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Southwest Airlines Possible Solution HBR Case
Southwest Airlines Possible Solution HBR Case
CASE ANALYSIS
TEAM
AKRITI SINHA
ARAVIND KUMAR
LIPIKA BRAHMA
NIKHILESH BHATTI
TARUN AGRAWAL
KOWSHIK YAKKALA
EXECUTIVE SUMMARY
Southwest Airlines entered the airlines market and within a few years was known amongst the market leaders by following a low cost
differentiation strategy. Not only did the airlines win numerous price wars by just religiously following its set of coherent activities but it also
gained many loyal customers who wanted to fly in South West and wrote to them for setting up new flight routes.
Southwest now had two major issues at hand, one was how would they continue to be the low cost leaders in the industry by making their
strategy sustainable. The other was they wanted to foray into new markets or establish new routes to expend their reach in the industry.
There were many activities that lead the strategy to be successful including low operating costs, low turnaround time, committed and efficient
employees etc. Their strengths seemed to be how well they managed time. They saved a lot of time on flight and in the airport which led to
cost savings later. They now were on cross roads and wanted to make their strategy sustainable.
The second dilemma was about their expansion strategy. South west had always followed a controlled expansion strategy and always was
known for its deliberate and cautious moves to expand. Now they had three options at hand
a) Expand within system, add a new segment between Detroit and Phoenix- where the airport gate and landing fee would be higher than
the average Southwest Standards
b) Grow in Chicago by adding a route from Chicago to Dayton- the fee per passenger would be lower than their average in other
airports, the airport was fairly uncongested and had room for further expansion
c) Establish base in east coast- kick off service from Baltimore- airport fees was in line with the system
In assessing the best option we evaluated all the three options both qualitatively and quantitatively. We evaluated the risks as well as the
returns in each of the three options separately and determined the best option. We forecasted the demand based on past growth rate. NPV
and an calculation of the payback period for each of the options gave us an understanding of the returns that each project would provide us
with. Risks are always based on the best case, worst case and expected case scenarios of the prices to be offered to the customers since
Southwest had to maintain a cost lower than almost 60% of the industry average to be competitive in the industry. They could maintain their
low prices only through their low operating costs. In the sensitivity analysis the final option seemed to go very well with the statement “higher
the risk higher the return” which does not go very well with Southwest’s controlled expansion theory. The second option seemed to turn very
bad in the worst case scenario in which southwest could operate due to entry of new competitors. The first option of expanding within the
system was moderate and fared well in both the worst and best case scenario.
Looking at it qualitatively the first option seemed lucrative since there were a lot of passengers already asking for the particular route to be
established and this would improve the brand image of Southwest since they would be responding to customer.
Contents
EXECUTIVE SUMMARY....................................................................................................................................................................................................................................................................................2
PROBLEM STATEMENT:.............................................................................................................................................................................................................................................................................4
ANALYSIS OF ACTIVITIES THAT ARE CRITICAL FOR MAINTAINING THEIR STRATEGIC COHERENCE..........................................................................................................................5
ANALYSIS OF RETURNS.................................................................................................................................................................................................................................................................................9
QUANTITATIVELY:.......................................................................................................................................................................................................................................................................................9
QUALITATIVELY............................................................................................................................................................................................................................................................................................9
SENSITIVITY ANALYSIS............................................................................................................................................................................................................................................................................9
RECOMMENDATION.......................................................................................................................................................................................................................................................................................11
APPENDIX 1: ASSUMPTIONS:...................................................................................................................................................................................................................................................................11
PROBLEM STATEMENT:
Southwest Airlines has two problems at hand now:
a) How to maintain the strategic coherence that it currently has and how to make them sustainable in the long term
b) Find the best possible expansion strategy amongst the three options of routes
Expand within the system, add a new segment between Detroit and Phoenix
Grow in Chicago by adding a route from Chicago to Dayton
Establish base in east coast- kick off service from Baltimore
Airlines Industry in the 1990s was one of the largest and growing industries. It remained the core for globalization due to its involvement in
international investments and world trade. But during the early years of 1990s the industry was hit with recession, Gulf war and the effects of
deregulation in 1978. In 1991 the number of passengers decreased with an effect on the financial results which were already at war with the
excess capacity losses due to overbuying of aircrafts in the 1980s. According to the reports airlines industry suffered a total loss of around
$20 billion from 1990-1994.
The airlines operating strategies also got changed as a result of deregulation, liberalization and increase in the competition. Rather than
focusing on increasing the load factor, the airlines started to work towards increasing the overall productivity with increased profitability
through economies of scale.
ANALYSIS OF PROBLEM 1: SUSTAINING LOW COST DIFFERENTIATION STRATEGY
Southwest Airlines strongly follows the strategy of low cost/differentiation strategy. They provide the lowest possible fare in the industry.
This leaves South West with not much competition in the industry. At the same time South West focuses on differentiating itself on the basis
of the service, operations, cost control, marketing, its people and corporate culture. They believe in providing customer focused services.
They believe in adding fun element to their services. Their main aim is to offer great service at the lowest cost.
ANALYSIS OF ACTIVITIES THAT ARE CRITICAL FOR MAINTAINING THEIR STRATEGIC COHERENCE
Southwest Airlines always banked upon their people for carrying out most of their time saving and cost saving activities. None of them would
be possible if the ground staff is not dedicated. To maintain the same amount of enthusiasm amongst the workforce to work efficiently even
with wages lower than the industry average
Selection procedure of employees they should always look out for people who crave psychological satisfaction more out of a job than
monetary satisfaction
Most of the times it was the employees who gave them new ways of saving time and money, so always keep up the org culture of
openness and employee involvement in major decisions
Recognitions and awards should continue to make employees happy and more self confident
TARGET ONLY SMALL CITIES AND CONTINUE WITH THE CITY TO CITY HOPPING ROUTE
TARGET CUSTOMERS: Their target customers mostly would be families who would be in the middle and lower middle class income range
who would not mind a little fun while travelling
BRANDING THEMSELVES AS THE “OFFICIAL HOLIDAY CARRIER”: Since they attract a lot of people during the vacations they should
market themselves as the carrier that brings together the whole family during a vacation at a very low cost. They should start hitting on the
emotional side
CONTROLLED EXPANSION: They should never go for any city that offers them a lot on revenue but where they might lose out due to bad
weather conditions or simply because of culture mismatch. They should foray into markets only after a study of their passengers
ANALYSIS OF PROBLEM 2: EXPANSION AND GROWTH INTO NEW MARKETS
ANALYSIS OF RETURNS
QUANTITATIVELY:
As per our expectation Southwest can get a profit of $2740714 for Detroit route, $570905 for Dayton route and $4146613 for Baltimore
route. Though the expected profit is most for the third option but if we would see the range of worst to best situation; in the first option the
possible revenue outcomes would be between $18, 59,289 net Profits in the worse situation and in the best case it is $37, 56, 708. For
Dayton route, the Company can earn ($1, 92, 529) net profits in the worse situation and in the best case it is $15, 96, 325. For Baltimore
route, the Company can earn $22, 55, 947 net profits in the worst situation and in the best case it is $63, 94, 353.
Hence It is clear that range is highest in third option so instead of highest expected revenue it has the highest risk. While second option has
the least variation but the chances of giving negative returns in worst conditions is high. Hence first option seems to be best option.
QUALITATIVELY
They respond to customer requests and also keep up the “Luv Culture” – Better Brand image and better connect with customers
SENSITIVITY ANALYSIS
South west’s competitive advantage rests with pricing or providing services at low fares. From the sensitivity analysis, we come to know that
southwest can get the profit of $2740714 for Detroit route, $570905 for Dayton route and $4146613 for Baltimore route where the prices are
quoted at $114, $49 and $87. If the price war occurs in these places by the competitors of south west, the company can go for worse fares
and increase the revenue still in competing with their competitors. The reasons being:
Cost control activities adopted by South west such as- Cost cutting- Pilots contributing new ideas to save fuels, Fuel costs- Buying fuel
from vendors who offer best prices by carrying inventory if possible, Gate costs and landing fee’s- Average fee in small airports is $2.50, and
in small airports it is $2.00, No of departures- Maximum productivity of passengers through 20 departures a day, Low cost service- Offering
services at low cost as it was 7.3 cents per passenger
Risk analysis:-
From NPV and break even analysis we get the third option as the best as it has least period for break even and highest NPV. The first option
comes second and then the second at last. But this does not give us a holistic picture to make any suggestions right away. We should also
analyse the risk in a certain investment along with the returns. Some factors which would arise as risk factors are follows:
Operating cost
Fuel cost
Employee cost
Weather conditions
Due to more time for “in and out” there would be more fuel consumption which will lead to increase in cost. A flight from Detroit to phoenix,
which is around 1000miles, takes 3 ½ hours to cover. It means a flight covers around 5 miles in one minute. So if flight has to wait for 90-
15=75 minutes more it means it will lost fuel equalling t0 75*5=375 miles.
It has given that per hour cost of operation of airline is $4000. So due to delay by 75 minutes operating cost will increase by
4000/60*75=$5000.
So after considering the risk part, third option gives negative returns as the revenue is declining and cost is increasing. So we will eliminate
the third option
RECOMMENDATION
Southwest should Chose the first option of expanding within the system since this options gives positive return, is less risky and also will help
the organization maintain its “Luv Culture”. This option will also improve their brand image as an airline carrier that cares not only for its
employees but its passengers as well.
This strategy also falls in line with their idea of controlled expansion.
APPENDIX 1: ASSUMPTIONS:
The loading factor is assumed to be 65% for expected demand and 55% for worst case and 75% for best case.
Growth rate for the trip is taken as average of last year’s quarter growth rate.
No of trips per day are 3 for Detroit – phoenix route and 10 for other two routes.
The price ranges are taken from $99-$129 where the expected case is priced at $114 for Detroit – phoenix route. The price ranges
are taken from $46.2-$54 where the expected case is priced at $49 for Dayton-Chicago route. The price ranges are taken from $74-
$100 where the expected case is priced at $87 for Baltimore- Chicago route
Operating cost excluding fuel and salary & wages are taken 43% of total revenue following last year proportion. Fuel cost would be
15% of total revenue and it would be reduced for first option as it is a more than 3 hour route.
To calculate salary & wages, total salary is divided by total employees to get salary per employee and then added for the additional
required route. Airport charges are charged by multiplying the number of charges to the no of passengers expected by its given rate
for the airport.
The expenses which are fixed and are common not considered for calculation. As the investment of two aeroplanes is common for all
options hence it was not considered to calculate cash flows.
For NPV, WACC is calculated on the basis of last year data. Tax rate, debt rate has taken from income statement while to find out cost
of equity we use dividend discount model (DDM). For DDM
The life of the project is taken as infinite because of investment done in airport which has the infinite life.
Baltimore
Q1 Q2 Q3 Q4 Total
Demand(trips) 900 990 1089 1197.9 4176.9
Revenue(price@87) 64719812.43
Operating cost
(Excludg Sal & Fuel) 27829519.34
WACC
APPENDIX wd*rd + we*re = 0.08002 5:
PORTER’S Threat of new entrants – Low FIVE
FORCES ANALYSIS
Supplier Power – Balanced Product at Competitive Prices
Product Differentiation through adding FUN to Travel and low price
The aircrafts were being Cost disadvantages independent of scale: Southwest operated in all the uncongested airports and had committed
Customer Power – High
provided by Boeing that could staff that made operational efficiency easy
negotiate with the airlines at ExpectedCompetitive Rivalry
Retaliation in - High from current industry players
the industry
higher prices The demand was inadequate to support the large number
The power of the staff Customers exercised high
of aircraft carriers
employees which form a major bargaining power as he could
The airlines competed for the high traffic routes , hubs and
portion of the expenses varied have easily switched to other
the airports
according to the type of person airline offering him a better
The presence of high fixed costs, high switching costs,
being employed or presence of service at lower costs due to the
ability to differentiate and keep lower prices than others
the union. presence of a large number of
also contributed to the high rivalry among the carriers
carriers at that point of time.
Substitutes - Low
The substitutes such as automobiles and railroads were present but could not affect southwest
airlines to a greater extent because the airlines was so positioned that the prices charged by the
airline were lower as compared to the total charges incurred in ground transportation.
Moreover the other substitutes as the airlines also posed a lesser threat due the difference in
prices at a higher side
The People:
Employees are motivated and completely dedicated towards achieving customer satisfaction
The airlines appointed people who were friendly and fun
Employee training focused on team building
They provided pension to the employees in form of profit sharing
Psychological satisfaction that they achieved while working there was enormous as compared to the salaries that they received
Customer Focused:
They believed in giving first preference to their customers over everything else and therefore came up with strategies which were well
suited to their customers.
They banked upon word of mouth of marketing and hence their customers were considered their ambassadors.
The airlines had a strong organizational culture that focused on getting a “fun” element within the organization.
Fun Element made work less tiring and fun
Boeing 737s:
South West Airlines made use of Boeing 737 jets only. They had around 150 of them in total and it accommodated around 137
passengers. The other competitors had a fleet that consisted of variety of planes made by Boeing, Airbus industries, etc. this helped
SWA on saving up on lots of cost and at the same time fast service delivery.
No Meals:
The South West airlines did not provide any meal to its customers hence saved up on the time of loading and unloading food on and
off the flight.
The airlines mainly relied on the uncongested airports in the small cities or less congested and smaller airports in large cities. This
prevented the passengers from transferring from Southwest to other flights and the same time saved time.
Southwest airlines generally flew short distances. The average length of a Southwest flight was 65 minutes. This helped in saving a
great deal of time and also enabled them in providing better service.
Turnaround Time of 15 Minutes:
The time taken to “turn” an aircraft was around 15 minutes which made Southwest differ from its competitors. The entire crew worked as a
team and made it happen which again helped in saving up time and thus enabled them in providing fast service to its customers.
The pilots contributed by coming up with new procedures for takeoffs and landings that helped saving a huge amount of fuel.
Buy fuel from different vendors depending upon the price being offered by them.