Organizational Pay Analysis:

A Case Study of Southwest Airlines

By: Aric Hall

Completed in Partial Fulfillment of the Requirements of
OM 5218 Managing Compensation and Rewards
Capella University
Spring 2008
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Abstract
Title
Organizational Pay Analysis: A Case Study of Southwest Airlines
Abstract
This report begins with an overview of Southwest Airlines, its strategies, and its compensation
and benefit structure. The author considers how the human resources department can use a
compensation strategy to strengthen the strategic and business strategy of the organization.

Hall, p. i
Table of Contents
Table of Contents

Organization Overview

Analysis of Strategy
SWOT Analysis
Rewards System
Role of Human Resource Management
Compensation and Benefits Strategy
Metrics Assessing the Effectiveness of HR

1
4
5
7
9
10

Conclusion

11

References

12

Hall, p. 1
Organization Overview
Southwest Airlines is known for its fun-loving corporate culture and its 32 years of
consistent profitability. The company has a unique strategy, and that strategy is implemented by
upper-level and functional managers. Human Resources has a key role in recruiting, hiring,
selecting, promoting, and training personnel who will be a good fit with the strategy and with the
fun-loving organizational culture.
Analysis of Strategy
Southwest Airlines was created in response to the high price of intra-Texas flights
(Freiberg, 1996). The airlines fares were originally set to compete with car and bus travel.
Over time, the little upstart would withstand time, legal challenges, a growing need for additional
capital, and would survive challenges with major air carriers. For the most part, Southwest is
still a no-frills carrier, not providing food, movies, reserved seats, or a first class. There service
strategy is based on a short-haul, point-to-point direct flights, accomplished with rapid
turnaround times. Given that strategy, Southwest has a strong majority of the market share in
those point-to-point markets.
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 (Mission,
2007). Southwest states that the customer comes second, because the employee comes first.
Southwest provides stability and equal opportunity for employee growth, and employees are
encouraged to be creative and innovative in solving organizational problems. Employees are
treated with the same respect and support they are expected to provide to customers in return.
The company has been ranked highly in employee satisfaction. As such, the organization must

Hall, p. 2
have a compensation and rewards strategy that supports this mission and customer service
strategy.
Southwest claims that their primary goal is to make air travel affordable to all (Freiberg,
1996). The market value of Southwest was at one point greater than all other airlines combined
(Gittell, 2003), and the airline was once called the most successful in history by Fortune. When
many airlines reduced routes, cut service, and laid off employees after September 11, Southwest
used their cash reserves and low debt/equity ratio to expand their low-cost model to new
markets. Southwests model benefits from good management-labor relations, fast turnaround
times at the gate, the faster speed of operations afforded by small airports, and that model
benefits from strong leadership, strategy, culture, and coordination.
Southwests functional strategy is to achieve competitive advantage, by offering the
lowest fares for comparable services or greater service. Strategy and operational effectiveness
may be applied differently in each company (Porter, 1996). Southwest uses a marketing strategy
of presenting itself as a low-cost leader, even though Southwest may not always be lowest.
Efficiency is achieved by doing more with less. Business-level strategy is composes of cost
leadership and service differentiation. The company is a cost leader, as they keep expenses and
consumer prices relatively low. They lead in differentiation through market segmentation, such
as the focus on point-to-point travel and marketing to cost-conscious business travelers. They
have distinctive competencies in offering necessary services without adding the cost of extras.
Corporate-level strategy can be accomplished in limited context in alliances and diversification
of operations. At Southwest that only exists with vendors and perhaps with diversity of
investment activities.

Hall, p. 3
Southwest does not have the luxury of manufacturers who can relocate to Mexico to
reduce costs. The company must operate domestically, and as such the company must continue
to provide wages and benefits commensurate with that demanded within the industry in the
United States. This can be a challenge to incur those greater costs and still be a low-cost carrier.
Over the years, major airlines have had to react to actions of the little airline. It would
seem that Southwest has exhibited a strategy of first entrant and first mover. This was done by
moving to new markets and buying up all gate space before competitors could. Creativity was
seen when Southwest was first to introduce ticketless travel. They serve half of the nation,
preferring to use the smaller airports to reduce costs and delays, while attracting a different
consumer niche. Southwest engages in a slow-growth or slow-expansion strategy where
competition is low (Company, 2004). This allows the airline to use its cash reserves and avoid
high debt obligations. Rather than using the common pricing strategy of lowering fares to cause
financial harm to the competitors, Southwest opted to make reasonably low fairs permanent to
prove profitability and build loyalty. The little airline that could has remained profitable through
airline deregulation, September 11, and through the bankruptcy of the competitors. They are
now on their 33rd year of profitability.
Porter (1996) wrote of positioning and needs-based positioning, and further discussed
tradeoffs that have to be made. Major airlines that tried to mirror Southwest without making
tradeoffs were not profitable. In addition to its slow-growth strategy, the company also does not
use travel agents, and for the most part has continued to avoid costs common to full-service
airlines. Southwest maintains its competitive advantage while avoiding the growth trap (Porter,
1996). But, they have held their competitive position with additional practices, such as investing

Hall, p. 4
heavily in fuel futures trading, avoiding price shocks during the summer or following terrorist
attacks.
In the future, Southwest could continue to use their cautious, cash-based approach to
expansion to build an even larger network of service routes. It could be possible to adopt another
alliance or code sharing partner, which they have done in the past, or merge or buyout other
small regional carriers. To a limited extent, Southwest could encroach on larger airports and
compete with major carriers, just to make more connections with the smaller airports.
SWOT Analysis
Southwest has several key internal strengths. It is a great climate and culture for
employees. It is considered one of the greatest companies to work for based on previous surveys
of employees. Employees are taught to help each other out and not get hung up on titles and
positions. Employees are given avenues to address grievances. Southwest also has a
consistently strong financial position, using high cash reserves for investments or emergencies.
Southwest also has an image of being fun-loving that attracts and maintains their customer base.
Southwest has few internal weaknesses. There may be an issue with a lack of unity in
decision making. Southwest does not pay low-level employees well, which could be seen as
negative in the lack of support for employees. However, that is offset by greater pay and
benefits for long-term employees. Simple things have led to strive, such as using actors for
advertisements rather than employees. There is a lingering fear of competition, due to the low
profit earned per passenger. There are also limited opportunities for advancement within the
company for the vast majority.
Southwest has external opportunities. There are additional markets that the company
could expand to. If a market is deemed to be expensive or would result in longer turnaround

Hall, p. 5
times, alliances could be made with other regional carriers. Regardless, there are markets that
are still not served by Southwest within the United States.
Southwest has long-standing external threats. There is always competitive risks, even
though Southwest uses distinctive service markets. New entrants into the airline industry is an
extremely low risk, due to the costs. However, mergers and takeovers of other airlines could
produce low-cost challenges to Southwest by those competitors. There is also some risk to
corporate raiders buying up Southwest stock to control management decisions, though employee
stock options limit that risk.
Rewards Systems
Southwest Airlines provides standard benefits that are common to most businesses
(Employee, 2007). This includes medical, dental, vision, and health coverage, with additional
coverage package options for family members (Benefits, 2008). Southwest provides time-off,
dependent care spending accounts, long-term care disability insurance, and a 401(k) retirement
savings plan. Less common benefits are profit sharing and stock purchase plans. Unique
benefits are space-available free flying privileges.
Profit-sharing is one way of linking compensation strategy to business strategy.
Southwests profit sharing program is designed to encourage employees to feel like they own the
place. Southwest encourages creativity and innovations from employees that will save time and
money. Employees are allowed to share in those profits, which encourages workers to apply
themselves. Such ideas include the ticketless travel idea and a determination by employees to
speed the turnaround times. Southwest calculated how much money would be wasted if a plane
spent more time at an airport and less time on a flight segment. Profit sharing provides
employees a motivation to increase speed of service, and therefore profitability.

Hall, p. 6
Southwest salaries are governed by contract, so specific and unique rewards may not be
possible for most rewards to individuals. However, Southwest does try to incorporate rewards
with a sense of pride and recognitions for jobs well done (Wilson, 1999). There could be a
greater use of perks, cash rewards, or some other benefit or opportunity of value. The
philosophy is to give top management a below-mean salary, yet to reward other managers with
an above-mean salary, coupled with stock options, thus allowing managers to share in the
profitability they create. It is a point of contention to have standardized salaries, since pay can
no longer be used as a motivation to excel. Individual-based pay leads to competition and a loss
of team-oriented behavior (Bergmann and Scarpello, 2008). On the other hand, profit-sharing
rewards the group and can lead to rewarding social loafers on that team who do not contribute.
Paying based upon the job rather than the individual is risky because it does not reward
for skill, worth, and actual work (Lawler, 2000). Human capital is key to organizations, as
organizations now consist of more professional people with greater education, experience, and
skill than in years past. Companies will be better able to retain those with the greatest talent if
they can pay based upon the individual and his market value. Pay needs to move from a
determination based upon job descriptions to being based upon a persons professional
development activities. Lawler (2000) suggests that organizations use personal descriptions, not
just position descriptions. A better reward system is individualized. A more contemporary
suggestion is a two-tiered pay system (Bergmann and Scarpello, 2008). This incorporates an
individual-based base pay, plus additional pay for the accomplishments of the whole team.
Total compensation includes pay, recognition, promotion and development opportunities,
and non-monetary benefits (Williams, 1999; Bergmann and Scarpello, 2008). The companys
strategy must incorporate a compensation strategy that rewards performance. This should

Hall, p. 7
include individual merit increases, spelling out what performance objectives must be met to
receive them. Southwest rewards employees, but individual rewards are limited to recognitions.
Total compensation must be individualized and should provide a wide array of potential benefits,
such as bonuses, recognition, promotions, training, and more.
Role of Human Resource Management
The human resource department has a critical role in recruiting, hiring, training, and
promoting individuals who fit with the strategy of Southwest Airlines. Further, the HR
department should take the role in assessing, evaluating, and redesigning the compensation
strategy to one that will promote business objectives. HR managers are only one voice, and it is
essential to assemble a management team who can support each other in designing the new
scheme. HR has greater latitude regarding its hiring procedures and in socializing new
employees (Gomez-Mejia, Balkin, and Cardy, 2007), and those new hires must be compatible
with the new pay structure.
Employees have lost faith in the management line, take care of the company, and the
company will take care of you. Through layoffs, firings, downsizing, scandals, hiring the
wrong managers, and for various lesser reasons, employees have lost faith in business.
Individuals are focused on developing their own career, regardless of which company or
companies it will be with. Employees look for development, training, and advancement
opportunities. With this in mind, HR managers must look for options in training employees,
providing job rotations, or providing other services that will have a vested interest in the
employee, all while strengthening the company. These factors must be considered in
compensation planning.

Hall, p. 8
The best people seek out the best employers. Talented individuals know who to work
for, in the interest of career potential. Job seekers will seek out an employer with the greatest
potential to provide name, image, and development opportunities. Such individuals may be
willing to start with lower pay, just for the potential for advancement and additional
opportunities. HR planners must consider a long-term approach to career planning and
compensation strategy. Employees are looking for training, job rotation, job enrichment, and
training opportunities, in addition to pay and benefits (Gomez-Mejia et al., 2007).
HR is also responsible for identifying great performers. Employees are interested in the
best company, and the company must market itself for the best employees. As part of this talent
management (Rodriguez, 2007), HR must continuously evaluate workers to see if they still fit in
the organization and where they would perform best. HR is also responsible for talent retention,
keeping great performers in the company. Many organizations are looking for star performers
(Chambers, 1998). The war for talent, and talent retention, can be one through an aggressive
compensation, benefit, and career development plan. Employees flow through an organization
and through a career (Rodriguez, 2007). Compensation and opportunities helps the organization
retain the talent it has invested so much in.
Southwest must continue to market its culture, and should also market its jobs
(Chambers, 1998). Attracting the right managers and staff will help continue the organization by
building a team that reinforces corporate values. HR should keep workers interested by giving
them new opportunities before employees demand them. As part of the strategy, the
organization might consider the opportunities for advancement. No pay package will keep
employees in a company, if seniority will bar them from advancement. Some other organization
will be looking to extract that talent.

Hall, p. 9
Compensation and Benefits Strategy
There must be an increased effort to reward individuals. Southwest does not technically
pay based upon performance, since pay is set by union contracts (Flynn, 1995). The company
motivates employees to perform through its culture and the promise of more benefits upon
achieving higher positions. Even if pay contracts limit monetary increases for individuals, there
are still many options as far as cash bonuses, recognition, or training opportunities (Bergmann
and Scarpello, 2008). Performance bonuses may range from pay, bonuses, allowing more
telecommuting work, or other opportunities that interest employees (Compensation trends,
2006). Higher level employees have shown increased interest in benefits such as flextime, time
off, and more time for family matters (Davolt, 2006). Companies may spend less time and
money on internal training and instead rely on a saturated applicant pool to provide specialized
skills and experience (Hansen, 2001). New strategies may focus more on job redesign, or on a
strategy that is based upon competitiveness. Lawler (2000) recommends individualized pay
plans. Personnel must be flexible in sharing their roles, but paying for how the individual
produces. That would be threatening to a team-based or profit-sharing approach. Companies
may tend toward fixed pay, or position-based pay, if individualized pay leads to increased claims
of discrimination or inequality. As it is, pay is largely fixed due to labor contracts.
Southwest must adopt a two-tier pay system, rewarding both individuals and teams
(Bergman and Scarpello, 2008). This will encourage individuals to excel, and will offset the
risks of social loafers on teams. Further, team members will have the continued opportunity to
complain about team members who are merely a burden.
Southwest must acknowledge the trend toward a strategy of total compensation
(Zingheim and Schuster, 2002). Employees are looking for more than just money. Skilled

Hall, p. 10
workers look for opportunities for advancement and growth. Further, a genuine concern for
employees, which Southwest already exhibits, will produce loyalty and improved performance
for years to come. Other valuable incentives may include: job security, contracts, or guarantees
of term employment (Gelinas, 2005). Compensation strategy must produce the desired results
and support the business strategy (Nelson, 1998). Southwest Airlines is an example of how an
organization can maintain a competent workforce and a supportive culture without having a
highly paid total force (Nelson, 1998).
Metrics Assessing the Effectiveness of HR
Southwest can conceivably verify the effectiveness of their compensation and reward
efforts. HR personnel may use a combination of surveys, observations, and performance
measures. The best considerations may come from retention numbers and the assessments of
performance by higher-level managers. Employees may report on their satisfaction with the new
plans or identify areas that need to be improved. HR should also set objective criteria to evaluate
performance, retention, absenteeism, turnover, and other statistics that compare current
employment trends under the new plan with those that existed previously. Each assessment or
metric must show positive results and an explanation for those results (Fit-enz and Davison,
2002).
The HR department, or what Southwest refers to as its People Department, will establish
quantifiable metrics for its objective assessments. This should connect customer satisfaction,
speed, performance, number of complaints, and other quantifiable measures to the benefits
provided under the new and old schemes. The People Department will hire and reward
employees based upon the most important objective measure, which is the improvement in
customer satisfaction (Cook, 2007). They also identify those who are supporting other

Hall, p. 11
employees and encouraging them. Likewise, managers and personnel submit complaints against
those who refuse to help other employees or who are rude to employees (Freiberg, 1996).
Southwest is not crazy about paperwork. They would rather address employee issues in brief,
face-to-face sessions. In all, the greater compensation, or non-monetary benefits, will go to those
who increase performance measures, customer satisfaction, or an improved workplace
environment.
HUMAN RESOURCES
BALANCED SCORECARD
Objective:

Measure/Assessment

Customer Satisfaction

Surveys
Complaints

Employee Satisfaction

Internal Complaints System

Absentee Rates
Time with Company
Time til Promotions
No. & Type of Recognitions Given

Employee Fit

Suggestions Made
Interview Employees Regarding Satisfaction with Pay
and Benefits

Operations

Turnaround time, changes in

Load Factors / No. of Vacant Seats

Conclusion
Southwest Airlines has reached the point of being well established. Changes to the
compensation strategy would likely require support of management and unions alike. However,
there would be additional benefit gained by creating additional options for rewarding individual
performance while still rewarding the team effort. HR managers are best suited to research the
needs and desires of employees in this area, and then to design an ideal compensation scheme
that is built on mutual participation.

Hall, p. 12
References
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Hall, p. 13
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Hall, p. 14
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