compared to the total charges incurred in ground transportation.
Moreover the other substitutes as the airlines also posed a lesser threat due the difference in prices
at a higher side
Threat of new entrants Low
Product at Competitive Prices
Product Differentiation through adding FUN to Travel and low price
Cost disadvantages independent of scale: Southwest operated in all the uncongested airports and had committed
staff that made operational efficiency easy
Expected Retaliation in the industry from current industry players
Appendix 6: HOW DOES SOUTHWEST ACHIEVE STRATEGIC COHERENCE
HOW DO THEY DO IT?
The People:
Employees are motivated and completely dedicated towards achieving customer satisfaction
The airlines appointed people who were friendly and fun
Employee training focused on team building
They provided pension to the employees in form of profit sharing
Psychological satisfaction that they achieved while working there was enormous as compared to the salaries that they received
Customer Focused:
They believed in giving first preference to their customers over everything else and therefore came up with strategies which were well
suited to their customers.
They banked upon word of mouth of marketing and hence their customers were considered their ambassadors.
The Organizational Culture:
The airlines had a strong organizational culture that focused on getting a fun element within the organization.
Fun Element made work less tiring and fun
Boeing 737s:
South West Airlines made use of Boeing 737 jets only. They had around 150 of them in total and it accommodated around 137
passengers. The other competitors had a fleet that consisted of variety of planes made by Boeing, Airbus industries, etc. this helped
SWA on saving up on lots of cost and at the same time fast service delivery.
Limited Use of Travel Agents:
South West did most of its booking on its own
Travel agents had to contact the airline directly before booking the tickets for which they were paid standard 10% commission.
Only 55% of SWAs tickets were booked by the travel agents unlike the 90% average of the industry.
No Meals:
The South West airlines did not provide any meal to its customers hence saved up on the time of loading and unloading food on and
off the flight.
Reliance on Secondary Airports:
The airlines mainly relied on the uncongested airports in the small cities or less congested and smaller airports in large cities. This
prevented the passengers from transferring from Southwest to other flights and the same time saved time.
Flew Short Distances:
Southwest airlines generally flew short distances. The average length of a Southwest flight was 65 minutes. This helped in saving a
great deal of time and also enabled them in providing better service.
Turnaround Time of 15 Minutes:
The time taken to turn an aircraft was around 15 minutes which made Southwest differ from its competitors. The entire crew worked as a
team and made it happen which again helped in saving up time and thus enabled them in providing fast service to its customers.
Saved up on Fuel Costs:
The pilots contributed by coming up with new procedures for takeoffs and landings that helped saving a huge amount of fuel.
Buy fuel from different vendors depending upon the price being offered by them.