CASE 4 Southwest Airlines

C-41

CASE 4

Southwest AirlinesFlying High with Low Costs

Southwest Airlines sent its first flights alo! in 1971. A!er almost 45 years, Southwest was so successful that the company was considered, in many ways, the crown jewel of the airline industry. The organization had achieved the longest continuous stretch of profitability in the history of the airline industry and was consistently ranked in the top 10 on Fortune’s list of “Most Admired Companies,” a list that spanned all industries. Southwest’s executives liked to say that they strove toward a triple bottom-line of People, Planet, and Performance.

In 2015, Southwest was on strong financial ground, despite the fact that the prior 15 years had been some of the most difficult in aviation history. The airline industry had been hurt by the 9/11 terrorist attacks and the Great Recession of 2008–2009. Although 2009 had been a dif-ficult year for the company, Southwest had still managed to eke out a positive net income of $99 million. The company’s performance improved in the subsequent years, with net income rising above $400 million and revenues increasing from $10.3 billion in 2009 to more than $17 billion in 2012 (see Exhibits 1 through 3). Southwest achieved its strong financial performance in large part by having a high load factor, the airline industry’s measure of the percentage of seats that are filled on an airline’s flights. In 2010, Southwest hit the highest load factor in its history: 79.3 percent. Following its successful “Bags Fly Free” ad campaign, Southwest also saw its domestic market share increase by almost 2 percent. Southwest was known for high levels of both customer service and employee satisfaction. In 2013, Southwest not only rated as the top airline in a Consumer Reports survey of passengers1 but also reigned at the top of the US Department of Transportation’s customer satisfaction rankings. By 2015, with the benefit of lower fuel costs, it achieved record profits of $4.1 billion. Overall, Southwest had an enviable record of performance.

The US Airline IndustryThe airline industry is critical to the health of the US economy. Airlines provide 11 million jobs in the United States and are responsible for five cents of every dollar of the US gross domestic product (GDP). For every 100 airline jobs that exist, 388 more jobs are supported outside of the airline industry.2

A key turning point in airline history was the deregulation of the industry in 1978. Before deregulation, the Civil Aeronautics Board regulated all passenger fares, which meant the price was the same for each flight between two cities. The board also regulated industry entrances and exits; mergers and acquisitions; and even airlines’ rates of return. Typically, any given market had only a few airlines, and price competition was essentially nonexistent.

Following deregulation, numerous new entrants moved into both established and unserved markets, and fare prices began to drop quickly. The average passenger fare in 1978 was about 8.49 cents per mile. In 2009, that price, adjusted for inflation, had decreased

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C-42 Southwest Airlines

EXHIBIT 1 Southwest Airlines Selected Financial & Operating Figures

Financial Data:(In Millions except per share)

2015 2013 2011

Total Operating Revenues: 19,820 17,699 15,658

Operating Expenses:

Salaries, wages, and benefits 6,383 5,305 4,371

Fuel and oil 3,616 5,763 5,644

Maintenance materials and repairs 1,005 1,080 955

Aircra! rentals 238 361 308

Landing fees and other rentals 1,166 1,103 959

Depreciation and amortization 1,015 867 715

Other operating expenses 2,242 86 1,879

Total Operating Expenses: 15,704 16,421 14,965

Operating Income: 4,116 1,278 693

Net Income: 2,181 754 178

Net income per share, basic 3.30 1.06 0.23

Total assets at period-end 21,312 19,345 18,068

Long-term obligations at period-end 2,541 2,191 3,107

Stockholders’ equity at period-end 7,358 7,336 6,877

Operating Data:

Revenue passengers carried 118,171,211 108,075,976 103,973,759

Enplaned passengers 144,574,882 133,155,030 127,551,012

Revenue passenger miles (RPMs) (000s) 117,499,879 104,348,216 97,582,530

Available seat miles (ASMs) (000s) 140,501,409 130,344,072 120,578,736

Load factor (1) 83.6% 80.1% 80.9%

Average aircra! stage length (miles) 750 703 679

Trips flown 1,267,358 1,312,785 1,317,977

Average passenger fare 154.85 154.72 141.90

Passenger revenue yield per RPM 15.57¢ 16.02¢ 15.12¢

Operating revenue yield per ASM 13.98¢ 13.58¢ 12.99¢

Operating expenses per ASM 11.18¢ 12.60¢ 12.41¢

Fulltime equivalent Employees at period-end 49,583 44,831 45,392

Aircra! in service at period-end (2) 704 680 698

(1) Revenue passenger miles divided by available seat miles(2) Includes leased aircra!Source: Southwest Airlines Annual Reports.

56 percent.3 As prices declined for passengers, however, more than 150 airlines went bankrupt, and eight of the 11 major airlines went bankrupt, merged, or closed.

The airline industry’s profit margins are some of the lowest in the world (see Exhibits 4 and 5). Airlines paid considerable attention to reducing their operating costs, but their con-trol over those costs was severely limited. In particular, labor costs represented the largest percentage of an airline’s costs, but union agreements limited labor flexibility. The sizes of the crew and ground sta# were typically proportional to the size of the aircra! they served. Other


The US Airline Industry C-43

operating costs were primarily determined by the distance traveled and not by the number of passengers boarded. Most airlines—notably Delta, American, and United—used a hub-and-spoke system to coordinate flights, which meant that they funneled the majority of their tra#ic through “hub” airports. Hub-and-spoke (HS) systems were designed to help airlines maximize their load factors, meaning they helped keep planes full going into and out of a hub airport.

EXHIBIT 2 Southwest Airlines Balance Sheet

As of December 31 . . . 2015 2013 2011 2009Current Assets: (In Millions)

Cash and cash equivalents 1,583 1,355 829 1,114

Short-term investments 1,468 1,797 2,315 1,479

Accounts and other receivables 474 419 299 169

Inventories of parts and supplies, at cost 311 467 401 221

Deferred income taxes 2,490 168 263 291

Prepaid expenses and other current assets 188 250 238 84

Total current assets 4,024 4,456 4,345 3,358

Property and equipment, at cost:

Flight equipment 19,462 16,937 15,542 13,719

Ground property and equipment 3,219 2,666 2,423 1,922

Deposits on flight equipment purchase contracts 1,089 764 456 247

24,685 20,820 18,421 15,888

Less allowance for depreciation and amortization 9,084 7,431 6,294 5,254

15,601 13,389 12,127 10,634

Other assets 717 530 626 277

21,312 19,345 18,068 14,269

Current Liabilities:

Accounts payable 1,188 1,247 1,057 732

Accrued liabilities 2,591 1,229 996 729

Air tra#ic liability 2,990 2,571 1,836 1,044

Current maturities of long-term debt 637 629 644 190

Total current liabilities 7,406 5,676 4,533 2,695

Long-term debt less current maturities 2,541 2,191 3,107 3,325

Deferred income taxes 2,490 2,934 2,566 2,200

Deferred gains from sale and leaseback of aircra! 43 65 75 102

Other noncurrent liabilities 760 771 910 493

Stockholders’ Equity:

Common stock, $1.00 par value 808 808 808 808

Capital in excess of par value 1,374 1,231 1,222 1,216

Retained earnings 9,409 6,431 5,395 4,971

Accumulated other comprehensive income –1,051 –3 –224 –578

Treasury stock, at cost: –3,182 –1,131 –324 –963

Total stockholders’ equity 7,358 7,336 6,877 5,454

Source: Southwest Airlines Annual Reports.



But they also o!en increased the distance that passengers had to fly to reach their final destina-tion and the time it took for passengers to get there.

Recessions, terrorist attacks, and cost increases have hurt the industry since the turn of the century. During the decade following 9/11, the price of jet fuel rose from $34 per barrel to nearly $135 per barrel, and the tax burden on airlines tripled. Moreover, a!er 9/11 and during the Great Recession, the number of passengers flying decreased, which made it di#icult to keep planes flying near full capacity. Between 2001 and 2011, 41 US airlines went bankrupt and the industry was estimated to have lost $55 billion and 160,000 jobs.4 While most airlines struggled to survive, Southwest had figured out a way to stay profitable.

The History of Southwest AirlinesLegend has it that the idea for Southwest Airlines was first conceived on a napkin while Herb Kelleher was meeting with Rollin King in a San Antonio restaurant.5 In 1966, Kelleher was prac-ticing law. King, one of Kelleher’s clients, approached him with the idea of bringing a low-cost intrastate airline to Texas. Because federal regulations made it di#icult to establish an airline that crossed state borders, the two founded Southwest Airlines in 1967 to focus on point-to-point travel among the three Texas cities of Dallas, Houston, and San Antonio.6 In contrast to

EXHIBIT 3 US Domestic Airline Total Operating Revenues (In millions)

American America West

Continental Delta Northwest Southwest United US Airways

JetBlue Alaska

2015 33,581 — — 40,816 — 19,820 37,864 7,504 6,416 5,594

2013 25,760 — — 37,818 — 17,699 38,287 14,936 5,442 5,151

2012 24,825 — — 36,917 — 16,411 37,160 14,121 4,982 4,650

2011 23,958 — 16,175 35,316 — 13,655 21,155 13,341 4,509 4,310

2010 22,151 — 14,011 31,894 — 12,104 19,682 12,196 3,781 3,427

2009 19,898 — 12,361 18,047 10,863 10,350 16,359 10,781 3,287 3,006

2008 23,696 — 15,033 20,973 14,096 11,023 20,237 12,459 3,390 3,221

2007 22,833 2737 14,105 19,239 12,735 9,861 20,049 9,318 2,843 3,070

2006 22,493 3770 13,010 17,339 12,555 9,086 19,334 8,076 2,363 2,693

2005 20,657 3397 11,108 16,112 12,316 7,584 17,304 7,212 1,703 2,416

2004 18,608 2482 9,851 15,154 11,266 6,530 15,701 7,073 1,266 2,241

2003 17,403 2223 7,333 14,203 9,184 5,937 13,395 6,762 998 2,027

2002 15,871 2021 7,353 12,410 9,152 5,522 13,916 6,915 635 1,832

2001 15,639 2035 7,972 13,211 9,592 5,555 16,087 8,253 320 1,763

2000 18,117 2309 9,129 15,321 10,957 5,650 19,331 9,181 105 1,760

1999 16,090 2164 8,024 14,901 9,868 4,736 17,967 8,460 — 1,696

1998 16,299 1983 7,299 14,630 8,707 4,164 17,518 8,556 — 1,581

1997 15,856 1887 6,361 14,204 9,984 3,817 17,335 8,501 — 1,457

1996 15,136 1752 5,487 13,318 9,751 3,407 16,317 7,704 — 1,307

Note: US Airways and America West started to report combined on-time data in January 2006 and combined tra#ic and financial data in October 2007 following their 2005 merger announcement. Delta and Northwest began reporting jointly in January 2010 following their 2008 merger announcement.Source: Bureau of Transportation Statistics, Air Carrier Financial Reports: Schedule P-1.2.


The History of Southwest Airlines C-45

EXHIBIT 4 US Domestic Airline Operating Profits (In millions)

American America West

Continental Delta Northwest Southwest United US Airways JetBlue Alaska

2015 5,032 — — 7,885 — 4,116 5,167 1,157 1,198 1,291

2013 1,488 — — 3,837 — 1,278 1,259 1,003 415 857

2012 41 — — 2,649 — 630 49 822 360 562

2011 –1,170 — 950 2,245 — 652 894 434 324 471

2010 151 — 622 2,616 — 988 1,268 781 345 456

2009 –1,163 — –211 –604 480 262 248 121 266 208

2008 –2,054 — –378 56 –540 449 –1,747 –1,774 84 –25

2007 702 –20 621 1,005 1,124 790 952 544 166 123

2006 815 –35 410 31 782 934 451 592 117 –103

2005 –351 –121 –94 –1,197 –895 820 –242 –213 62 –8

2004 –421 –3 –290 –1,613 –434 554 –1,167 –348 113 –39

2003 –1,444 24 29 –1,157 –276 482 –1,556 –421 169 –-11

2002 –3,313 –164 –481 –1,036 –783 418 –3,021 –919 105 –81

2001 –2,558 –424 –341 –972 –796 631 –3,743 –1,182 35 –65

2000 1,243 –13 587 1,460 664 1,021 741 –45 -15 –12

1999 1,004 198 478 1,730 769 782 1,358 202 - 177

1998 1,749 198 660 1,793 –129 684 1,436 990 - 195

1997 1,447 164 645 1,621 1,204 524 1,225 586 - 133

1996 1,331 69 394 571 1,108 349 1,130 369 - 81

Note: US Airways and America West started to report combined on-time data in January 2006 and combined tra#ic and financial data in October 2007 following their 2005 merger announcement. Delta and Northwest began reporting jointly in January 2010 following their 2008 merger announcement.Source: Bureau of Transportation Statistics, Air Carrier Financial Reports: Schedule P-1.2.



EXHIBIT 5 US Domestic Airline Revenue Passenger Miles* (In billions)

American America West Continental Delta Northwest Southwest United US Airways JetBlue Alaska2015 167.1 — — 188.4 — 117.6 183.6 38.4 41.8 30.3

2013 128.4 — — 194.0 — 104.3 178.6 65.6 35.8 28.8

2012 126.4 — — 193.0 — 102.9 179.4 62.4 33.6 27.0

2011 126.5 — — 192.8 — 97.6 181.8 60.8 30.7 25.0

2010 125.5 — 79.7 193.2 — 78.1 102.5 59.0 28.3 20.4

2009 122.4 — 77.8 100.7 63.0 74.6 100.5 57.9 26.0 18.4

2008 131.8 — 80.5 105.7 71.6 73.6 110.1 60.6 26.1 18.7

2007 138.4 17.7 81.4 103.3 72.9 72.3 117.4 43.5 25.7 18.5

2006 139.4 23.5 76.3 98.8 72.6 67.7 117.2 37.4 23.3 17.8

2005 138.4 24.3 68.4 103.7 75.9 60.3 114.3 40.2 20.2 16.9

2004 130.2 23.3 63.4 98.3 73.4 53.5 115.2 40.5 15.7 16.2

2003 120.3 21.3 57.6 89.4 68.8 48.0 104.4 37.8 11.5 14.6

2002 121.7 19.9 57.3 95.3 72.1 45.5 109.4 40.0 6.8 13.2

2001 106.2 19.1 58.8 97.7 73.3 44.7 116.6 46.0 3.3 12.3

2000 116.6 19.1 62.4 107.8 79.2 42.4 126.9 46.9 1.0 12.0

1999 110.2 17.7 58.0 104.8 74.2 36.8 125.5 41.5 - 11.8

1998 108.9 16.4 51.0 102.0 66.8 31.6 124.6 41.4 - 11.3

1997 107.0 16.2 44.3 99.7 72.1 26.4 121.4 41.7 - 10.4

1996 104.6 15.3 37.6 93.9 68.7 27.3 116.7 39.2 - 9.8

Note: US Airways and America West started to report combined on-time data in January 2006 and combined tra#ic and financial data in October 2007 following their 2005 merger announcement. Delta and Northwest began reporting jointly in January 2010 following their 2008 merger announcement.*A Revenue Passenger Mile is counted when an airline transports one passenger one mile.Source: Bureau of Transportation Statistics, T1: U.S. Air Carrier Tra#ic and Capacity Summary by Service Class.


Southwest’s Strategy and Operations C-47

larger airlines servicing the cities through connecting interstate routes, Southwest would fly directly to each of the cities, and the flights would take roughly one hour each.

When deregulation hit the airline industry in 1978, Southwest decided to compete with low fares. Demand for travel among the three cities had been rising at the time, and, with little price competition in the market, passenger fares were high. Targeting business travelers and commuters among its initial three cities, Southwest’s fares were typically priced between $40 and $100 round trip in order to compete with the cost of driving.

Southwest was based out of Love Field in Dallas, which although a small airport, o#ered travelers a more convenient location because of its closer proximity to the city than the larger Dallas–Fort Worth Airport. Using Love Field as inspiration, Southwest adopted a “love” theme for the airline’s marketing and operations. Drinks were called “love potions,” and ticket machines “love machines.” Later, when Southwest went public, its stock ticker would be LUV. The flight attendants were women chosen for their striking looks. They wore boots and “hot pants” (small, form-fitting shorts), which were a fashion trend. Said Kelleher, “You can have a low-cost carrier and people still don’t fly it because they don’t know about it. And so, the shtick kind of fits in with getting known.”7

Southwest also emphasized a culture of fun. Employees were known to sing announce-ments to passengers and deliver entertaining instructions. For example, flight attendants were known to tell passengers how nice they would look in their life vests or that they will need to deposit 25 cents for oxygen to begin flowing to their oxygen masks. It is easy to find videos on the Internet of flight attendants singing, rapping, and telling jokes to their passen-gers. Southwest brought the culture of fun to its employees not only through the example of its senior executives but also through its “fun” training programs. The company’s advertising also tended to be a fun, even a little edgy. On one occasion, marketers brought an ad to Kelleher that targeted extra regulations and fees that other airlines stated in “fine print” marked by aster-isks in their ads. Kelleher quickly approved running Southwest’s ad, which read, “Some airlines should have their asterisks kicked.”8

The company’s point-to-point service led to frequent departures between city-pair routes. With only three planes operating until 1974, Southwest had to focus on turning its planes around as quickly as possible. Its choice to fly into less-congested airports such as Love Field helped Southwest make those faster turnarounds. At the beginning, Southwest set the goal of turning its planes around in 15 minutes, which was 30 minutes faster than the industry average.

Southwest also quickly discovered that it could segment its pricing. A!er starting its fares at $20 one way, Southwest raised fares for travel before 7:00 pm to $26. To target budget-minded leisure travelers, Southwest lowered fares for flights a!er 7:00 pm and weekend flights to as low as $13. Such decisions were key to Southwest’s early success and laid the foundation for the company’s successful low-cost strategy.9 Southwest’s business model set it apart from its competitors, and the company began to grow quickly. It took the company only two years to become profitable, and it has been profitable every year since 1973.

Southwest’s Strategy and OperationsSouthwest’s strategy involved o#ering no-frills, short-haul, high-frequency, point-to-point, low-fare service. Although Southwest’s approach would later become well known and fre-quently studied, it started out primarily as a response to the constraints faced by the company. Federal regulations led Southwest to focus on intrastate travel among just Dallas, Houston, and San Antonio. The company’s first planes were three Boeing 737s purchased because they were available at a discount because of overproduction.10 This small fleet caused Southwest to focus on reducing the time to turn its planes around and get them back in the air. Because of its short flights, the airline did not serve meals. Eventually, Southwest would become renowned for these strategies of flying only point-to-point routes between less congested airports, adopting



EXHIBIT 6 US Domestic Airline Annual Passengers Boarded

American America West Continental Delta Northwest Southwest United US Airways JetBlue Alaska2015 93,340,810 — — 115,074,415 — 142,470,152 69,310,060 24,790,680 28,825,334 21,346,759

2013 65,070,199 — — 98,590,233 — 115,376,527 65,220,534 50,037,109 25,858,306 17,889,819

2012 65,027,098 — — 95,640,986 — 112,276,657 67,628,693 47,481,320 24,885,092 16,771,209

2011 65,253,442 — 31,242,827 92,864,167 — 110,624,339 39,551,017 46,208,387 22,940,694 16,003,023

2010 65,733,760 — 30,653,722 90,141,070 — 106,270,433 43,322,801 45,179,861 21,144,663 14,901,113

2009 66,168,794 — 31,954,535 55,708,779 32,624,283 101,374,390 45,582,670 44,554,186 20,022,359 14,060,609

2008 71,563,663 — 34,524,968 59,375,572 38,510,984 101,965,552 51,681,045 48,544,910 20,517,934 14,864,602

2007 76,581,414 14,674,045 37,117,030 61,599,411 43,812,180 101,947,800 56,420,151 37,220,911 20,527,593 15,328,828

2006 76,813,449 19,956,043 35,795,440 63,495,888 45,140,701 96,330,250 57,229,074 31,886,350 18,098,021 14,916,122

2005 77,296,967 20,867,974 32,971,219 77,581,274 46,690,086 88,435,832 55,172,705 37,040,080 14,462,932 14,603,547

2004 72,647,682 20,150,587 31,528,695 79,373,578 45,959,204 81,121,296 60,080,792 37,810,424 11,616,090 14,304,622

2003 72,202,834 19,187,175 30,853,319 77,792,560 43,310,361 74,768,258 56,307,542 37,302,321 8,949,744 13,103,525

2002 77,448,660 18,798,859 31,653,035 83,746,977 43,313,590 72,459,290 57,830,147 43,480,092 5,672,028 12,305,968

2001 61,703,981 19,012,929 34,635,032 86,888,411 44,786,477 73,628,735 63,946,774 52,657,538 3,056,371 11,949,955

2000 68,318,711 19,466,518 36,590,818 97,965,050 48,462,068 72,568,465 72,449,712 56,666,734 1,128,146 11,875,380

1999 63,892,853 18,265,042 36,129,566 98,212,271 46,666,307 65,287,540 75,435,685 53,271,910 — 12,073,680

1998 63,986,759 17,304,899 34,985,100 97,878,777 41,930,858 59,053,217 75,058,073 55,603,253 — 11,652,685

1997 63,976,882 17,743,106 33,858,113 95,965,747 45,168,283 55,943,405 71,875,986 56,364,488 — 11,223,438

1996 62,343,746 17,585,980 32,217,152 89,598,231 43,535,244 55,372,361 70,041,013 54,585,324 — 10,965,353

Note: US Airways and America West started to report combined on-time data in January 2006 and combined tra#ic and financial data in October 2007 following their 2005 merger announcement. Delta and Northwest began reporting jointly in January 2010 following their 2008 merger announcement.Source: Bureau of Transportation Statistics, T-100: Domestic Market (U.S. Carriers).



only one model of plane (the Boeing 737), and o#ering only one class of service, without meals or assigned seating.

Southwest bucked the industry trend of routing planes through a hub-and-spoke (HS) model by flying its planes point-to-point (PTP) on city-pair routes. The HS model—developed in the 1960s and 1970s and used by full-service carriers such as American, United, and Delta—was designed to maximize the load factors for each of an airline’s individual planes by bringing cus-tomers traveling to the same location together in a central hub from all their di#erent points of origination. The HS model was, however, generally considered to be inconvenient by passen-gers, and a delay in one flight on a spoke would create a domino e#ect of delays that would cascade throughout an airline’s system of flights. Southwest determined that it would instead focus on putting as many flights as possible on its point-to-point routes by turning the planes around as quickly as possible (see Exhibits 6 and 7).

Southwest was able to successfully decrease its turnaround times to close to 15 minutes for a variety of reasons. Flying PTP meant Southwest’s flights weren’t waiting on other flights. Since Southwest’s flights were shorter, its passengers typically checked less baggage. The absence of meals on the airline’s flights meant that less cleanup time was required. In addition, Southwest focused its employees on working as a team to turn planes and gave them significant latitude to work outside of formal guidelines and do whatever it took to turn a plane around quickly. Finally, Southwest stressed a high-speed boarding process. Most airlines assigned seats to their passengers, but Southwest ignored that method of boarding. Instead, each passenger got a boarding number as he or she arrived at the gate. Eliminating assigned seating meant that the airline didn’t have to reconcile double-booked seats, and it motivated passengers to arrive early. Taken together, these practices combined to help Southwest turn around planes much faster than most of its competitors. By 2009, Southwest was turning planes at an average of 23 minutes, which was still roughly half of the industry average.11

In an industry facing some of the highest fixed costs in the world, Southwest’s business model allowed it to keep costs low. Southwest had continued to exclusively use Boeing 737s throughout its history. By 2010, there were 548 Boeing 737s in Southwest’s fleet (451 owned, 97 leased).12 The e#iciencies created by the common fleet of the 737s also meant that Southwest spent less money training its pilots, flight attendants, and mechanics and was able to sta# smaller teams for its gate crews. In fact, the uniform configuration was so impor-tant to Southwest that, following its purchase of AirTran in 2011, all of AirTran’s planes were reconfigured to match Southwest’s current fleet. Purchasing the same type of plane also gave Southwest some leverage negotiating prices with Boeing—which was not insignificant, since

EXHIBIT 7 Total Passengers per Full-time Employee Equivalent

2015 2012 2011 2010 2009 2008 2001 1996American 1,485 1,340 1,295 1,316 1,290 1,309 847 1,006

Continental — — 1,231 1,154 1,137 1,156 1,015 1,186

Delta 1,693 1,489 1,420 1,449 1,463 1,513 1,343 1,653

Southwest 3,053 3,058 3,065 3,106 2,908 2,942 2,391 2,490

United 1,134 1,052 1,086 1,175 1,204 1,225 801 1,035

US Airways — 1,737 1,679 1,679 1,628 1,677 1,651 1,424

JetBlue 2,434 2,346 2,245 2,160 2,116 2,144 1,444 NA

Alaska 1,969 2,019 1,997 1,909 1,746 1,746 1,351 1,544

Source: Data compiled by MIT Airline Data project using US DOT Form 41 via BTS, Schedule T1 & P10.http://web.mit.edu/airlinedata/www/Employees&Productivity.html.http://web.mit.edu/airlinedata/www/2012%2012%20Month%20Documents/Employees%20and%20Productivity/ Total/Total%20Passengers%20per%20Full-time%20Employee%20Equivalent.htm.



a Boeing 737 cost between $75 million and $107 million in 2013, depending on the features included on the aircra!.

Southwest also limited the commissions it paid to ticketing services and booking agents by refusing to pay fees for any third-party ticketing services except the SABRE system. These fees had historically run 5 percent to 10 percent of the price of a ticket but had moved to a lower flat fee in recent years. Instead, Southwest developed an online ticketing system of its own, and in 1995 it became the first airline to sell tickets directly from its own website. In 2010, 79 percent of Southwest’s tickets were purchased online.13 In contrast, only 35 percent of Delta’s tickets were purchased online during the same period.14

Although Southwest saved significant money on its operations, it was spending more than the average airline on marketing. In its first year of business, the airline spent 10 percent of its budget on advertising. The company had continued to emphasize marketing throughout its his-tory, even increasing its marketing during di#icult years. As Kelleher explained, “When do you need advertising the most? When times are bad.”15 When Southwest achieved record profits and load factors in 2010, CEO Gary Kelly credited the company’s highly successful “Bags Fly Free” ad campaign for the success.16 The campaign cost Southwest $159.5 million to produce, which was nearly the same as the combined advertising budgets of Delta, United, American, and Continental.17

Although multiple cities were clamoring for Southwest’s business, the airline made an early decision to grow slowly. Even in the best years, Southwest restricted increases in its capacity to 20 percent to 15 percent and added only two or three new cities per year. In 1996, Kelleher reflected, “Southwest has had more opportunities for growth than it has airplanes. Yet, unlike other airlines, it has avoided the trap of growing beyond its means.”18 Following the devastating e#ects of the 9/11 terrorist attacks, Southwest explained in the opening statement to its 2001 annual report, “Southwest was well poised, financially, to withstand the potentially devastating hammer blow of September 11. Why? Because for several decades our leadership philosophy has been: We manage in good times so that our company and our people can be job secure and prosper through bad times.” As noted, the airline recession a!er 9/11 as well as the US Great Recession of 2008–2009 had a strong negative impact on industry profitability (see Exhibits 8 and 9).

Managing its growth in such a way kept far more cash in Southwest’s pockets than was common for the industry. When fuel prices skyrocketed a!er 2005, Southwest was able to stay profitable because of its practice of fuel hedging, or buying options that guaranteed the price of fuel in the future. Most of the rest of the industry wasn’t able to follow suit, however, because hedging required an enormous cash outlay.19

Southwest’s Market Share inSouthwest’s Top 100 City-Pair Markets

OtherCarriers

30%

Other Carriers76%

Southwest70%

Southwest24%

Southwest’s Market ShareTotal Domestic Market

EXHIBIT 8 Southwest Airlines’ Market Share Source: Southwest Annual Report 2013.



EXHIBIT 9 Profitability (Operating Profit/Revenues) by Airline Over Time

American America West Continental Delta Northwest Southwest United US Airways JetBlue Alaska2015 15.00% — — 19.30% — 20.80% 13.60% 15.40% 18.70% 23.10%

2013 5.80% — — 10.10% — 7.20% 3.30% 6.70% 7.60% 16.60%

2012 0.20% — — 7.20% — 3.80% 0.10% 5.80% 7.20% 12.10%

2011 –4.90% — 5.90% 6.40% — 4.80% 4.20% 3.30% 7.20% 10.90%

2010 0.70% — 4.40% 8.20% — 8.20% 6.40% 6.40% 9.10% 13.30%

2009 –5.80% — –1.70% –3.30% 4.40% 2.50% 1.50% 1.10% 8.10% 6.90%

2008 –8.70% — –2.50% 0.30% –3.80% 4.10% –8.60% –14.20% 2.50% –0.80%

2007 3.10% –0.70% 4.40% 5.20% 8.80% 8.00% 4.70% 5.80% 5.80% 4.00%

2006 3.60% –0.90% 3.20% 0.20% 6.20% 10.30% 2.30% 7.30% 5.00% –3.80%

2005 –1.70% –3.60% –0.80% –7.40% –7.30% 10.80% –1.40% –3.00% 3.60% –0.30%

2004 –2.30% –0.10% –2.90% –10.60% –3.90% 8.50% –7.40% –4.90% 8.90% –1.70%

2003 –8.30% 1.10% 0.40% –8.10% –3.00% 8.10% –11.60% –6.20% 16.90% –0.50%

2002 –20.90% –8.10% –6.50% –8.30% –-8.60% 7.60% –21.70% –13.30% 16.50% –4.40%

2001 –16.40% –20.80% –4.30% –7.40% –8.30% 11.40% –23.30% –14.30% 10.90% –3.70%

2000 6.90% –0.60% 6.40% 9.50% 6.10% 18.10% 3.80% –0.50% –14.30% –0.70%

1999 6.20% 9.10% 6.00% 11.60% 7.80% 16.50% 7.60% 2.40% — 10.40%

1998 10.70% 10.00% 9.00% 12.30% –1.50% 16.40% 8.20% 11.60% — 12.30%

1997 9.10% 8.70% 10.10% 11.40% 12.10% 13.70% 7.10% 6.90% — 9.10%

1996 8.80% 3.90% 7.20% 4.30% 11.40% 10.20% 6.90% 4.80% — 6.20%

American America West Continental Delta Northwest Southwest United US Airways JetBlue Alaska2010–2013 0% — — 8% — 6% 4% 6% 8% 13%

2008–2009 –7% — –2% –2% 0% 3% –4% –7% 5% 3%

2006–2007 3% –1% 4% 3% 8% 9% 4% 7% 5% 0%

2001–2005 –10% –6% –3% –8% –6% 9% –13% –8% 11% –2%

1996–2000 8% 6% 8% 10% 7% 15% 7% 5% — 7%

1996–2000, 2006–2007, 2010–2013: (Positive economic growth periods) 2001-2005: (Airline industry recession due to 9/11/01 terrorist attacks) 2008–2009: (Recession in the United States); Source: Annual Reports & Bureau of Transportation Statistics.



Leadership, Culture, and ValuesHerb Kelleher was known for his unique style of leadership. As Kelleher reached 80 years old in 2011, he continued to display the quick wit and sense of humor that made him the face of Southwest a!er its founding. He was o!en featured in commercials and videos about the com-pany. For one training video, he created a fully costumed rap persona called “Big Daddy O.” He once dressed in a purple dress with a purple hat a!er losing a challenge with the mainte-nance crew.

Kelleher was highly admired by his employees, perhaps because he was so engaged with them. For example, Kelleher was o!en seen helping to unload bags or serving drinks with flight crews. During one di#icult period, when his pilots were willing to freeze their salaries for five years, Kelleher responded by freezing his own for the same period. As a token of their esteem for him, employees purchased Kelleher a custom Harley-Davidson motorcycle that he rode o!en.

One of Kelleher’s basic principles of business for Southwest was that the customer wasn’t always right. Instead, his credo was that employees come first.20 Kelleher said, “You put your employees first and if you take care of them, then they will take good care of you. Then your cus-tomers will come back, and your shareholders will like that, so it’s really a unity.”21 Southwest went to great lengths to maintain a culture of fun and to build a family spirit all across the air-line. It even created a “Culture Committee” sta#ed with employees who volunteered their time a!er being nominated by their peers. The committee worked to create events and programs to celebrate Southwest employees at all levels from across the organization.

Employees at Southwest were recruited for their positive and engaging attitudes and were given extensive training to ensure that they not only understood the airline’s opera-tions, but also embraced its culture. During hiring, Southwest conducted group interviews in which potential employees would share personal stories while interviewers observed the group for signs of empathy and interest.22 In order to facilitate empathy among di#erent types of employees, Southwest implemented Walk-A-Mile Day. Employees in all departments were encouraged to experience their coworkers’ jobs first-hand. Walk-A-Mile Day and other practices encouraged collaboration throughout the company. When a flight did leave behind schedule, the team would meet to focus on the problem together, thus eliminating finger pointing at indi-viduals. The results of Southwest’s e#orts were the highest level of employee productivity in the industry (see Exhibit 7).

Southwest’s employees have also benefited from its profit-sharing plan. Roughly 10 per-cent of Southwest’s stock is held by its employees. Some think that these practices explain why, even though 82 percent of Southwest’s 35,000 employees are unionized, the airline has one of the lowest rates of union complaints. It also didn’t hurt that Southwest hasn’t laid o# or furloughed an employee since its founding in 1971. Looking back, Kelleher said during a 2011 interview that the facet of Southwest that made him most proud was having “total job security for our employees for over 40 years. I’ve spent my entire career staying out of their way.”23

Southwest’s Growth and ExpansionDespite facing constant opposition to expansion from its competitors, Southwest was still able to grow steadily a!er its founding. Southwest moderated its growth in the face of enormous demand for what became known as the Southwest e!ect. In less than one year, cities newly served by Southwest would o!en see up to a 1,000 percent increase in air tra#ic, largely because of lower airfares. The Oakland–Burbank route improved from the 179th largest passenger route to the 25th largest within one year of Southwest’s entry. As Exhibit 10 shows, Southwest was the dominant carrier in all of its top 100 city-pair routes.

Although most of Southwest’s routes were short-haul flights of fewer than 1,000 miles, in the late 1990s, the airline began to look at expanding into long-haul routes. On Thanksgiving Day 1998, it commenced its first transcontinental flight from Baltimore to Oakland, a five-hour


JetBlue: A Tough Competitor C-53

trip. Southwest was able to expand to longer routes in large part because Boeing had devel-oped the 737-500 model aircra!. The 500 flew the longer flights at a far lower cost per mile while still maintaining the basic 737 structure and configuration that Southwest employees were used to.24

In 2007, Southwest moved to start catering more to business travelers by introducing Business Select service. Although the airline still provided only one class of seating, Business Select o#ered early boarding privileges, special business services at gates, and improved fre-quent flyer points. Initially, some observers expressed concerns about alienating core cus-tomers, but a few years later the Business Select service appeared to have increased interest from business travelers without having a noticeable e#ect on other travelers.

In 2010, Southwest made its second acquisition (the first was Morris Air in 1993) of AirTran for $1.4 billion. AirTran followed a very similar strategy of o#ering short-haul, point-to-point, low-fare service. AirTran’s routes had little overlap with Southwest and included short inter-national routes to the Caribbean and Mexico. The move would eventually extend Southwest’s presence into Atlanta, the busiest airport in the world, and connect the airline to international markets. Full integration of the acquisition was expected to be completed by the end of 2014, by which time Southwest would begin showing AirTran’s routes on its website. In keeping with its strategy of using a single type of plane, Southwest decided to lease AirTran’s fleet of Boeing 717s to Delta so that it could use the standard Boeing 737s that it used throughout its operations.25

JetBlue: A Tough CompetitorJetBlue was founded in 1999 by former Morris Air president David Neeleman. A!er receiving more than $800 million in funding to establish its base of operations in JFK airport in New York, the airline grew quickly. During its first five years, JetBlue’s revenues increased by more than 1,100 percent, although it slowed significantly during the US recession in the latter part of the decade. In 2002, JetBlue had a successful initial public o#ering of stock (IPO); the airline’s stock price increased by 70 percent on the first day alone. JetBlue flew both domestically and interna-tionally, with both short- and long-haul routes. For example, JetBlue could fly long-haul flights

Low PriceLow

Per

form

ance

High

Meals Lounges SeatingChoices

HubConnectivity

Purchase Criteria

FriendlyService

Speed FrequentDepartures

Car Full service airlines Southwest

EXHIBIT 10 The Strategy Canvas of the Short-Haul Airline Industry Source: (Adapted from) W. Kim and R. Mauborgne, “Charting Your Company’s Future. (cover story),” Harvard Business Review, 80, 6 (2002): 76–83.



from New York to Los Angeles, which Southwest could not do with the Boeing 737. Jet Blue’s strategy and operations mimicked Southwest in many ways, including flying point to point, using one type of aircra! (Airbus 320, which could fly longer routes; it later added Embraer 190 Jets for short-haul flights), not serving meals, and creating a team approach to quickly turning around flights. The airline distinguished itself from Southwest with comfortable leather seat-ing, in-flight television o#ered in partnership with DirecTV, and assigned seating. JetBlue also o#ered its passengers simple boxed meals during flights (at an added charge) and charged for checking more than one bag.

Although JetBlue’s revenues were less than one-third of Southwest’s, it was still a note-worthy competitor. JetBlue came in second to Southwest Airlines by only a couple points (84 to 87 out of 100) in a 2011 Consumer Reports survey of passengers.26 In 2014, Jet Blue beat out Southwest for the highest customer satisfaction rating among airlines by the American Customer Satisfaction Index (ACSI). JetBlue was also the only airline other than Southwest to show positive operating profits year a!er year. The airline was steadily growing its fleet of Airbus A320 and Embraer 190 jets and was consistently adding new routes. JetBlue’s strategy finally brought a competitor to the industry that could compete directly, and e#ectively, with Southwest.

Looking Forward from 2015: Challenges with Growth and CompetitionSouthwest had set the standard for the industry in multiple areas of operation, including flying more passengers per employee than any other airline, maintaining a debt-to-equity ratio far below the industry average, and never having to stop a flight because of a union strike. Profit-ability at Southwest, and among all of its major competitors, was at an all-time high as a result of industry consolidation, higher capacity utilization of planes, and lower fuel costs because of the significant drop in oil prices. But despite Southwest’s strong historical performance, key challenges lay ahead.

Southwest had achieved steady growth following the Great Recession of 2008–2009, but some observers believed that, with record industry profitability, Southwest needed a growth plan. Southwest had gradually saturated most of the short-haul markets in the United States with little opportunity to add additional short-haul routes. Southwest had historically avoided both long-haul and international routes, but if the company was going to grow it would need to expand into those markets. CEO Gary Kelly acknowledged that long-haul markets were attrac-tive for two reasons: first, they were the biggest, fastest-growing markets in US air travel and second, these markets had been dominated by the legacy carriers and Southwest had low market share—and thus had room to grow.

But while the long-haul markets represented an opportunity, they also would not be easy to capture. For one thing, there was the question of whether Southwest could service long- haul markets with the Boeing 737, or whether Southwest would need to add a longer range aircra!, as JetBlue had done with the Airbus 320. Moreover, the traditional carriers dominated those markets and recent acquisitions (and restructurings) had strengthened their positions. Delta’s acquisition of Northwest in 2008 made it the industry’s largest carrier, as measured by share of revenue passenger miles (RPMs), which is the number of times that an airline carries one passenger one mile. In order to keep pace, UAL corporation, parent of United Air-lines, announced in 2010 a merger with Continental Airlines. And in 2013, American Airlines acquired US Airways, which made it the industry’s largest carrier, surpassing Delta in share of revenue passenger miles. The consolidation of hub-and-spoke competitors in the industry reduced competition among these players and created an industry where the four largest airlines—American, Delta, UAL, and Southwest—controlled roughly 80 percent of the US air travel market. While American (with US Airways), Delta (with Northwest), and United (with Continental) all had more revenue passenger miles than Southwest (because of more long-haul


References C-55

flights), Southwest led the domestic market in the number of passengers boarded annually. But the consolidations (and restructurings) also helped the legacy carriers improve their cost posi-tion. Delta Airlines had higher profitability than Southwest from 2011 to 2015, and American and UAL were also realizing profits that were closer in line with what Southwest was achieving. In short, the legacy carriers were stronger and better positioned to protect their long-haul routes from encroachment by Southwest. This raised key questions about Southwest’s growth pros-pects. Should Southwest invest heavily entering long-haul routes in the United States? Should it consider adding a longer haul aircra! to its fleet? Should it target international flights? These were questions facing CEO Kelly and Southwest as it looked for growth in an industry where growth in short-haul flights—its historical bread and butter—was limited.

References1Consumer Reports Sta#, “Best and Worst Airlines: Southwest Is Tops and US Airways Trails in Our Latest Survey,” Consumer Reports (June 2011), pp. 17–19.2N. Calio, April 27, 2011. Speech Printed by Air Transporta tion Assoc., http://www.airlines.org/News/Speeches/Pages/speech_04-27-11.aspx.3“A History of Airline Deregulation: Part 4,” Travel Insider (May 28, 2011) http://thetravelinsider.info/airlinemismanagement/airline deregulation2.htm.4Calio.5National Aviation Hall of Fame, “Herb Kelleher,” 2011, http://www .nationalaviation.org/kelleher-herbert/.6J. L. Heskett and W. E. Sasser, Jr., “Southwest Airlines in a Di#erent World,” Harvard Business School Case 9-910-419, rev. 2013.7CBSNews Sta#, “Something Special About Southwest Airlines,” CBSNews (February 11, 2009).8R. Crain, “Herb Kelleher on the Importance of Advertising to South-west’s Success,” Advertising Age (May 2, 2011).9Southwest Airline’s Company History, 2011, http://www.swamedia .com/channels/By-Date/pages/1972-to-1978.10Heskett.11CBSNews Sta#.12Southwest Airlines Annual Report, 2010.13Ibid.14D. Schaal, “Delta Increases Share by Squeezing Online Travel Agencies and Metasearch,” Tnooz (August 05, 2011).

15Crain.16Southwest Airlines Annual Report, 2010.17G. Lindsay, “Why’d You Pick That Airline to Fly on Thanksgiving? We Thought So,” Advertising Age (November 29, 2010).18K. Frieberg and J. Frieberg, Nuts! Southwest Airlines‘ Crazy Recipe for Business and Personal Success (Austin, TX: Bard Press, 1996), p. 61.19M. Herbst, “Hedging Against $200 Oil,” Bloomberg Businessweek (May 7, 2008).20Crain.21CBSNews Sta#.22Heskett and Sasser.23Crain.24M. E. Raynor, “Disruptive Innovation: The Southwest Airlines Case Revisited,” Strategy & Leadership 39 (4) (2011): 31–34.25T. W. Martin, “Southwest Eager for Atlanta Seat,” The Wall Street Journal (May 10, 2011).26Consumer Reports Sta#, “Best and Worst Airlines: Southwest Is Tops and US Airways Trails in Our Latest Survey.”27Southwest Airlines Corporate Factsheet, 2014, http://www.southwest .com/html/about-southwest/history/fact-sheet.html.28“Southwest’s Gary Kelly Talks about His Next Steps” (August 20, 2009), The Wall Street Journal Online.
