Southwest airlines: A case study linking employee needs satisfaction and organizational capabilities to competitive advantage

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<ul><li><p>Southwest Airlines: A Case Study Linking Employee Needs Satisfaction and Organizational </p><p>Capabilities to Competitive Advantage </p><p>Roger Hallowell </p><p>This article analyzes the sources of Southwest Airlines competitive aduantage using an integrative approach, employing economic analysis tools to illustrate the roles of commitment and organizational capabilities in delivering competitive advantage at South- west. A framework is presented illustrating that much of the value Southwest generates is ( 1 ) created through employee needs satisfaction, ( 2 ) converted to customer and shareholder value via organizational capabilities, and (3 ) captured by the f irm as a result of its cost advantage and superior service. This three-part framework may be applicable to other labor-dependent service organizations. 0 1996 by John Wiley &amp; Sons, Inc. </p><p>Introduction </p><p>Southwest Airlines has demonstrated its superior comprehensive strategy by (1) being the only major United States (US) airline to earn a profit throughout the early 1990s, (2) having one of the most successful airline stocks, and (3) being the only airline to ever win the industrys triple crown (measures of customer satisfaction).2 As an example of Southwests success, both Continental3 and United Airlines have copied aspects of its strategy in their efforts to improve profitability. </p><p>Southwests success may be due largely to its unusual focus on creat- ing value for employees. LUV and FUN, the cornerstones of South- wests employee-relations approach, represent concern and respect for the individual, as well as the conscious creation of an environment that encourages all employees to have fun on the job. Southwests low turn- over and high productivity4 suggest that the airline creates significant value for employees. </p><p>Southwests success is also dependent on its organizational capa- bilities that enable it to convert some of the value created for employees to customer and shareholder value. As a result of these capabilities, </p><p>Human Resource Management, Winter 1996, Vol. 35, Number 4, Pp. 513-534 0 1996 by John Wiley &amp; Sons, Inc. CCC 0090-4848/96/040513-22 </p></li><li><p>employees deliver both low cost and superior service which form the basis of Southwests competitive advantage (Porter, 1985), enabling it to capture value. Thus Southwest provides an example of competitive ad- vantage created through people, as suggested by Pfeffer (1994). </p><p>The creation and maintenance of Southwests competitive advantage can be seen as a virtuous cycle.5 Describing this cycle requires theories of motivation, organizational capabilities, and strategic positioning. First, Southwest creates value for its employees, which increases their motiva- tion. Second, Southwest converts some of that value to customer and firm value by designing operating processes, and encouraging behavioral norms that enable employees both to reduce cost and to improve ser- vice. Third, Southwest captures value through low costs and superior service (relative to its competitors). This create value, convert value, capture value cycle may apply to some portion of competitive advantage in other Iabor-dependent services (services where labor is both a large proportion of total costs and employees can dramatically affect day-to- day quality). </p><p>One goal of this article is to illustrate the role human resources can play in creating and sustaining competitive advantage. The Southwest case illustrates how a focus on human resources in organizational values and culture and the use of specific human resource tools can aid in delivering competitive advantage. It is a particularly good example be- cause commercial airlines form an industry in which competitive advan- tage is generally acknowledged to be difficult, if not impossible, to ob- tain. Southwest uses a variety of human resource practices to create value for employees and to convert that value to customer and share- holder uses. Human resource practices also play a role in the ultimate capture of value as they must be aligned with an organizations competi- tive positioning, technology, and environment if value created through an organizations people is to be captured by the firm. </p><p>Conventional Strategic Approaches to Airlines </p><p>Southwests competitors historically have relied on a more conven- tional interpretation of their competitive status and managed their orga- nizations accordingly. Since the early 1980s, they have focused on the barriers to entry created by hub and spoke networks, and by sophisti- cated customer segmentation and information via computer reservation systems. </p><p>These actions are consistent with the strategy literature. This litera- ture suggests that contestability (an airlines inability to keep a route prof- itable because its competitors can enter the route and contest it) is not ubiquitous due to investment in certain tangible assets, specifically hub and spoke networks and computer reservation systems (Bailey et al., </p><p>514 / Human Resource Management, Winter 1996 </p></li><li><p>1986; Ghemawat, 1989). This literature offers an insightful alternative to the predictions of pure contestability in a deregulated airline environ- ment (Baumol et al., 1982). It does not, however, explain the success of a carrier such as Southwest, which uses neither hubs nor sophisticated customer segmentation schemes made possible by yield- and informa- tion-driven computer reservation systems.6 </p><p>Southwest does present an unusual case. Yet it is difficult to consider it an aberration occupying a niche in the airline game given this state- ment by Bennett from a 1993 Department of Transportation study: </p><p>For the year ended September 30, 1992, Southwest controlled or strongly affected price for more than 60% of the travelers in the most dense markets under 500 miles . . . [and] . . . In the top 100 48-state markets for the industry, which account for about one third of domestic passengers, Southwest is the dominant airline (p. 2). </p><p>This begs the question of whether tangible impediments to contest- ability exclusively suffice as the most meaningful variables of success in the airline industry. Southwests continuing success suggests that em- ployee commitment may play a greater role than previously ascribed. Hints of this idea exist in the competition literature, . . .a dispirited workforce could exact a severe economic penalty . . . (Ghemawat, 1989, p. 8). Yet the role of employees in the operation of an airline tends to be viewed as a possible disadvantage to be avoided, rather than a pos- sible advuntage to be pursued. </p><p>Another Approach to Airline Strategy </p><p>Southwests fundamental strategy, as described by its management, is to compete against the car. Southwest serves the traveler wanting friendly, reliable, low-cost service on short-haul (generally under ninety- minute) flights. Southwest CEO, Herb Kelleher, believes his company has been successful because friendly, reliable, low cost service is more for less, not less for less. Delivering more for less requires rapid aircraft turn (the time an aircraft is parked at a gate) standardization of machinery, adherence to published schedules, extensive selection and training of all employees, and restriction of service to those airports characterized as unc~nges ted .~ Southwest closely adheres to these oper- ating principles. In contrast, less disciplined carriers (such as the now defunct People Express) focus on only a few of these principles and often apply them inconsistently. Perhaps most important (and in starkest contrast to People Express), Southwests management acknowl- edges that the companys growth is limited to the rate it can hire and train new people who fit into its culture. </p><p>An examination of Southwests competitive strategy using value anal- ysis (Brandenburger &amp; Stuart, 1996; Brandenburger &amp; Nalebuff, 1995) </p><p>Hallowell: Southwest Airlines / 515 </p></li><li><p>illustrates the effects of motivation and organizational capabilities on the airlines operations. It also illustrates how those operations simul- taneously contribute to a low cost and differentiated strategic position which has been sustained for more than 22 years. </p><p>Value analysis is based on Porters (1980,1985) concept of value chains and cooperative game theory. At its heart, value analysis is an economic analysis tool that illustrates where value is created and which constitu- ent will ultimately capture it. The simplest way to approach value analy- sis is to examine the creation of value. Consider a value chain consisting of a buyer, a firm, and a supplier. For any value to be created by a firm, the buyers willingness to pay (the worth of a good or service sold by the firm to the buyer) must be greater than the suppliers opportunity cost (the amount of worth suppliers believe they can receive for their goods or labor if sold to other firms). For example, in order for a retail store to create value, a shopper (the buyer) must be willing to pay more for an item than what its manufacturer (the supplier) charges the store for the item. </p><p>Adding value is not enough. The next step in value analysis asks the question, Who captures that added value? To answer this question price (the price charged by the store or firm) and cost (the firms total costs for a good or service) must be considered. Figure 1 depicts a gener- ic value analysis that illustrates what portion of added value will be captured by each constituent. Willingness to pay (the amount a custom- er, or buyer, is willing to pay for a good or service) is at the top of the diagram because it (optimally) is the largest amount. The difference between willingness to pay and price is the amount of value captured by the buyer. For example, if a buyer thinks a pie is worth $8.00 and a bakery charges $6.00 for it, the buyer gets $2.00 in values by purchasing the pie. The difference between price and cost is the amount of value captured by the bakery. If the bakerys price for a pie is $6.00 and its total costs per pie are $5.00, it captures $1.00 in value on the sale. Finally, the difference between the bakerys cost and the suppliers opportunity costs is the value captured by suppliers. If the bakerys costs per pie are $5.00 while suppliers of flour, shortening, fruit, labor, etc. would be willing to part with their supplies for as little as $3.00, the suppliers capture $2.00 in value. Note that employees are considered one type of supplier. </p><p>One important implication of value analysis is that all four of these elements (willingness to pay, price, cost, and opportunity cost) may be changeable. Thus the game (business), which is often considered zero sum and played by varying only price and cost, is often a pie which can be expanded through increases in willingness to pay and de- creases in opportunity cost. Southwest Airlines is a good example of a company adept at expanding the pie. Southwest does this by: (1) in- creasing its passengers willingness to pay, (2) decreasing the price pas- sengers are charged, (3 ) decreasing its cost, and (4) reducing employees opporf uni ty cost. </p><p>516 I Human Resource Management, Winter 1996 </p></li><li><p>The Value Chain The Portion of Value Captured by: </p><p>- Buyers The Buyer Wil~ingneSS to Pay what a buyer is willing to pay the firm for a good or service </p><p>Bakery Example: $8 - Firms I </p><p>The Firm Price what the firm charges buyers for goods or services Bakery Example: $6 - Firms </p><p>Cost what suppliers charge the firm for inputs Bakery Example: $5 </p><p>Suppliers The Suppliers </p><p>I - Opportunity Cost the minimum amount suppliers are willing to accept for inputs sold to the firm-including labor Bakery Example. $3 </p><p>Figure 1. Value creation and division: Value analysis for a generic firm. Notes: 1) Value captured by refers to the amount of value the buyer, the firm, or the suppliers capture as a result of being in the relationship. 2) The arrows suggest that each point on the value chain (buyers willingness to pay, firms cost, etc.) can and does move. For example: willingness to pay can increase if the quality of a service increases. Source: Adapted from Brandenburger and Stuart (1996). </p><p>Willingness to Pay </p><p>Southwest increases its passengers willingness to pay by (1) provid- ing higher levels of service (defined as reliability and conformance), (2) offering frequent departures to and from its cities, and (3) amusing its passengers. As a result, Southwest is differentiated in the eyes of many travelers who will choose it over another carrier if ticket prices are simi- lar or very close. Herb Kelleher describes this result simply: Everybody values a very good service provided at a very reasonable price.9 </p><p>Higher levels of service refer to more on-time flights, fewer lost bags, and fewer passenger complaints. Statistics compiled by the Department of Transportation indicate that Southwest consistently outperforms its competitors on these service dimensions. Southwest defines frequent de- partures as numerous daily flights to and from cities served so that pas- sengers can fly at their convenience. The airline amuses passengers by playing jokes and generally fooling around, which makes the end of a long day a bit more entertaining and takes some of the tension out of delays. At the same time, Southwests strict and serious attention to </p><p>Hallowell: Southwest Airlines / 517 </p></li><li><p>safety has helped it to achieve the best safety record among the major airlines. </p><p>Southwest has been called a no-frills carrier, which suggests that willingness to pay would decline. Yet the services Southwest does not offer are considered relatively unimportant by its passengers. Meals are not critical on flights averaging 65 minutes. Interline baggage transfer is not important to passengers flying from departure to destination on one airline (Southwest books only tickets involving its own flights). As- signed seating is not essential on short flights; passengers who care about their seats can arrive early and guarantee their choice. Thus: </p><p>Increased willingness to pay, a result of </p><p>1) superior timeliness and baggage han- dling, </p><p>resulting in com- plaints, </p><p>3) frequency of depar- ture, </p><p>4) employee attitude </p><p>2) fewer situations </p><p>- less results in reduced a net increase in willingness to pay, a result of no </p><p>1) meals, 2) assigned seats, </p><p>and 3) interline baggage </p><p>transfer </p><p>willingness to pay]() </p><p>Price </p><p>Southwest operates with one long-term price structure11 as opposed to the multiple structures used by the other major airlines to intricately segment customers. Southwests pricing strategy is to offer the lowest (or equivalent) airline fare in a specific market. </p><p>As Southwests cost position is lower than those of its competitors* (see Table I), it can maintain a low price position indefinitely while competitors matching its price slowly bleed. Because of their higher cost structures, competitors generally have no interest in dropping their prices below Southwests, which enables Southwest to determine the price floor. This gives Southwest the opportunity to set price at a level wher...</p></li></ul>