Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES

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Southwest Airlines An analysis of the factors of motivation, culture, leadership and structure Ryan Abbott ORG580 Dr. Becky Takeda-Tinker In partial fulfillment of the Master of Management Degree Colorado State University-Global Campus December 2009

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Table of Contents
Chapter I-Introduction Introduction and Background .................................................................................................................. 5

Leadership and Management Theories ............................................................................ 8 Key Factors ...................................................................................................................... 9
Research Sources ...................................................................................................................... 10 Chapter II- Literature Review Organizational Design and Structure ...................................................................................................... 11 Early Theorists........................................................................................................................... 11 Modern Theorists ...................................................................................................................... 12 The Systems Approach .............................................................................................................. 13

Power and Leadership............................................................................................................... 14 Power ............................................................................................................................ 14 Fiedler s Contingency Model ......................................................................................... 15 Path-Goal Theory .......................................................................................................... 16 Organizational Culture .............................................................................................................. 16 Culture Theory .............................................................................................................. 16 Types of Culture ............................................................................................................ 18 Human Relations Management ................................................................................................. 20 Motivation .................................................................................................................... 20 Job satisfaction .............................................................................................................. 21
Chapter III- Methods Introduction .......................................................................................................................................... 22

Theoretical Framework ............................................................................................................. 22 Outcomes ................................................................................................................................. 24
Chapter IV- Application and Analysis Introduction .......................................................................................................................................... 26

Industry Analysis ....................................................................................................................... 27 Power and Leadership............................................................................................................... 31

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Organizational culture ........................................................................................................................... 34

Human Relations Management ................................................................................................. 36
Chapter V- Summary and Recommendations

Summary .................................................................................................................................. 39
Appendices Southwest Airlines Mission Statement ................................................................................................... 41

Corporate Structure .................................................................................................................. 41 Capital Asset Pricing Model (CAPM) .......................................................................................... 45
Weighted Average Cost of Capital (WACC) ............................................................................................. 46

Ratio Summary-Table 1 ............................................................................................................. 48 Working Capital Management .................................................................................................. 49
Income Statement ................................................................................................................................. 50

Balance Sheet .......................................................................................................................... 52 Cash Flow.................................................................................................................................. 54
Income Statement-10 Year Summary..................................................................................................... 56

Balance Sheet-10 Year Summary............................................................................................... 57
References References............................................................................................................................................. 58

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES Abstract

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Southwest Airlines is the current low-cost leader in the air travel industry, taking care to keep costs down in every aspect of day-to-day operations, which allows them to pass the savings on to customers, resulting in higher returns for investors. This report details the factors that are plausible to the success of Southwest Airlines, examining their strategic structure, analyzing their leadership and culture, and discussing the company¶s human relations aspect that motivates and satisfies a vast workforce across the United States. These key points are all considered important indicators of an organizations health through this analysis.

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CHAPTER 1 Introduction and Background Early endeavors from the Romans to the Egyptians where groups of people were organized and led to accomplish a planned task exhibited some of the earliest principles of management theory. From Frederick Taylor and the scientific management principles he espoused to the 14 Principles set forth by Henri Fayol and the theoretical constructs of organizational behavior and the systems approach, management has evolved and adapted with the times to varying degrees of success (Robbins & Coulter, 2007). The simplest term of managing as defined by Robbins & Coulter (2007), is to coordinate and oversee the work activities of others to complete a task efficiently and effectively and has changed little since the Romans and Egyptians. However, the ideas of management have varied but the simple definition remains constant. What then constitutes a good management theory? How these groups are managed, successfully or not, is often up to the manager or leader of the group. Some argue that leaders are born and not made while others take an opposing view. In any light leadership can make or break a company. The top leadership in any organization should set the course the organization shall take and embody that organizations culture. What they do and what they say are important and should be seen as important by those within the organization. Through their actions and words leaders can shape the culture within the organization and perpetuate its success or failure (Spector, 2007). A leader, according to Robbins and Coulter (2007), ³is someone who can influence others and who has managerial authority.´ (p.488) ³Leadership is what leaders do. More specifically, it¶s the process of influencing a group to achieve goals´ (Ibid). To be an effective change agent a leader needs to focus on driving the

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mission and vision of the organization that must be embodied in the culture of the organization through management control efforts and a transformational style of leader. Through a strong and visionary leader an organization can lay out its vision, mission, and execute a plan that embodies the whole of the corporation that will allow it to accomplish great endeavors. ³Strategic planning is a process that involves describing the organization¶s destination, assessing barriers that stand in the way of that destination, and selecting approaches for moving forward. The main goal of strategic planning is to allocate resources in a way that provides organizations with a competitive advantage. Overall, a strategic plan serves as a blueprint that defines how the organization will allocate its resources in pursuit of its goals´ (Aguinis, 2009, p.51). This blue print is driven in large part by the leadership and the overall mission of the organization. A mission statement can be used to guide the organization and define its overall culture; however, it is the CEO and other senior corporate officers that must set the tone at the top. The mission statement represents the goals the company will strive to achieve and the commitments it has made to its various constituents-employees, shareholders, customers, and others´ (Epstein, 2009, p. 71). From the top leadership the mission and vision are borne that drives the company¶s plan and its culture. According to Aguinis (2006), a mission statement summarizes the organization¶s most important reason for its existence and provides insight into the purpose and scope of the organization as a whole. ³Every organization has a mission, a purpose, a reason for being. Often the mission is why the organization was first created-to meet a need identified many years ago. Sometimes, the same problems that the organization initially tried to address continue to haunt generation after generation. In that case, the organization¶s purpose does not

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change-although how it does business has probably evolved. Other times, even 10 or 20 years can change the landscape so markedly that the original mission must be updated, altered, or changed dramatically in order to address those new realities´ (Radtke, 1998, p.1). Through effective leadership an organization can have a strong culture. Organizational culture is defined as ³A pattern of shared basic assumptions that the group learned as it solved its problems of external adaptation and internal integration that has worked well enough to be considered valid and therefore, to be taught to new members as the correct way to perceive, think, and feel in relation to those problems´ (Schein, 1992). This culture is borne of the vision and mission and can serve as a motivating factor for the organization. Through a strong culture that is espoused through the visionary leader, employees feel a sense of security and satisfaction. This safe cultural harbor exists to motivate the employees to accomplish great tasks as a family or clan.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES Leadership and Management Theories

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Like any solid structure an organization needs to be built upon a solid foundation. Just as the Romans and Egyptians great building projects, every organization since that time has exhibited certain characteristics of management from planning, organizing, leading and controlling. From the early theories of classical and scientific management, Fayol¶s 14 principles and Weber¶s theories, to the more modern and progressive thinking¶s of McGregor¶s Theory X and Y (1960) to the systems approach, management theories and principles abound and create the organizations that have driven global expansion. How an organization is designed, its structure, and corporate governance are all considerable assets to the organizations overall effectiveness and strength. An organization can have a strong foundation based upon any management theory and still not be effective if the leadership is not effective. Power and leadership in organizations are carried out in a variety of manners. Leaders have been overseeing the execution of work since the Romans and Egyptians. The manner in which they lead and utilize their power in a transformational manner or through use of coercive efforts illicit a response in the followers that ultimately determines the effectiveness of the organization. This effectiveness is in large part due to the culture that the leader creates and the followers are willing to accept (Vecchio, 2009). Culture, however, is not a new concept, it has been present since before the Romans, yet our understanding of how it is applied and exhibited within an organization is new as modern management theories are concerned. From Fiedler¶s (1974) early ideas on the topic to the groundbreaking works of Schein, organizational culture and its constructs are a new paradigm in viewing how organizations are effective. However, the fundamental concept of how leaders approach an organization and lead and control the followers and how the culture can contribute

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to employee morale, loyalty and motivation, have a lasting impression on the success or failure of the organization. It is human nature to have needs that must be satisfied; hunger, love, safety, acceptance, etc. (Maslow, 1954). These needs are also manifested in how we are motivated and the satisfaction generated from being productive and working (Herzberg, 1966). Yet, to be a truly motivated and satisfied worker and member of an organization, leaders have to foster a spirit of inclusiveness and bestow rewards upon their employees, either in an intrinsic or extrinsic fashion. Through a strong culture employees are afforded a satisfying need to be part of the larger family or clan aspect of the organization, and many employees have found incentive in varying degrees and forms to contribute to the organization to further its continued success, as well as the employees. This study will analyze Southwest Airlines and the forces that have contributed to its successes, financially and otherwise, from the overall leadership of the organization through management theories and organizational design constructs that have allowed the airline to create a culture that has motivated followers and created continued success. Key Factors The key factors for this study assume that the basic theories of management hold true in the organization selected, that is: do the organizational constructs based upon the founders philosophies contribute to the overall success of the organization? It is assumed that the culture created through the leadership within the organization has contributed to employee motivation that has forced the organization down the path that the leaders had intended. If this is then the case is it the leader, the followers, or other mitigating factors that have created the success?

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES Research Sources Many of the underlying premises for this study are found in the basic textbooks of

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graduate school coursework on management, organizational behavior, and leadership theories. Though not exhaustive or complete, the works of many theorists that have been examined for this analysis come from the textbooks and many were developed through a more thorough effort to conduct research from the primary sources. This analysis has focused on the seminal works of the likes of Maslow, Herzberg, Fiedler, Schein, Kotter, Vecchio, and Bass who have all contributed to theories in organizational management, behavior, leadership, and social psychology. The selected airline and its industry are the noted figures of this analysis and industry specific research will be conducted to the effectiveness of the corporation selected.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES CHAPTER 2 Literature Review Organizational Design and Structure

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The historical context of organizational design and management has been around since organized endeavors have planned, organized and directed activities such as the building of the pyramids of Egypt, the Roman aqueducts, and the Great Wall of China. Through the ages different approaches to management were developed and refined from scientific/classical management and general administrative or human relations theory to the theories of systems approach and the contingency model (Robbins & Coulter, 2007). As America became more industrialized and advanced the management theories evolved to reflect growing trends in society and business. The newer theories by McGregor and Drucker, Theory X/Y and management by objectives respectively, grew from the early classical thinking¶s of Frederick Taylor and his 4 principles of management and Henri Fayol¶s five functions of managers (Robbins & Coulter, 2007). Early Theorists Early theorists in the classical school of management theory introduced concepts that are still heavily utilized in organizations to this day. Henri Fayol introduced the five critical elements that all managers in organizations must do: plan, organize, command, coordinate and control, many of these ideas are basic tenets that managers rely upon in the strategic planning process in today¶s modern organizations. Fayol¶s five functions coupled with his 14 principles, that included division of work; the scalar chain; equity; and esprit de corps (Robbins & Coulter, 2007), laid much of the groundwork for the ensuing theorists to base their principles of management theory upon. Through Fayol¶s theories the practical application of a manager¶s

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work could be categorized into functions for employees and the organization (Stanley, 2004). Fayol¶s principles and theories during the day were widely heralded as a new paradigm in management theory and adapted and adopted in many fields. Building upon Fayol¶s theories, Max Weber established the idealization of bureaucracy within an organization. This concept espoused that organizational form should be considered through the division of labor, hierarchy, rules and regulations, and impersonal relationships (Robbins & Coulter). Weber¶s theory grew out of the thought of controlling the organization much like the 14 principles of Fayol. This control was an idealized version of the organization and the constructs of bureaucracy to ³emphasize rationality, predictability, impersonality, technical competence, and authoritarianism (Robbins & Coulter, 2007, p.33). Weber¶s theory grew out of the authoritarian and impersonal Gilded Age of the late 19th century that saw the expansion of industrialization and wealth in the United States ³his theory became the model structural design for many of today¶s large organizations´ (Ibid). It was through Fayol and Weber¶s theories that a new paradigm in the management field was growing in a post industrialized nation would continue to be heavily utilized, adapted, and adopted over the next century. Modern Theorists The underpinnings of modern theory date back to the theories of the classical or scientific management school of thought and the teachings of Fayol and Weber. However, the modern theories of McGregor and the systems approach grew out of a transitional period in post war America during the 1960s. McGregor (1960) initially posited in his Theory X that ³the average human being has an inherent dislike of work and will avoid it if he can´ (p.33). This theory¶s roots lie in the early works of Fayol and Weber and their espousal of a strict authoritarian control

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of the division of labor within organizations. However, as McGregor (1960) stated ³to some, the preceding analysis will appear unduly harsh. Have we not made major modifications in the human resources of industry during the past quarter century?´ (p.45). With this paradigm shift, McGregor began to examine the human dimension and its influences on the overall affect on management and the organization. As McGregor (1960) stated, ³there is no question that important progress has been made in the past two or three decades. During this period the human side of enterprise has become a major preoccupation of management´ (p.45). It was through this new ³preoccupation´ that McGregor posed his new theory, labeled theory y, which was vastly different than that of theory x and ³assumes that people will exercise self-direction and self-control in the achievement of organizational objectives to the degree that they are committed to those objectives ³(p.56). Through his theories McGregor instituted a paradigm shift that still held the classical underpinnings that organizations were based upon authority and the division of labor, however a new dimension to organizational effectiveness based upon human relations entered the equation. The Systems Approach Building upon the natural evolution of organizational theories, the systems approach grew from the theories in both the natural and physical sciences (Mullins, 1999). This new approach to organizational behavior examines the organization as a system, according to Gibson, et al. (2009) that consists of a ³grouping of elements that individually establish relationships with each other and that interact with their environment both as individuals and as a collective´ (p.19). Through the systems approach, expanding upon the concepts of Fayol and other earlier theorists, the organization is viewed as a whole operating machine that consists of inputs and creates outputs through the process of transformation (Robbins & Coulter, 2007). In this new

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approach all facets of the organization are integral to its successes. ³What this means is that the managers coordinate work activities in the various units of the organization, they ensure that all these interdependent units are working together so that the organization¶s goals can be achieved´ (Robbins & Coulter, 2007, p. 38). In short the manager has to have the power to exercise his influence across the whole of the organization and establish goals and lead the organization towards those goals. Power and Leadership Power Organizational design and structure are fundamental components to the success of an organization; however, power and leadership at the top can be critical to the success of the organization. Authority and power demand respect and can be garnered in numerous different ways, from legitimate, coercive and referent, power is the cornerstone of how leaders shape the structure and culture of the organization. The power exerted by a leader can be a driving force in the culture and motivation of employees One of the early theorists on authority in organizations, Max Weber, posited that organizations were one of three distinctive authority types; traditional, charismatic, and bureaucratic, and that superiors within the organization base their power over subordinates upon these constructs (Mullins, 1999). In the traditional sense authority is ³legitimized by custom and a long standing belief in the natural right to rule´ (Ibid, p. 96). Others feel that through ³formal rules and procedures´ that the bureaucratic authority is established. Yet, others feel that, as Weber alluded to, authority is based upon the ³belief in the personal qualities of the leader´ (Ibid, p.96). From early theories on authority, such as Weber¶s, the thinking on power and leadership has been a growing field within management theory that has garnered much attention.

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Power is exhibited differently by different people throughout an organization. However, the style and tone should be set at the top and filter down through the organization. This style and tone can have different consequences based upon the power exhibited by top leaders in the organization. If a leader is to lead in the legitimate sense then they would automatically have power based upon their position within the organization. Subordinates are a critical component to legitimate power in the fact that if they do not see the power or authority as ³legitimate´ then they are more apt to not follow the figure (Gilley, 2006). If power is not legitimatized then other approaches must be taken through coercive actions. Coercive power, as Gilley (2006) states ³is the ability to punish others´ and ³some subordinates may comply because of fear´. This power structure may seem contradictory to common leadership practice; however, it is effective in compliance and corrective action issues and managers often utilize this style when large numbers of employees comprise the organization (Gibson, et al. 2009). However, it may be that many of the individuals in a large organization are influenced by a leader due to their personality or behaviors that may be more common or referent to those within the organization (Gibson, et al. 2009). As Gilley (2006) articulates referent power ³is based upon a personality or style of behavior marked by charisma and personal magnetism that easily attracts admiration and appeal´ (p.23). It is through this type of power and leadership style that the exceptional leader can establish trust and loyalty in his followers and throughout the organization. Fiedler¶s Contingency Model It was through the early work of Fred Fiedler that the ideas of leadership were poised to take shape through the leaders¶ style and situational factors. As Robbins & Coulter (2007) argue, ³ Being an effective leader requires not only an understanding of traits and behaviors, but an

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understanding of the situation in which the leader is attempting to lead, as well´ (p.493). It was Fiedler who argued for two styles of leadership in task-oriented leadership and relationship oriented leadership. Through these two models the personality was the cornerstone to which model was employed by the leader and the fact that leader cannot employ both models. ³Individuals in leadership positions will be more comfortable, sincere, and effective practicing the leadership behavior that supports their own underlying personality´ (Robbins & Coulter, 2007, p.321). It was through Fiedler¶s work that the idea of leader-member relations, task structure, and position power were first posed. Through these thinking¶s, much like the idea of the power of authority a leader exhibits in an organization as proposed by Weber, these models contend that a leader leads with confidence, trust, respect and important structures of subordinates jobs through the amount of power they exhibit through their position (Gibson, et al., 2009). The power structure from the early thinking¶s of Weber had progressed to be more inclusive in Fiedler¶s contingency model as to the personality that the leader exhibits and how that is carried out through the goals he sets within the organization. Path Goal Theory As Gibson et al. (2009) argued, like other leadership approaches such as Fiedler¶s contingency model the path-goal leadership model assumes how leaders are effective in different situations based upon their effect on their follower¶s. As Robert House developed the early model of path-goal he espoused that ³leaders are effective because of their positive effect on follower¶s motivation, ability to perform, and satisfaction´ (Gibson, et al. 2009, p.325). The effectiveness of the leader through the path-goal theory has been broken into four distinctive behaviors: directive which proposes that subordinates know what is expected of them; supportive

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in the fact that the leader treats subordinates as equals; participative leaders offer suggestions and ideas to subordinates to reach a conclusion; and achievement-oriented leaders who set goals and have expectations of subordinates (Gibson, et al. 2009). The path-goal method takes a charismatic and transformational leader that can set goals and motivate their followers to achieve those goals and those of the organization (Robbins & Coulter, 2009). The transformational leader stimulates and inspires followers to achieve outcomes through establishing goals and objectives (Robbins & Coulter, 2009). This type of leadership style is built largely upon the transactional leader style however it does not espouse legitimate authority over the followers to accomplish goal. Transformational leadership according to Gibson et al. (2009) espouses an internal reward factor in the followers through the leader ³expressing a vision, the transformational leader persuades followers to work hard to achieve the goals envisioned´ (p.354). It is through the path-goal model that the transformational leader motivates his employees to become followers as they gain an intrinsic value which creates a strong culture within the organization allowing it to grow and accomplish great things. Organizational Culture Culture Theory Theories surrounding culture have been prevalent in various disciplines such as anthropology, psychology and sociology (Bass, 2006). However, as Hofstede argues, ³culture is a construct, that means it is µnot directly accessible to observation but inferable from verbal statements and other behaviors and useful in predicting still other observable and measurable verbal and nonverbal behavior´ (Vecchio, 2007, p.484). Yet, this latent phenomenon has a potent impact on an organization through the shared values, thoughts, perceptions, and behaviors of individuals and the organization (Schein, 1999) as a whole that the leaders and followers either

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accept or reject as the overriding force of the organization. As Schein (1999) highlighted, culture ³exists at several ¶levels¶, and that we must understand and manage the deeper levels´ (p.15). It is through this examination that you can then understand the multifaceted concept of culture; deep, broad and stable. As Gibson et al. (2009) argue strong cultures emerge in an organization when the employees share and accept the values and behaviors that are portrayed throughout the organization and have a greater impact upon employee satisfaction and motivation. Types of Culture As Fiedler (1974) asserted, the emphasis placed upon the individual as the basis for the examination of organizational climate ³has been on interpersonal aspects of the situation´ (p.57), he also states that some writers have identified its components as the degrees of managerial support, concern for new employees, and conflict within or between departments of the organization. Others have defined organizational climate as including organizational constraints and red tape, the degree to which the employee has independence to make decisions, the nature and frequency of rewards, challenge and risk, and warmth of support´ (ibid). This breaks down the generalization of organizational cultures into various types. Types of culture based upon Fiedler¶s analysis and the theory posited by Schein show that the individual is a large component of the general property of organizational culture. The various types of culture; bureaucratic, clan, entrepreneurial, and market, all are based upon the individual¶s perception of the shared values and norms within the organization and how they are neatly classified into those categories. In the bureaucratic cultures as Gibson et al. (2009) argued, the individual prefers rigidity and hierarchy and can easily identify with the formal rules and procedures that are prevalent in organizations such as the military. For

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individuals who prefer less formal authority and align themselves with the rituals, traditions and sociability of the organization may prefer the close knit familial unit of the clan culture according to Gibson. Yet, others, as Fiedler argued, may like independence and autonomy and prefer the entrepreneurial culture that allows them to set goals and take risks (Gibson, et al. 2009). However, others prefer the market culture and its reliance on the bottom line and profitability and has little effort from individuals given towards teamwork (Ibid, 2009). Regardless of the type of culture that is prevalent within an organization the tone must be set from the top. According to Smith & Vecchio (2007), ³the founder of a company, or small group of founding members who start a firm, can play a particularly important role in the development of an organizations culture´ (p.494). It is the philosophy of the founders and the norms, beliefs, stories, and rituals that they establish at the onset that become the lifeblood of the organization and its culture. Myths and stories, as Gibson (2009) stated ³are the tales about the organization that are passed down over time and communicate a story of the organizations underlying values´ (p.39). Myths coupled with the rituals, or ³recurring events or activities that reflect important aspects of the underlying culture´ (Gibson 2009, p.39) can create a strong culture based upon the founders¶ role in affirming the myths and rituals within the organization. As Gibson (2009) states ³older strong culture organizations have established stories, use symbols, conduct rituals, and even use their own language. In a strong culture organization, the core values are widely shared, respected, and protected´ (p.39). Through the founders¶ vision and the establishment of rituals and traditions the culture is poised to be well received by the employees who will be more motivated and find satisfaction in their jobs within this strong organizational culture.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES Human Relations Management

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Human relations and performance management are critical components to the success of any organization. According to Aguinis (2009) performance management is an ongoing process that involves several components that are closely related and that human capital is the greatest asset to any organization. How this capital is managed and motivated and they find satisfaction in their job is part and parcel to the continued success of the organization. Motivation Motivation of an individual is a challenging task as each individual has different needs and feels motivated based upon different internal factors (Robbins & Coulter, 2007). From the earl theories of Maslow (1954) and his hierarchy of needs that espouse that an individual needs to have certain basic requirements (food, shelter, etc.) met in order to be motivated to the more modern theories of goal-setting that posit that an individual needs to have specific goals proposed to them and their performance is based upon the rewards associated with the assigned task which allows them to be motivated (Robbins & Coulter, 2007). Motivation can be achieved through assigning tasks to an individual that are rewording and allows them to receive satisfaction from their job. As previously outlined, groundbreaking work as to the organizational design as posited in McGregor¶s (1960) theory y is also a construct in how employees are motivated. Theory y ³assumes that people will exercise self-direction and self-control in the achievement of organizational objectives to the degree that they are committed to those objectives ³(McGregor, 1960, p.56). If, as McGregor argues with his Theory Y the amount of control given to the employees is abundant then the motivational factor is even greater which allows the employee to do their job with great satisfaction.

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Job Satisfaction Job satisfaction is a critical component of employee motivation. Through satisfaction with their job an employee is motivated to continue to strive to accomplish tasks that were set out for them. As Gibson, et al. (2009) contend, job satisfaction involves many factors of how an individual perceives their work environment; from a supervisors style, working conditions, and benefits. Yet, there are ³five crucial characteristics´ according to Gibson, et al. (2009) that encompass the generalization of job satisfaction that include; ³pay, job, promotion opportunities, supervisor, and co-workers´ (p.106). These key factors may be a determinant of an employee¶s ability to be motivated and be productive and do a satisfactory job. This satisfaction in turn can then create customer satisfaction which makes the organization viable and increases the bottom line.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES CHAPTER 3 Methods Introduction

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This study will analyze Southwest Airlines and the forces that have contributed to its successes, financially and otherwise, from the overall leadership of the organization through management theories and organizational design constructs that have allowed the airline to create a culture that has motivated followers and created continued success. Through the theoretical constructs of organizational design, culture, leadership, and human motivation this analysis will examine how organizations can function and thrive. Theoretical Framework This analysis is based upon the construct that the theories examined are all interconnected in some fashion; whereby form follows function in a sense from the thinking¶s of modern theories that were based upon classical thought in the development of organizations. If there is a breakdown in any of the manners of theoretical areas within the organization, that of the leader/follower, structure, culture, and system, then an overall failing of the organization may result. Through the organizations strategy and its mission, goals, and objectives propelled by top leadership, as set forth through the founders principles, has established the overall philosophy and governance of the organization that determines its future performance. Southwest Airlines, from its inception, has run like a well oiled machine to ensure that all pistons-leadership, system, culture, etc.-are working in concert. Through the founders principles, Southwest has adhered to and maintained their core philosophy and strategy that has driven the company and created their continued success

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All humans, according to Maslow, have basic needs that must be met for an individual to feel satisfied. This ideal is one construct of the larger human relations management theory and movement. It has often been said that human capital is the greatest asset to any organization (Aguinis, 2007). This need of satisfaction for the greatest asset in the organization is typified in the motivation and incentives of an employee¶s job. It is through this motivation and satisfaction that employees feel as they are a valuable and integral part of the organization. This then creates employee loyalty to the organization and a sense of belonging to a group of like individuals. The culture that has thrived, and continues to so, at Southwest is legendary and an almost cult-like religion. From this familial clan unit and the fostering of the group cohesiveness from the employees at Southwest are afforded great satisfaction and motivation from and through their peers and leaders. This group of individuals within the organization that feels valued creates a sense of strong culture within the organization (Schein, 1999). This strong sense of culture that stems from the motivation and satisfaction of the individuals and is often reflective of the organizations leadership allows the leaders to exert their power and control over the followers. Leadership and power are reflective of the overall strengths, traits, and behaviors of an individual (Robbins & Coulter, 2007) and how they apply these traits and utilize their power to exert influence in either a negative or positive manner. Much thought has been given to leadership and how leaders lead over the ages and the impact they have on their followers. Through an effort to extol power over someone in a coercive manner through punishment to the charismatic transformational leader that enables the followers to feel value (Vecchio, 2009) the context of the organizations design and culture can be shaped by the traits and behaviors the leader exhibits. It is through this analysis of the leadership style within the organization that the key factor may be determined that the leaders set the tone of the organization and allows the

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followers to create a strong culture and in essence a strong organization. The accolades for both Southwest Airlines and its founder and former CEO, Herb Kelleher, are many. Through Kelleher¶s charismatic, flamboyant, and zany personality that exudes confidence and is brimming with fun, no other leader could have created organized, lead and sustained in as legendary a fashion as Kelleher. Many theories abound regarding organizational design and management; from the classical thinking¶s of Fayol and Weber to the more modern theories that have a human dimension to them as McGregor alludes to in his theories, the design and function of an organization can be the catalyst for the organizations successes or its failures and its ability meet the bottom line and create value. It is through the strategy and implementation of the overall mission, goals and objectives of the organization through the chosen system and management philosophy that the organization in essence can determine its own fate as to its future continued success. This analysis will examine the mission and structure of Southwest Airlines and its simple strategy for organizational management and how they have contributed to the overall success of the organization. The simple strategy that was instituted in the beginning has been a cornerstone for the continued successes at Southwest and in the airline industry that has befuddled many that have tried to imitate it to little avail. Outcomes Through an examination of the theoretical constructs as described this analysis will attempt examine the leadership style and their foundations and the constructs and the implementation in the organization and how these theories affect the culture through the motivational aspects of the employees which in turn generates profits in a value added environment. Through analyzing Southwest Airlines and their innovative culture and the industry

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norms in which they operate a conclusion should be evident as to the financial outcomes of the organizations.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES CHAPTER 4 Application and Analysis Introduction Southwest Airlines is a low-cost domestic airline headquartered in Dallas, Texas,

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servicing primarily leisure travelers on short-haul routes. Southwest currently operates 520 of the 737 type aircraft serving 411 nonstop city pairs (Datamonitor, n.d.). While the airline¶s primary customer base is the leisure traveler, they also provide airline service to business travelers, as well as, limited freight transportation. The story of Southwest Airlines began in 1967 as a diagram on a cocktail napkin, however it would be years before the airline would take flight in 1971. Southwest Airlines began as the brainchild of Rollin King, a San Antonio entrepreneur, and Herb Kelleher, a prominent San Antonio lawyer who saw a need to create a regional airline that served the Dallas, Houston, and San Antonio triangle (Freiberg, 1996). Through the visionary style and leadership of cofounder and former CEO Herb Kelleher, Southwest Airlines has had a remarkable flight path in terms of corporate and financial success. The simple corporate structure and legendary culture of Southwest was borne out of Kelleher¶s visionary leadership and his willingness to go the extra mile and do the right thing that has set the mission for Southwest. The airline has countless stakeholders that depend on and affect the success and viability of the organization. The airline is customer and employee oriented; therefore these two groups unarguably have the greatest stake in the airline. Customers depend on this airline to provide discounted, competitive travel options and have come to expect above par customer service. As a result, a large part of the airline¶s success is a consequence of ³their commitment to providing the highest level of customer service with pride and caring´ (Rhoades, 2006, p. 542). This

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unrelenting commitment to customer service has enabled the airline to build and maintain a loyal customer base, ensuring future success. Southwest¶s successful flight path was driven by discipline that is instilled in the mission, vision, values, and culture that embodies Southwest Airlines that has lead to a company that has been profitable for more than 35 years while maintaining a core philosophy and strategy that has endured through economic downturns carried out through brand loyalty to ensure the customers low fare no frills air transportation with a fun loving spirit and zany attitude. Industry analysis Few inventions have changed how people live and experience the world as much as the invention of the airplane. Since the first flight by the Wright brothers at Kitty Hawk in 1903 to the creation of interstate routes and international travel with jumbo jets, the airline industry has seen enormous growth and staggering competition. The airline industry exists in an intensely competitive market. Not only from within but without as well, through auto and bus travel competition. According to Investopedia, ³The airline industry can be separated into four categories: International - 130+ seat planes that have the ability to take passengers just about anywhere in the world. Companies in this category typically have annual revenue of $1 billion or more. National - Usually these airlines seat 100-150 people and have revenues between $100 million and $1 billion. Regional - Companies with revenues less than $100 million that focus on shorthaul flights. Cargo - These are airlines generally transport goods.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES Southwest airlines originally began as small regional airline in the Texas Triangle

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between Houston, Dallas, and San Antonio and grew to national prominence with deregulation in 1978 that allowed them to fly interstate routes. Through focusing on a regional/national definition of airline travel and keeping costs low and offering little product differentiation (to both customer and supplier) Southwest has changed how the industry operates. Gone are the days of the larger corporation dictating price and service. Southwest has done well to set them apart from the competition in the industry and has consistently ranked among the tops in the industry several years running in on-time records, fewest customer complaints and misplaced bags (Freiberg, 1996). This success has been achieved through Southwest¶s adherence to their core principles and believing in themselves and their customers. From their humble beginnings, scratched out on a cocktail napkin, to becoming the most successful and profitable airline within the industry, Southwest Airlines has found a recipe for success that many others cannot imitate, the key to success at Southwest has been due to unrelenting discipline. ³Southwest Airlines recipe for success is really no secret at all. Throughout its existence, Southwest has consistently adhered to a clearly defined purpose and a well-thought-out strategy for accomplishing it. As simple as it sounds, Southwest Airlines exists to make a profit, achieve job security for every employee, and make flying affordable for more people´ (Freiberg, 1996, p.49). Much of the success was borne from the simple vision and strategic plan set forth by the founders. The founders believed the key to corporate success lie in discipline and simplicity; flying one type of aircraft, a horizontal structure, flying short routes. This simplicity coupled with the values that drive the corporation have been the recipe for success at Southwest for more than 35 years.

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³From the beginning, Kelleher, then a board member and the airline's chief counsel, was Southwest's "master strategist"11 and led development of its point-to-point, intra-Texas, discounted fares for business travelers. Southwest considered the automobile its primary competition, and priced its flights to present a faster, more convenient alternative to driving. Its 1971 premier flight from Dallas to Houston cost $20 per ticket. The cheap fares were revolutionary. Other airlines charged three times as much. To make money on such low fares, the upstart airline was very strict on minimizing costs. From the beginning, that meant no frills. As time went on, those cost savings expanded to include a fast turnaround - 10 to 20 minutes in and out of the gate. Since then, Southwest's business model hasn't changed. Its planes have never served a meal and the 20-minute-turnaround is a Southwest hallmark. As a result, Southwest's costs are 22% below the industry average. Its operating margins (16.5%) are triple the industry average´ (ANBHF). The competitive advantage that Southwest Airlines has within the industry is in part due to the vision set forth by the founders and largely through the horizontal and functional corporate structure that has been created and maintained at Southwest. ³Kelleher's strategy, broadly stated, was low cost, low fare, and strong-but-manageable growth to yield high profits. Specifically, Southwest appealed to customers with affordable, enjoyable, reliable service and made that service profitable through tight cost controls and high capacity utilization. At the heart of it all -the key to the successful implementation of cost controls, great service and 20- minute turnarounds -- were Southwest's employees´ (ANBHF). Southwest Airlines has provided an excellent opportunity cost to investors over its 30 plus year history. In examining the Principle of Risk-Return Trade-Off according to Emery, Finnerty, and

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Stowe (2007), Southwest Airlines has proven to be a lucrative investment vehicle compared to others in the industry. It has fared better than the 5- and 10-year T-Bill rates that were 1.09% and 2.96% respectively, in comparison with The Standard and Poor Index (S&P 500), which yielded 5.27% for the 10-year period of 1998 to 2007; 6.72% for the 10-year period of 1997 through 2006; and 7.07% for the 10-year period of 1996 through 2005. (See Appendix- Capital Asset Pricing Model Analysis). Much of the advantage at Southwest has been placed upon the simple philosophy of one aircraft, low fares, no frills. Another strategy was the manner in which the corporation was governed and the span of control that was exhibited form Herb Kelleher at the top down to the front line workers. ³After the supervisory level, Southwest has a single layer of middle management (directors) before the Vice President level. Unlike the major airlines there is no geographic breakdown of management responsibility. The Vice Presidents hold responsibility for specific functions such as: Special Marketing, Schedule Planning, Properties, Fuel, Treasury, Purchasing, Maintenance, Customer Relations, Reservations, Marketing, Ground Operations, Legal, Labor Relations, and Planning. Each Vice President reports to one of eight Senior Vice Presidents. In turn, each SVP reports to one of two Executive Vice Presidents, one for Customer Operations and the other for Aircraft Operations. The two Executive Vice Presidents, along with Southwest¶s president (whose duties are mostly related to investor issues and public discourse) report to Gary Kelly, CEO´. (Leavenworth) Much of the success at Southwest has been from the value they have placed upon their employees. Yes, they are in business to make a profit, however, how those profits are made,

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according to the Southwest Spirit, are through valuing the human side of the enterprise and placing a greater emphasis on the employees and how the organizational structure operates around them and their continued successes. Human capital at Southwest has been the driving force behind the overall success of the organization. As McGregor (1960) argues in his Theory Y, ³people will exercise self-direction and self-control in the achievement of organizational objectives to the degree they are committed to those objectives´ (p.56). This has been the embodiment of the core values of Southwest since Herb Kelleher first scribbled his idea on a cocktail napkin; allow the people great latitude and the company will prosper. Power and Leadership The success of any organization at times depends upon the top leadership within the organization. There is a sense that a truly great leader can set the tone and empower those around him to carry out the mission and vision he has sought for the organization. Herb Kelleher, cofounder and former CEO, of Southwest Airlines has been argued to be one of the greatest organizational leaders in the past century through his continued successes at Southwest. Kelleher has accomplished this through his articulation of power through his personality and charismatic behavior. This behavior and personality have allowed Kelleher to persuade and motivate his followers to accomplish the goals and vision of the organization. ³Some may attribute Southwest¶s success to its dynamic CEO and founder Herb Kelleher, who has been honored as the most admired CEO in the USA by his employees. Herb would attribute it to other factors, such as the people who work for Southwest Airlines. Both seem to admire each other, as evidenced perhaps by Southwest Airlines¶ turnover rate, which is the lowest in the U.S. airline industry´ (Avolio & Bass, 2002, p.13).

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Authority and power demand respect and according to Weber can be exerted over those in organizations in various ways, from legitimate to coercive and referent, power is the cornerstone of how leaders shape the structure and culture of the organization. The power exerted by a leader can be a driving force in the culture and motivation of employees and much of the power that a leader has over his followers is driven by the leader¶s charismatic style. ³Southwest¶s culture also emphasizes small supervisory spans of control compared to the major airlines. For example, Southwest president Colleen Barrett claims that the major airlines have 30 to 40 front-line workers to each supervisor whereas Southwest has only 8 to 9. A Southwest supervisor is on the job to help the 8 or 9 front-line employees do their jobs better, not police the duration of someone¶s lunch hour. The supervisors at the major airlines perform largely administrative functions. ³Like most airlines, Southwest¶s horizontally coordinated ground employees must work under tight time schedules and high stress. Contrary to its competitors, Southwest has not created a flat organization based on individual performance managed under low supervision like those of its competitors. These flat individual structures tend to lend themselves toward excessive finger pointing and ill will among employees. Rather Southwest has created a horizontal organization based on cross-functional teams to diffuse blame, with adequate staffing to provide coaching, feedback, and learning´ (Leavenworth). Much of the success that Kelleher has created at Southwest he has attributed to the employees within the organization. ³Although there are many similarities among successful and effective leaders, there are also wide differences in attitudes, beliefs, and behavior. Successful leaders get their followers to follow them; effective leaders motivate and enable their followers

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to reach shared goals. Such leaders create a sense of alignment and direction that is shared by colleagues and followers´ (Avolio & Bass, 2002, p.11). Kelleher has always had a shared vision, purpose, and values for the organization he cofounded. ³If you study the people who participate in dynamic leadership relationships, you will find that the majority of them never set out to be great leaders. Rather, they set out to pursue a purpose, a cause, or a calling that was worthy of giving it everything they had´ (Freiberg, 1996, p.308). Kelleher has shown through his more than 35 plus years of leading Southwest by example that his vision and leadership style have resonated throughout the whole of the organization to make Southwest what it is today. ³At Southwest Airlines, leadership is practiced through collaborative relationships. The people of Southwest Airlines work in relationships where the roles of leader and collaborator are interchangeable. Essentially, leadership is something leaders and their collaborators do together. The relationship between leaders and collaborators at Southwest Airlines is based upon commitment, not compliance. Leadership isn¶t some sophisticated technique for getting people to do what you want them to. Leadership is getting people to want to do what you want them to do.´ (Freiberg,1996, p.299). This, in essence has been the key success of Kelleher¶s leadership at Southwest, to allow the employees to be part of the solution and lead the company through collaborative efforts. It has always been Kelleher¶s belief that he is not the lone ranger, or sole leader, of Southwest Airlines. He has empowered the more than 35,000 people within the organization to become collaborators in leading the success of Southwest Airlines. This has been accomplished through Kelleher sharing a vision, mission, and higher purpose with those ³collaborators´ and allowing them to forge ahead to make Southwest Airlines the success it has become. Through

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Kelleher¶s dynamic leadership he has empowered the employees and created a culture that allows the leaders to ask the employees to accomplish great things even at a cost. Organizational Culture The leadership at Southwest has set the tone at the top that has allowed a robust culture to thrive within the organization. As Smith & Vecchio (2007) have argued ³the founder of a company, or a small group of founding members who start a firm, can play a particularly important role in the development of an organizations culture´ (p.494). This thinking is highly evident at Southwest Airlines through the visionary leadership that co-founder Herb Kelleher created. The culture at Southwest Airlines has become legend within the corporate world and many have tried to copy it and its successes to little avail. ³The idea of corporate culture is too important to the effective functioning of today¶s organizations to be dismissed as a fleeting craze. Culture is the glue that holds our organizations together. It encompasses beliefs, expectations, norms, rituals, communication patterns, symbols, heroes, and reward structures´ (Freiberg, 1996, pp.144-5). The culture at Southwest has been embodied in the ³Southwest Spirit´ that is the driving force behind the company¶s success. The strength of the company rests on the strong and robust culture that embodies the ³Southwest Spirit´. Much of the culture can again be traced back to the founder¶s principles and the values that Herb Kelleher envisioned to be the integral part of the organization. ³In all organizations, formal and informal values, philosophies, and norms interact and overlap to create the fabric we call µculture¶. Southwest is no exception. Southwest¶s values, philosophies, and norms are so tightly meshed that they have created a µthick¶ culture´ (Freiberg, 1996, p.146). To this end Southwest has gone to great lengths to ensure the culture remains strong and viable.

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Much of the vision and values has been set forth in the mission statement at Southwest Airlines. This mission statement drives the culture as a founding document that ensures the employees are an integral part of the organization and its successes and are highly valued. As Hofstede observed, culture is an intangible thing that can only be inferred through verbal statements on a piece of paper. It is through these verbal statements, the mission at Southwest Airlines, that the culture is created and it is through the non-verbal cues that the culture at Southwest thrives. Much of the success of Southwest is directly attributed to the culture, the culture that founder Herb Kelleher inadvertently created through his vision and values. However, one man alone cannot create an overt culture that drives the organization. The clan culture that has been instilled at Southwest grew in part out of Kelleher¶s vision but also due to the nature of the mission and the service the employees were providing to customers. This culture, as Fiedler and Schein argued, grew through interpersonal aspects of individuals and an eschewing of bureaucracy and red tape. ³According to Southwest¶s corporate philosophy, bureaucracy exhausts the entrepreneurial spirit, slows the organization down, and constrains its competitive position. That is, bureaucracy creates a mindset of dependency, which makes people do what they are told but no more. Rather than encouraging employees to assume ownership and responsibility, bureaucracy teaches them to transfer responsibility´ (Freiberg, 1996, p.76). To ensure that the culture at Southwest Airlines remains strong and robust the organization created the Culture Committee in 1991 to ³convey an understanding of the history, spirit, and culture of Southwest to new hires and fellow employees´ (Haasen & Shea, 2003, p.98). It was through the Culture Committee that the spirit of Southwest has been embodied and the norms, rituals, vision and value have empowered the culture climate to foster ownership and responsibility in the organization that promotes job satisfaction and motivation.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES Human Relations Management

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A vital aspect of Southwest¶s success has been due in part to the stakeholders; its 31,000 employees working throughout the country (Hardage, 2006). The airline¶s mission to provide unprecedented customer service could not be accomplished without equally committed employees. While Southwest is similar to other airlines in that it is highly unionized, they have overcome this potential obstacle through a commitment to providing flexible contracting and a trusting relationship between the various unions and Southwest management (Rhoades, 2006). Of the many benefits offered to Southwest employees, profit sharing is perhaps the most significant benefit available to employees. The practice of profit sharing benefits ensures employees have a vested financial interest in the airline¶s success. As Aguinis (2009) human capital is one of the most important assets that an organization has. Through motivation and job satisfaction this capital can be a considerable asset in the overall success of the organization in financial and other terms. Southwest has taken great caution in managing the greatest asset the organization has. Though they are in business to creaete a profit and increase the bottom line, Southwest has considerable return on investment when it comes to the emphasis placed upon the employees within the organization. As Herb Kelleher argued in a Ney York times article, ³We¶ve never had layoffs, we could have made more money if we furloughed people. But we don¶t do that. And we honor them constantly. Our people know that if they are sick, we will take care of them. If there are occasions or grief or joy, we will be there with them. They know that we value them as people, not just cogs in a machine´ (Nocera). Kelleher ³recognized that good employee relations would affect the bottom line. He knew that having employees who wanted to do a good job would drive revenue and lower costs´ (Nocera).

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While airline customer satisfaction continues to decline on most major domestic airlines, Southwest¶s commitment to increasing not only customer satisfaction, but the satisfaction and well-being of their employees, is perhaps the most compelling reason to research this company. The nation¶s current financial crisis makes it all the more important to understand the foundation that has contributed to the airline¶s success. Southwest has proven that an airline can not only be successful, but can also cater to one of their most important stakeholders, their customers. With many airlines instituting baggage fees, reducing the amenities available to customers, as well as the number of service areas available, Southwest has continued to flourish. It is important to grasp an understanding of the strategies employed by Southwest, the corporate culture contributing to their success, as well as, the airline¶s operations and the impact of each on the financial viability and success of the airline.
³Most major airlines, for example American Airlines, focus intensely on individual accountability. Negative focus (stimulus) accompanies the delays in the form of a manager who seeks to find out who caused the delay and why it occurred. The bigger the stakes, the more people involved. If a mistake causes planes to miss their intended connection in another city, then a minor mistake adds up to millions of lost dollars. If this scenario occurred inside of American Airlines, it was said that former CEO Robert ³Crandall wanted to see the corpse´ of the employee who make the mistake. Therefore, while the customer was alleged to be the center of focus, it was really the negative repercussions to the employee. Southwest¶s culture emphasizes teamwork over individual effort. Southwest uses a procedure called ³team delay´ which is a less precise reporting of the cause of delays with the goal of diffusing blame and encouraging learning. The team delay is used to point out problems between two or three different employee groups in working together. For example, if customers were still in the jetway at departure time, then the delay was declared a station

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delay. If customers were on-board at departure time, then it was a flight crew delay. During a team debriefing, all members of the crew would meet to determine the cause of the delay and learn how not to have it happen again. Southwest headquarters emphasizes the theme of ³learning from mistakes.´ (Leavenworth). Southwest Airlines believes that the employees are a major priority and the driving force behind the success of the airline. It is through the emphasis that has been placed upon the employee from the founder principles that Herb Kelleher set out to foster in the organization that have created the strong and robust organizational culture that has motivated the employees to accomplish great deeds in often uncanny ways.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES CHAPTER 5 Summary

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Every organization has many constructs to carry out how they function and do business. Yet, the underlying principles of the organization involved in this study are to increase the bottom line. How the organization is successful in accomplishing this task and remaining a viable corporate entity is carried out through various theoretical constructs that have permeated organizational management and leadership for millennia. The thoughts of the early theorists of how to define, compartmentalize and lead organizations are still inherent in the way organizations are operated in this day age. The dramatic shift over the course of centuries has gone from a predetermined focus on the organization to the more human side of the enterprise and that of the capital asset of employees and their motivation and satisfaction as the driving force of the organization. How the organization in this analysis operates is fundamental to how the employees are treated within the organization and lead by the top leadership. Southwest Airlines conducts business in a highly competitive industry where new entrants are gaining market share every year. However, the strategies that have lead to Southwest Airlines success have been fundamental to them retaining the majority of the market share and continuing to be a viable organization. This has been driven not by the bottom line but from an extraordinary charismatic leadership style that has placed a great emphasis on how the bottom line is achieved through the asset of human capital. The success of the organization has been driven in large part due to the success that the founder, Herb Kelleher, has instilled and ensured through his vision and leadership. From the founders principles and Kelleher¶s simple strategy Southwest has had a remarkable flight path that has enable it to be a driving economic force through turbulent times and remain the organization that Kelleher set out to create.

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For Southwest to remain a viable organization and retain their market share they need to ensure that they adhere to the mission and vision that Kelleher set forth for the organization more than 35 years ago when he scribbled his idea on a cocktail napkin. Southwest¶s vision through Kelleher¶s charismatic and zany leadership style that he set forth for the organization is the momentum that has sustained the organization through deregulation in 1978 to the post 9/11 world that saw many airlines cutting services and staff. Southwest must maintain the momentum that Kelleher had created to remain the success story that it has been for 35 years.

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Appendix Southwest Airlines Mission Statement 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. We are committed to provide our Employees a stable work environment with equal opportunity for learning and personal growth. Creativity and innovation are encouraged for improving the effectiveness of Southwest Airlines. Above all, Employees will be provided the same concern, respect, and caring attitude within the organization that they are expected to share externally with every Southwest Customer (southwest.com).

Corporate Structure
Directors
David W. Biegler Chairman of the Board Estrella Energy L.P. Retired Vice Chairman of TXU Corp. Dallas, Texas Audit, Compensation (Chair) and Safety and Compliance Oversight Committees C. Webb Crockett Attorney Fennemore Craig, Attorneys at Law Phoenix, Arizona Executive and Nominating and Corporate Governance (Chair) Committees Gary C. Kelly Chairman of the Board, President and Chief Executive Officer Southwest Airlines Co. Dallas, Texas Executive Committee

Nancy B. Loeffler Longtime advocate of volunteerism San Antonio, Texas Compensation Committee

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William H. Cunningham, PhD James L. Bayless Chair for Free Enterprise University of Texas at Austin Red McCombs School of Business Former Chancellor of The University of Texas System Austin, Texas Presiding Director Audit, Compensation, Safety and Compliance Oversight and Executive Committees John G. Denison Former Chairman of the Board Global Aero Logistics Inc. Plano, Texas Audit Safety and Compliance Oversight (Chair) Committees Travis C. Johnson Attorney at Law El Paso, Texas Audit, Executive (Chair), and Nominating and Corporate Governance Committees

John T. Montford Senior Vice President State Legislative Affairs Western Region AT&T Services, Inc. San Antonio, Texas Audit (Chair), Compensation and Nominating and Corporate Governance Committees

Daniel D. Villanueva Partner RC Fontis Pasadena, California Compensation and Safety and Compliance Oversight Committees

Honorary Designations
Herbert D. Kelleher Chairman Emeritus Southwest Airlines Co. Dallas, Texas Colleen C. Barrett President Emeritus Southwest Airlines Co. Dallas, Texas

Officers
Gary C. Kelly* Chairman of the Board, President and Chief Executive Officer Robert E. Jordan* Executive Vice President Strategy and Planning Kevin M. Krone Vice President Marketing, Sales and Distributio

Teresa Laraba Vice President Ground Operations

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Ron Ricks* Executive Vice President Corporate Services and Corporate Secretary Michael G. Van De Ven* Executive Vice President and Chief Operating Officer

Chuck Magill Vice President Flight Operations

Jan Marshall Vice President Technology and Chief Information Officer

Ginger C. Hardage* Senior Vice President Culture and Communications Daryl Krause* Senior Vice President Customer Services Jeff Lamb* Senior Vice President Administration and Chief People Officer Dave Ridley* Senior Vice President of Marketing and Revenue Management Greg Wells* Senior Vice President Operations

Pete McGlade Vice President Schedule Planning Bob Montgomery Vice President Properties Rob Myrben Vice President Fuel Management

Lori Rainwater Vice President Internal Audit

Tammy Romo Vice President Financial Planning

Laura H. Wright* James A. Ruppel Senior Vice President Finance and Chief Financial Officer Vice President Customer Relations and Rapid Rewards Gregory N. Crum Vice President Director Operations Darren Dayley Vice President Technology, Customer Experience Portfolio Matt Hafner Vice President Ground Operations Mike Hafner Vice President Inflight Services Scott Halfmann Vice President Safety and Security Joe Harris Linda B. Rutherford Vice President Communications and Strategic Outreach Mike Ryan Vice President Labor Relations

Jim Sokol Vice President Maintenance and Engineering Scott E. Topping Vice President Treasurer Ellen Torbert Vice President Customer Support and Services Chris Wahlenmaier

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Vice President Labor and Employee Relations Laurie Hulin Vice President Technology, Aircraft Operations & Enterprise Management Portfolios Madeleine Johnson Vice President General Counsel Leah Koontz Vice President Controller

Vice President Ground Operations Kathleen Wayton Vice President Strategy and Change Leadership

Kay Weatherford Vice President Revenue Management and Pricing Bob Young Vice President Technology and Chief Technology Officer

*Member of Executive Planning Committee

(southwest.com)

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Capital Asset Pricing Model (CAPM) For any shareholder to invest in a company there is always some degree of risk. However, there is a risk return trade off according to the principle. If an investor can invest the same amount of money and earn an amount that is equal to what the current T-Bill rate is through the United States Treasury then they are safer, and smarter, to invest in this ³risk-free´ manner. If the investor believes they can earn at a greater percent than the T-Bill rate and also greater than the index in the market they are investing in, then they would be wise to invest in the company. The Capital Asset Pricing Model (CAPM) allows an investor to wisely decide on their investment portfolio and the amount of risk they are going to take. The equation for calculating the expected return an investor must receive to undertake the investment is: , whereby rj is the required return, rf is the riskless return (or the amount of the T-Bill comparison), rm is the risk premium (or the market index average return over a period of time), beta can be found on many investing websites online such as www.msnmoneycentral.com or www.m.Morningstar.com. The CAPM for an investor that wants to invest in Southwest Airlines can be found by utilizing this equation and the 10-year T-Bill rate of 2.96%, the S&P 500 10 year average of 5.27% and the beta of .99 obtain from www.msnmoneycentral.com. Thus,

=

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=2.96+2.29 =5.25% The CAPM for Southwest Airlines is 5.25%. An investor could expect to earn a return on their invest of 5.25% which is greater than the riskless return if investing in T-Bills at 2.96% and is comparable to the average market premium return of 5.27% with the S&P 500. However, in looking at the weighted average cost of capital (WACC) for Southwest Airlines, the burden is spread out amongst the investors so they all share in a constant average. Yet, the leveraging factor influences the amount of risk borne by each investing group based upon the risk factor of the airline (Emery, Finnerty, and Stone, 2007). The average cost of capital and the burden of debt and equity are leveraged across the board to determine the required amount and risk, on both debt and equity for the investor. In looking at the WACC equation for Southwest Airlines, the leveraging of the debt and equity factor must be determined. This can be obtained utilizing the Balance Sheet (Exhibit B) and examining the total liabilities ($9,355,000,000) and the total equity ($4,953,000,000) of the firm. Therefore L= $9,355,000,000/ ($9,355,000,000 + $4,953,000,000) which equates to 65%.

= (.35).35 + .65 (.65).65 =.12 + .27

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES = .39 or 39%

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This calculation reveals that Southwest Airlines has a weighted average cost of capital of 39%. Financial Performance As exhibited in Table 1 featured below (Morningstar.com, msnmoneycentral.com, Emery, Finnerty, and Stowe), Southwest Airlines has shown steady performance over the past 5 years. In the categories that data was provided for the industry average, Southwest has beat the average in nearly all categories. While examining the ratios, it is to be found that the current ratio for FY08 is 1.03, which allows the assets in Southwest¶s portfolio to cover their liabilities by a factor of 1. This has shown consistent over the 5 year period. Equally debt/equity and the quick ratios hold constant over the same period. However, to increase this ratio Southwest needs to undertake a greater capital contribution campaign to boost liabilities while at the same time increasing inventory.

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Table 1: Southwest Airlines Ratio Summary

2004 Debt/Equity Ratio Current Ratio Quick Ratio Leverage Ratio 0.31 1.01 0.73 2.05

2005 0.21 0.94 0.72 2.13

2006 0.24 0.9 0.69 2.09

2007 0.3 0.92 0.63 2.42

2008 0.74 1.03 0.72 2.89

IndustryCurrent year 1.34 1.3 1.3 3.4

S&P 500Current Year 1.02 1.3 1.1 2

Gross Margin Net Margin Return on Assets Return on Equity P/E Interest Coverage

52.50% 52.60% 49.50% 46.20% 59.80% 4.79% 7.23% 5.49% 6.54% 1.61% 2.95% 4.29% 3.61% 4.27% 1.15% 5.92% 8.98% 7.60% 9.63% 2.99% 0.31 8.2 0.21 8.7 0.24 12.1 0.3 11.5 0.74 4.3

N/A N/A N/A N/A 10.6 N/A

N/A N/A N/A N/A 13.5 N/A

Southwest Airlines has consistently shown a profit over its more than 35 years in the regional airline industry. This is evidenced in the gross margin that ranges from a low of 46.2% to high of 59.8% over the 5 year period. This allows Southwest to continue its operations and ³keep the gates open.´ This, coupled with their net margin, allows Southwest to make a profit year after year. The profit margins have permitted investors to grow their portfolios with relatively little risk over the life of the corporation and the last 5 years. However, it should be noted, as shown in the FY08 Return on Assets and Net margin amounts that the airline has seen considerable retraction in the amount of profits the company or investors are seeing. This should hold true as the economy is dwindling and Southwest¶s fuel hedging program costs increase.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES Working Capital Management

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Emery, Finnerty and Stowe describe trade credit as a standard business-to-business courtesy between suppliers and buyers (2007, p. 649). Typically, companies will pay for goods or services upon actual delivery of the goods or services, with added incentives for faster repayment in the form of discounts ± one way to increase short-term financing (Emery, Finnerty & Stowe, 2007, p. 648). Southwest has a downloadable publication on its website, detailing its policies on procurement and consideration of potential suppliers. The publication clearly states: We pay suppliers on time and in accordance with our contractual agreements when products or services have been received and we are presented with an accurate invoice. An accurate invoice bears the appropriate purchase order number and must match the purchase order in all material respects (n.a., 2008, p. 4). Additionally, Southwest Airlines is the only airline to currently hold an ³investment´ grade credit rating, which must be at least ³BBB+´ or higher according to the Standard & Poor¶s and Moody¶s. However, Standard & Poor¶s placed a credit watch on this rating as a result of Southwest¶s 2009 first quarter loss of $91 million (Loyd, 2009). The future direction of the economy and fuel prices will ultimately determine Southwest¶s fate.

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES

50

INCOME STATEMENT
2008 Period End Date Period Length Stmt Source Stmt Source Date Stmt Update Type 12/31/2008 12 Months 10-K 2/2/2009 Updated 2007 12/31/2007 12 Months 10-K 2/4/2008 Updated 2006 12/31/2006 12 Months 10-K 2/1/2007 Updated 2005 12/31/2005 12 Months 10-K 2/1/2007 Restated 2004 12/31/2004 12 Months 10-K 2/1/2007 Restated

Revenue Other Revenue, Total Total Revenue

10,694.00 329 11,023.00

9,587.00 274 9,861.00

8,884.00 202 9,086.00

7,412.00 172 7,584.00

6,397.00 133 6,530.00

Cost of Revenue, Total Gross Profit

8,590.00 2,104.00

7,235.00 2,352.00

6,311.00 2,573.00

5,186.00 2,226.00

4,637.00 1,760.00

Selling/General/Administrative Expenses, Total Research & Development Depreciation/Amortization Interest Expense (Income), Net Operating Unusual Expense (Income) Other Operating Expenses, Total Operating Income

0 0 599 0 0 1,385.00 449

0 0 555 0 0 1,280.00 791

0 0 515 0 0 1,326.00 934

0 0 469 0 0 1,204.00 725

0 0 431 0 0 1,058.00 404

Interest Income (Expense), Net Non-Operating Gain (Loss) on Sale of Assets Other, Net Income Before Tax

0

0

0

0

0

0 -92 278

0 292 1,058.00

0 -151 790

0 90 779

0 -37 339

Income Tax - Total Income After Tax

100 178

413 645

291 499

295 484

124 215

Minority Interest Equity In Affiliates U.S. GAAP Adjustment Net Income Before Extra. Items

0 0 0 178

0 0 0 645

0 0 0 499

0 0 0 484

0 0 0 215

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES

51

Total Extraordinary Items Net Income

0 178

0 645

0 499

0 484

0 215

Total Adjustments to Net Income Preferred Dividends General Partners' Distributions Basic Weighted Average Shares Basic EPS Excluding Extraordinary Items Basic EPS Including Extraordinary Items Diluted Weighted Average Shares Diluted EPS Excluding Extrordinary Items Diluted EPS Including Extraordinary Items Dividends per Share Common Stock Primary Issue Gross Dividends - Common Stock Interest Expense, Supplemental Depreciation, Supplemental

0 0 0

0 0 0

0 0 0

0 0 0

0 0 0

735 0.24 0.24

757 0.85 0.85

795 0.63 0.63

789 0.61 0.61

783 0.27 0.27

739 0.24 0.24

768 0.84 0.84

824 0.61 0.61

806 0.6 0.6

804 0.27 0.27

0.02

0.02

0.02

0.02

0.02

13 105 599

14 69 555

14 77 515

14 83 469

14 49 431

Normalized EBITDA Normalized EBIT Normalized Income Before Tax Normalized Income After Taxes Normalized Income Available to Common Basic Normalized EPS Diluted Normalized EPS

1,048.00 449 278 178 178

1,346.00 791 1,058.00 645 645

1,449.00 934 790 499 499

1,194.00 725 779 484 484

835 404 339 215 215

0.24 0.24

0.85 0.84

0.63 0.61

0.61 0.6

0.27 0.27

Source: msnmoneycentral.com

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES

52

BALANCE SHEET
2008 Period End Date 12/31/2008 2007 12/31/2007 2006 12/31/2006 2005 12/31/2005 2004 12/31/2004

Stmt Source Stmt Source Date Stmt Update Type

10-K 2/2/2009 Updated

10-K 2/4/2008 Updated

10-K 2/1/2007 Updated

10-K 2/1/2007 Restated

10-K 2/4/2005 Updated

Assets Cash and Short Term Investments Cash & Equivalents 1,803.00 1,368.00 435 Short Term Investments Total Receivables, Net Accounts Receivable Trade, Net Total Inventory Prepaid Expenses Other Current Assets, Total Total Current Assets 209 209 203 313 365 2,893.00 279 279 259 57 0 4,443.00 241 241 181 51 0 2,601.00 258 258 150 40 0 3,620.00 248 248 137 54 0 2,172.00 3,848.00 2,213.00 1,635.00 2,128.00 1,390.00 738 3,172.00 2,280.00 892 1,733.00 1,048.00 685

Property/Plant/Equipment, Total - Net Goodwill, Net Intangibles, Net Long Term Investments Note Receivable - Long Term Other Long Term Assets, Total Other Assets, Total Total Assets

11,040.00 0 0 0 0 375 0 14,308.00

10,874.00 0 0 0 0 1,455.00 0 16,772.00

10,094.00 0 0 0 0 765 0 13,460.00

9,212.00 0 0 0 0 1,171.00 0 14,003.00

8,723.00 0 0 0 0 442 0 11,337.00

Liabilities and Shareholders' Equity Accounts Payable Payable/Accrued Accrued Expenses

668 0 574

759 0 296

643 0 1,245.00

524 0 1,585.00

420 0 829

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES
Notes Payable/Short Term Debt Current Port. of LT Debt/Capital Leases Other Current Liabilities, Total Total Current Liabilities 0 163 1,401.00 2,806.00 0 41 3,742.00 4,838.00 0 122 877 2,887.00 0 601 1,138.00 3,848.00 0 146 747 2,142.00

53

Total Long Term Debt Long Term Debt Deferred Income Tax Minority Interest Other Liabilities, Total Total Liabilities

3,498.00 3,498.00 1,904.00 0 1,147.00 9,355.00

2,050.00 2,050.00 2,535.00 0 408 9,831.00

1,567.00 1,567.00 2,104.00 0 453 7,011.00

1,394.00 1,394.00 1,681.00 0 405 7,328.00

1,700.00 1,700.00 1,610.00 0 361 5,813.00

Redeemable Preferred Stock Preferred Stock - Non Redeemable, Net Common Stock Additional Paid-In Capital Retained Earnings (Accumulated Deficit) Treasury Stock - Common Other Equity, Total Total Equity

0 0 808 1,215.00 4,919.00 -1,005.00 -984 4,953.00

0 0 808 1,207.00 4,788.00 -1,103.00 1,241.00 6,941.00

0 0 808 1,142.00 4,307.00 -390 582 6,449.00

0 0 802 963 4,018.00 0 892 6,675.00

0 0 790 299 4,089.00 -71 417 5,524.00

Total Liabilities & Shareholders Equity

14,308.00

16,772.00

13,460.00

14,003.00

11,337.00

Total Common Shares Outstanding Total Preferred Shares Outstanding

739.99 0

734.8 0

783.31 0

801.64 0

784.98 0

Source: msnmoneycentral.com

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES

54

CASH FLOW
2008 Period End Date Period Length Stmt Source Stmt Source Date Stmt Update Type 12/31/2008 12 Months 10-K 2/2/2009 Updated 2007 12/31/2007 12 Months 10-K 2/4/2008 Updated 2006 12/31/2006 12 Months 10-K 2/1/2007 Updated 2005 12/31/2005 12 Months 10-K 2/1/2007 Reclassified 2004 12/31/2004 12 Months 10-K 2/1/2007 Reclassified

Net Income/Starting Line Depreciation/Depletion Amortization

178 599 0 56

645 555 0 328

499 515 0 277

484 469 0 291

215 431 0 166

Deferred Taxes Non-Cash Items Other Non-Cash Items 6 6 -2,360.00 Changes in Working Capital Accounts Receivable Other Assets Payable/Accrued Other Liabilities Other Operating Cash Flow Cash from Operating Activities 71 -384 -1,853.00 32 -226 -1,521.00 -38 -229 1,609.00 131 -151 2,845.00 -5 87 -223 150 102 1,406.00 -9 -59 855 120 -50 2,118.00 -75 -44 231 68 -22 1,066.00 -5 -5 1,322.00 4 4 111 17 17 857 96 96 158

-923 Capital Expenditures Purchase of Fixed Assets Other Investing Cash Flow Items, Total Sale/Maturity of Investment Purchase of Investments Other Investing Cash Flow Cash from Investing Activities 5,831.00 -5,886.00 0 -978 -923 -55

-1,331.00

-1,399.00

-1,146.00

-1,707.00

-1,331.00 -198

-1,399.00 -96

-1,146.00 0

-1,707.00 49

4,888.00 -5,086.00 0 -1,529.00

4,392.00 -4,509.00 21 -1,495.00

1,810.00 -1,804.00 -6 -1,146.00

4,611.00 -4,487.00 -75 -1,658.00

Financing Cash Flow Items

168

5

60

46

15

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES
Other Financing Cash Flow Total Cash Dividends Paid Issuance (Retirement) of Stock, Net Issuance (Retirement) of Debt, Net Cash from Financing Activities Foreign Exchange Effects Net Change in Cash 168 -13 63 1,436.00 1,654.00 5 -14 -862 378 -493 60 -14 -540 -307 -801 46 -14 77 151 260 15 -14 -158 313 156

55

0 -845

0 823

0 -890

0 1,232.00

0 -436

Net Cash - Beginning Balance Net Cash - Ending Balance

2,213.00 1,368.00

1,390.00 2,213.00

2,280.00 1,390.00

1,048.00 2,280.00

1,484.00 1,048.00

Source: msnmoneycentral.com

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES

56

Income Statement - 10 Year Summary (in Millions)
Sales 8-Dec 7-Dec 6-Dec 5-Dec 4-Dec 3-Dec 2-Dec 1-Dec Dec-00 Dec-99 10,694.00 9,587.00 8,884.00 7,412.00 6,397.00 5,835.00 5,426.02 5,469.97 5,578.71 4,665.61 EBIT 278 1,058.00 790 779 339 708 392.68 827.66 1,017.36 773.61 Depreciation 599 555 515 469 431 384 356.3 317.83 281.28 248.66 Total Net Income 178 645 499 484 215 442 240.97 511.15 625.22 474.38 EPS 0.24 0.84 0.61 0.6 0.27 0.54 0.3 0.63 0.79 0.59 Tax Rate (%) 35.97 39.04 36.84 37.87 36.58 37.57 38.64 38.24 38.54 38.68

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES

57

Balance Sheet - 10 Year Summary (in Millions)
Current Assets 8-Dec 7-Dec 6-Dec 5-Dec 4-Dec 3-Dec 2-Dec 1-Dec Dec-00 Dec-99 14,308.00 16,772.00 13,460.00 14,003.00 11,337.00 9,878.00 8,953.75 8,997.14 6,669.57 5,653.70 Current Liabilities 9,355.00 9,831.00 7,011.00 7,328.00 5,813.00 4,826.00 4,532.13 4,983.09 3,218.25 2,817.92 Long Term Debt 3,498.00 2,050.00 1,567.00 1,394.00 1,700.00 1,332.00 1,552.78 1,327.16 760.99 871.72 Shares Outstanding 740.0 Mil 734.8 Mil 783.3 Mil 801.6 Mil 785.0 Mil 789.4 Mil 776.7 Mil 766.8 Mil 756.2 Mil 749.1 Mil

Source: msnmoneycentral.com

Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES

58

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Running Head: AN ANALYSIS OF SOUTHWEST AIRLINES

59

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