Strategic Management

Cost Advantage

Professor Jeff Dyer

 COST ADVANTAGE AT SOUTHWEST

“Airlines don’t have revenue problems, they have cost problems.” Southwest.

Conventional Strategy: Meals, pre-assigned seats, membership in airline

reservation system, travel agents, and hub & spoke system
are key to success.

Southwest Strategy: Lowest cost operations and lowest prices.

Sales/Marketing Operations Human Resource Mgmt.

• Offer direct flights to busy
cities of less than 500 miles
• No pre-assigned seats
• Little reliance on travel
agents (saves 5-10%)
• Snacks rather than meals
• Prices 20-50% lower than
the competition
• Fly only Boeing 737s
(smallest, most fuel efficient craft)
• Train pilots & mechanics only on • Cross training, flexible
737s
• Fly to cheaper, less congested
airports (i.e. Love Field Dallas;
Midway, Chicago)
• Don’t transfer baggage to other
airlines
• Fast turnaround of aircraft
(20 minutes vs. 50 minutes
for industry)
• Initially non-union, now
partially union labor
workforce
• Employees receive same
pay per job hour
regardless of location
(low turnover overall but
accept high turnover in
high cost areas; i.e. Calif.)
Professor Jeff Dyer
 COST ADVANTAGE AT SOUTHWEST

 Airfares in Southwest markets are roughly 25 percent lower

than in non-Southwest markets.

 Southwest has an average 65 percent marketshare

compared with
less than 40 percent for other airlines in their top 100
markets.
 Unit costs of other airlines are 50-60 percent higher than
Southwest’s, except for America West with unit costs that
are 20 percent higher.
 Southwest has been the most profitable U.S. airline from
1980-1995.

Source: U.S. Dept. of Transportation Professor Jeff Dyer

 Southwest Profitability vs Industry: 1988-1996

10

Operating 0
profit as
a percent
of sales
-5

-10

-15

PanAm
Delta

TWA
American

USAir
United
Northwest
Southwest

Continental

Professor Jeff Dyer

 THE RELATIONSHIP BETWEEN
PRICE AND COST
EXPERIENCE CURVES
Cost/Unit (Constant Dollars) (COMPANY PROFITABILITY)

Industry
A Price

B
C Cost
Accumulated Experience (units of experience)

• Different companies within an industry will have similar prices but will have accumulated different amounts of
experience

Predictable Unit Cost Differences

Predictable Profitability Differences

Professor Jeff Dyer
 THE IMPORTANCE OF
RELATIVE MARKET SHARE

• Relative market share is an excellent proxy for relative accumulated

experience
- of leader relative to next largest follower
- of all followers relative to leader
• Therefore, there will be a relationship between RMS and profitability
High
Profitability

Low
Low High
Relative Accumulated Experience (Relative Market Share)

Relative market share is a key indicator of relative long-term profitability

Professor Jeff Dyer
 PROFITABILITY VS MARKET SHARE
US CONSTRUCTION COMPANIES
(MEGABUILDERS)

0.1

0.08
Return on Sales (Average 1972 - 1978)

Brown & Root (Halliburton

0.06
Bechtel
0.04
Fluor
Roytheon Pullman
0.02 Parsons Foster Wheeler
Morrison-Knudsen
McKee
0

-0.02
0 0.5 1 1.5
Relative Market Share (Revenues, 1972 - 1978)

Professor Jeff Dyer

Airline Industry: Relationship between Experience and
Profitability

Professor Jeff Dyer

 STRATEGIC IMPLICATIONS OF THE
EXPERIENCE CURVE
 First movers in a fast growing market will secure a widening cost
advantage. Firm’s must grow as fast, or faster, than rivals or be at a
cost disadvantage.
 Understanding the behavior of costs allows for more sophisticated
pricing strategies. The experience curve can be used:
– As a basis for pricing a production run or contract
– As a basis for market share based pricing strategy
– As a basis for planning future prices
 Experience curves can be plotted for a company and its competitors
to assess how well each company is managing its costs. Companies
with the greatest cumulative experience should have the lowest
costs (if business is properly defined).
 Product life cycles influence how you use the experience curve for
pricing. Products with a short product life cycle (rapid development
of new models) need to be priced to make money more quickly
because they can’t count on a long learning curve and long
productions runs.

Professor Jeff Dyer