South West Airlines Operations – A Strategic Perspective

Background:

Southwest Airlines is the largest airline measured by number of passengers carried each year
within the United States. It is also known as a ‘discount airline’ compared with its large rivals in
the industry. Rollin King and Herb Kelleher founded Southwest Airlines on June 18, 1971. Its
first flights were from Love Field in Dallas to Houston and San Antonio, short hops with no-
frills service and a simple fare structure. The airline began with one simple strategy: “If you get
your passengers to their destinations when they want to get there, on time, at the lowest possible
fares, and make darn sure they have a good time doing it, people will fly your airline.” This
approach has been the key to Southwest’s success. Currently, Southwest serves about 60 cities
(in 31 states) with 71 million total passengers carried (in 2004) and with a total operating
revenue of $6.5 billion. Southwest is traded publicly under the symbol “LUV” on NYSE.

Facts:

* The first major airline to fly a single type of aircraft (Boeing 737s)

* The first major airline to offer ticketless travel system wide including a frequent flier program
based on number of trips and not number of miles flown.

* The first airline to offer a profit-sharing program to its Employees (instituted in 1973).

* The first major airline to develop a Web site and offer online booking. In 2001, about 40
percent ($2.1 billion) of its passenger revenue was generated through online bookings at
[http://www.southwest.com]. Southwest's cost per booking via the Internet is about $1, compared
to a cost per booking through travel agents of $6 to $8.

Key competitive advantages:

* Low Operational costs / High Operational Efficiency

* Award winning customer service

* Human Resource practices / Work culture

Operations Analysis – Competitive Dimensions:

Southwest clearly has a distinct advantage compared to other airlines in the industry by
executing an effective and efficient operations strategy that forms an important pillar of its
overall corporate strategy. Given below are some competitive dimensions that will be studied in
this paper.

1. Operational Costs and Efficiency

2. Customer Service

3. Employee/Labor Relations

4. Technology

1. Operational Costs and Efficiency

After all, the airline industry overall is in shambles. But, how does Southwest Airlines stay
profitable? Southwest Airlines has the lowest costs and strongest balance sheet in its industry,
according to its chairman Kelleher. The two biggest operating costs for any airline are – labor
costs (approx 40%) followed by fuel costs (approx 18%). Some other ways that Southwest is
able to keep their operational costs low is - flying point-to-point routes, choosing secondary
(smaller) airports, carrying consistent aircrafts, maintaining high aircraft utilization, encouraging
e-ticketing etc.

Labor Costs

The labor costs for Southwest typically accounts for about 37% of its operating costs. Perhaps
the most critical element of the successful low-fare airline business model is achieving
significantly higher labor productivity. According to a recent HBS Case Study, southwest
airlines is the “most heavily unionized” US airline (about 81% of its employees belong to an
union) and its salary rates are considered to be at or above average compared to the US airline
industry. The low-fare carrier labor advantage is in much more flexible work rules that allow
cross-utilization of virtually all employees (except where disallowed by licensing and safety
standards). Such cross-utilization and a long-standing culture of cooperation among labor groups
translate into lower unit labor costs. At Southwest in 4th quarter 2000, total labor expense per
available seat mile (ASM) was more than 25% below that of United and American, and 58% less
than US Airways.

Carriers like Southwest have a tremendous cost advantage over network airlines simply because
their workforce generates more output per employee. In a study in 2001, the productivity of
Southwest employees was over 45% higher than at American and United, despite the
substantially longer flight lengths and larger average aircraft size of these network carriers.
Therefore by its relentless pursuit for lowest labor costs, Southwest is able to positively impact
its bottom line revenues.

Fuel Costs

Fuel costs is the second-largest expense for airlines after labor and accounts for about 18 percent
of the carrier's operating costs. Airlines that want to prevent huge swings in operating expenses
and bottom line profitability choose to hedge fuel prices. If airlines can control the cost of fuel,
they can more accurately estimate budgets and forecast earnings. With growing competition and
air travel becoming a commodity business, being competitive on price was key to any airline’s
survival and success. It became hard to pass higher fuel costs on to passengers by raising ticket
prices due to the highly competitive nature of the industry.
Southwest has been able to successfully implement its fuel hedging strategy to save on fuel
expenses in a big way and has the largest hedging position among other carriers. In the second
quarter of 2005, Southwest’s unit costs fell by 3.5% despite a 25% increase in jet fuel costs.
During Fiscal year 2003, Southwest had much lower fuel expense (0.012 per ASM) compared to
the other airlines with the exception of JetBlue as illustrated in exhibit 1 below. In 2005, 85 per
cent of the airline’s fuel needs has been hedged at $26 per barrel. World oil prices in August
2005 reached $68 per barrel. In the second quarter of 2005 alone, Southwest achieved fuel
savings of $196 million. The state of the industry also suggests that airlines that are hedged have
a competitive advantage over the non-hedging airlines. Southwest announced in 2003 that it
would add performance-enhancing Blended Winglets to its current and future fleet of Boeing
737-700’s. The visually distinctive Winglets will improve performance by extending the
airplane’s range, saving fuel, lowering engine maintenance costs, and reducing takeoff noise.

Point-to-Point Service

Southwest operates its flight point-to-point service to maximize its operational efficiency and
stay cost-effective. Most of its flights are short hauls averaging about 590 miles. It uses the
strategy to keep its flights in the air more often and therefore achieve better capacity utilization.

Secondary Airports

Southwest flies to secondary/smaller airports in an effort to reduce travel delays and therefore
provide excellent service to its customers. It has led the industry in on-time performance.
Southwest has also been able to trim down its airport operations costs relatively better than its
rival airlines.

Consistent aircrafts

At the heart of Southwest's success is its single aircraft strategy: Its fleet consists exclusively of
Boeing 737 jets. Having common fleet significantly simplifies scheduling, operations and flight
maintenance. The training costs for pilots, ground crew and mechanics are lower, because there's
only a single aircraft to learn. Purchasing, provisioning, and other operations are also vastly
simplified, thereby lowering costs. Consistent aircrafts also enables Southwest to utilize its pilot
crew more efficiently.

E-Ticketing

The idea of ticketless travel was a major advantage to Southwest because it could lower its
distribution costs. Southwest became electronic or ticketless back in the mid-1990s, and today
they are about 90-95% ticketless. Customers who use credit cards are eligible for online
transactions, and today Southwest.com bookings account for about 65% of total revenue. The
CEO Gary Kelly thinks that this idea would grow further and that he wouldn't be surprised if e-
ticketing accounted for 75% of Southwest’s revenues by end of 2005. In the past, when there was
a 10% travel agency commission paid, it used to cost about $8 a booking. But currently,
Southwest is paying between 50 cents and $1 per booking for electronic transactions that
translate to huge cost savings.
2. Employee and Labor Relations

Southwest has been highly regarded for its innovative management style. It maintains a relentless
focus on high-performance relationships and its people-management practices have been the key
to its unparalleled success in the airline industry.

Mission Statement

To Our Employees
“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.”

The Southwest mission statement shows that the company has a strong commitment to its
employees. The company affords the same respect to its employees that is provided to its
customers. The Southwest mission statement is unique in that it recognizes the importance of its
employees within the broader business strategy, which emphasizes superb customer service and
operational efficiency. The employees reciprocate the respect, loyalty and trust that Southwest
demonstrates. Southwest employees are known for their loyalty, dedication, attitude and
innovation. The employees are the distinguishing factor between Southwest and the rest of the
airline industry.

Hiring

Southwest hiring policy is unique not only within the airline industry, but also more broadly, and
revolves around finding people with the right attitude that will thrive in the Southwest culture.
Extensive procedures are employed to hire for positive attitude and dedication. Those who do not
posses those qualities are weeded out. Colleen Barrett, a non-operational officer at Southwest,
states that

“Hiring is critical, because you cannot institutionalize behavior. Instead, you must identify those
people who already practice the behaviors you are looking for. Then you can allow Employees to
be themselves and make decisions about Customer service based on common sense and their
natural inclinations.” 1

Recruiting and interviewing at Southwest is a two-step process. The first step is a group
interview, conducted by employees, where communication skills of potential candidates are
evaluated. The next steps in this process are one on one interview, where the candidates' attitudes
and orientation toward serving others are evaluated. These hiring criteria apply to all job
functions since all Employees at Southwest play a customer service role. A critical part of
Southwest operational strategy is that every job at Southwest is a customer service position,
whether it directly applies to the customer or whether it is internal.
The table below shows that even though Southwest is the most heavily unionized airline, at
approximately 80%, that contract negotiations between the unions and Southwest are much
shorter in duration than of the other major carriers. This shows the quality of relationship that
Southwest has with its employees and with the unions that represent them.

Culture

Southwest was created as a different kind of company and from its beginnings a unique culture
was nurtured. In 1990 Colleen Barrett formed the Southwest Culture Committee. This is unique
within the industry and among all large companies. The committee also has a mission statement:

“This group's goal is to help create the Southwest spirit and culture where needed; to enrich it
and make it better where it already exists; and to liven it up in places where it might be
"floundering". In short, this group's goal is to do "whatever it takes" to create, enhance, and
enrich the special Southwest spirit and culture that has made this such a wonderful
Company/Family.”

It is this unique approach to company values that has created a culture that differentiates itself
from others. Southwest’s culture is the reason why it is successful.

3. Customer Service

The Mission of Southwest Airlines

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.

Approach

Herb Kelleher, founder of Southwest, has been quoted as saying that "We're in the Customer
service business; we just happen to provide airline transportation".2 Award winning customer
service is a distinguishing characteristic of Southwest and it is referred to internally as
“Positively Outrageous Service”. It means that from the top to bottom everyone does whatever
he or she can to satisfy the customer. This includes Herb Kelleher, who has been known for
helping out baggage handlers on Thanksgiving. It is through emphasizing the customer and
employee that Southwest is able to differentiate itself from others in the airline industry. On a
more technical level, each employee or group within Southwest has his or her own customer.
This means that every employee ‘serves’ in one way or another despite not being directly
involved with the passenger. The mechanic’s customer is the pilot and the caterer’s is the flight
attendant.

Results

It can be said that the "Positively Outrageous Service" that is unique to Southwest “is not the
result of a department, or a program, or a mandate from management. It is not secondary to the
product; it is the product.” This approach creates the conditions where Employees are more
likely to treat customers in ways that distinguish the company from others. There are numerous
accounts of passengers who have received exceptional treatment from Southwest employees.

The question that needs to be answered is how Southwest’s customer service is different and
why? Is it common for customers of other airlines to rave about their special service? The answer
is that it is not. While Southwest does not have a monopoly on people who are kind and who are
willing to go above and beyond to satisfy a customer, such behavior is nurtured at Southwest to a
much greater extent.

It can then be concluded that the customer service that is inherent to Southwest is a part of its
culture. This culture is supported through employee encouragement to do the extra to satisfy the
customer. This approach inspires people who would ordinarily only on occasion go out of their
way to help someone, to become consistent performers that offer exceptional service all the time.
Southwest employees are what differentiate its customer service from the other airlines.

4. Technology

Southwest utilizes technology in many ways to fulfill its business objectives and maintain its
efficient operations. According to its CEO, technology equals productivity. Launched in 1996,
ticketless travel was first introduced by Southwest. On May 1st 2000, Southwest Airlines
introduces "SWABIZ," a portal that assists company travel managers in booking and tracking
trips made through its web site [http://www.southwest.com]. There are many new technology
initiatives being undertaken currently and some are in the pipeline.

Bar codes in Boarding Passes

Southwest Airlines has invested $12 million during the past three years to standardize corporate
and terminal operations on about 10,000 Dell OptiPlex desktop and Latitude notebook computers
according to its company executives. Southwest wanted to replace its well known, brightly
colored plastic boarding passes with an electronic system with bar-code paper boarding passes.
So it installed about 350 touch screen ticket readers powered by Dell OptiPlex desktops. The bar
code gives Southwest more information to automatically reconcile the number of boarding
passes with the number of passengers that actually board the plane.

Although the technology will help Southwest Airlines remain efficient by consolidating
passenger information for the company's 3,000 daily flights, there were concerns it could
lengthen the time to get travelers on board. However it was found that scanning each bar code on
the boarding passes didn't increase or shorten boarding schedules, but it did take minutes from
administrative processes, such as looking up customer records. The new paper bar code system is
giving Southwest ticket agents the ability to match a customer record within having to scroll
through and log into multiple software screens. The process is much more automated. Once the
bar code on the boarding pass is scanned at the terminal gate it checks off the person from the
passenger list in real time.

The old process was manual that involved finding the information, scrolling through several
software screens from reservations to check-in to boarding. The bar code hardware to scan the
boarding passes has been deployed. The company is in the process of replacing customer service
back-office equipment at airports including at its headquarters in Dallas.

Software Upgrades

Software applications, such as those used by clerks to check in passengers, are being replaced.
Southwest Airlines' internally written "Airport Application Suite" is expected to rollout next year
as the company transitions from green screens to Window-based user interface. Similar to Wal-
Mart Stores Inc., Southwest Airlines believes in developing in-house the software that runs its
operations. The company uses very little off-the-shelf software. There are between 75 and 100
projects in the works each year supported by approximately 900 IT employees.

RFID

Radio frequency identification technology, a favorable alternative to bar-coding for luggage

identification, is also on Southwest's radar. It plans to test RFID technology sometime in 2006.
Even though, Southwest is playing a little catch-up with other airlines such as Air Tran, Alaska
and Champion Airlines, in many cases they are able leapfrog to more sophisticated applications
easily having waited longer.

Challenges:

Southwest has emerged very successful, despite the most troubled times in the airline market.
However, it faces new challenges in the face of increasing competition from other low fare
airlines such as JetBlue, ATA airlines, America West.

Reserved Seating

Due to increasing security guidelines since September 2001, Southwest would need to prepare
for assigned (reserved) seating to track its in-flight passengers. This change will involve large
technology investments and may impact its gate operations negatively since the current way of
unassigned seating has helped in quick gate turnarounds.

Passenger Demand

The keep-it-simple philosophy has served Southwest well. But as its own business grows and
grows more complex, with plans to purchase dozens of new aircraft and an expected upsurge in
passenger traffic to about 80 million boarding’s a year, the simplicity strategy that has been
reflected in the airline's IT philosophy is evolving. The CIO Tom Nealon says that "It's time to
adapt our business processes for efficiency. As our airline scales for us to provide the same kind
of high-touch customer service, we have to automate a lot of things we've been able to do
without technology previously. The challenge is doing that without conceding the customer
touch." Southwest is also aggressively pursuing customer relationship management (CRM)
techniques and has applications to get insight into customer’s wants and dislikes. According to
an interview with its CEO Gary Keller, Southwest has its focus on improving in two areas -
customer’s airport experience and in-flight experience.
In-Flight Entertainment

In an overall effort to improve customer’s in-flight experience, in-flight entertainment is

something that Southwest is currently evaluating and which JetBlue has been very successful at
already because of its introduction in its long-haul flights. In comparison, Southwest has 415
airplanes to consider and that represents an investment decision at a whole new dimension.
Additionally, Southwest has to consider how things may fit into their environment. At this point,
60% of its service is still very short haul. Southwest needs to be mindful of the fact that a certain
approach that has been successful for its competitor may not be necessarily work to its
advantage.