Southwest Airlines Portfolio

Running head: SOUTHWEST AIRLINES PORTFOLIO 1

Southwest Airlines Portfolio

Amber Berlin

2012


Abstract

Southwest Airlines has been a successful low-cost carrier for the last 39 years. The

direction of this company is a result of innovative leadership and proper management of its

assets. The cost-driven nature of Southwest Airlines sets the stage for simplified operations, and

illuminates the path to efficiency. Optimal utilization of assets is paramount to success, and with

the assets of the recent AirTran acquisition, Southwest Airlines must not deviate from the

strategic management decisions that ensured its success. This company is a prime example of

using persistence, innovation, and appropriate risk taking for entrepreneurs world-wide. This

portfolio contains detailed information on the history, structure, finances, and future expansion

that provides a successful foundation for potential investors.


Introduction

The events of September 11, 2001 had devastating effects on the airline industry, causing the

majority of U.S. carriers to experience several years of lost revenue. With the economic crisis of 2008, the

airline industry also experienced massive setbacks in growth. In contrast, Southwest Airlines has operated

in profitability for 39 consecutive years, holding a solid position in the face of various economic

inconsistency and industry disaster. This company has taken an uncommon path to stability and financial

success. Their high standard of excellence paired with the unique combination of personnel and

leadership have shaped a solid foundation not easily replicated.

This portfolio is a comprehensive look at Southwest Airlines, including: history, finances,

personnel, asset utilization, scheduling, cargo management, international operations, and marketing

strategy. Each section reveals the efficiency created by continually striving for excellence. Southwest

Airlines is on a path to expansion with the addition of international flights, increased cargo services, and

sound financial decisions. Potential investors should take a close look, as this company’s success could

also be their own.

History

In an industry which experiences regular ups and downs, Southwest Airlines has

managed to stay at the top of their game. A product of the innovative minds of Rollin King and

Herb Kelleher, the originally named Air Southwest Company was incorporated in 1967 (History

of Southwest Airlines, n.d. ). With the vision of a commuter airline serving Dallas, San Antonio,

and Houston, King and Kelleher were granted permission to fly by the Texas Aeronautics

Commission in 1968 (International Directory of Company Histories, 2005). However, three

competing airlines filed suit against Air Southwest Company, determined to keep them on the

ground (International Directory of Company Histories, 2005). After a lengthy legal battle,


which ended up in the U.S. Supreme Court, Air Southwest Company was cleared for takeoff

(History of Southwest Airlines, n.d.).

On June 18, 1971, after changing its name to Southwest Airlines, the company finally

began operations in Texas with a fleet of three Boeing 737’s (Fact Sheet, 2012). Targeting the

commuter market, and staying within the confines of Texas to avoid federal pricing regulations,

Southwest Airlines was able to undercut the competition (Innovators: Herb Kelleher, n.d.).

Under the direction of M. Lamar Muse, the company set themselves apart with “beautiful flight

attendants with unique personalities”, and dressed them in hot pants and go-go boots

(International Directory of Company Histories, 2005).

With the deregulation of the airline industry in 1978, Southwest Airlines had the

opportunity to expand outside of Texas, and cautiously entered new markets (International

Directory of Company Histories, 2005). One advantage of the company’s leadership is their

ability to find market demands not addressed by the major carriers. These untapped markets were

approached with the highest standard of customer service, safety, and a unique style that

incorporated fun into the otherwise mundane event of business air travel. The result was top

customer service rankings, a sound safety record, and more departures than any other U.S.

airline.

Southwest Airlines quickly climbed the ranks and positioned itself as a top competitor in

the airline industry, never losing sight of the motivation to keep costs down. While other airlines

tout first class amenities, Southwest has consistently offered only coach class, open seating, and

no meals (Drake, 1998). With the realization that a single type of aircraft would reduce training

and maintenance costs, Southwest Airlines flies only B737’s with the GE engine. Additionally,


in 1997, the online booking site was launched, further contributing to their ability to offer

inexpensive travel options for the budget-minded flier (International Directory of Company

Histories, 2005).

In 2011, Southwest Airlines experienced its 39th consecutive year of profitability (Fact

Sheet, 2012). This astounding record has held strong through turbulent times, as Southwest

watched other airlines declare bankruptcy and leave the industry. The visionary leaders of this

company have everything to do with its long-term success. With moves such as reducing the

average plane turn-around time to 15 minutes, Kelleher estimates a savings of $600 million in

fleet costs, as compared to the 45-minute average turn-around that has become the industry

standard (Jaffe, 1991).

Company Drivers

There are generally two types of airline, those that focus on lowering cost, and those that

focus on generating revenue. The managerial focus of the airline determines the specifics of the

operating environment, including the choice of point-to-point or hub-and-spoke operations,

leasing or buying the aircraft, type of aircraft flown, and the number of people hired to support

the endeavor. According to a study on the drivers influencing an airline’s operating income,

“…an airline can either choose to be a cost-driven or revenue-driven airline, but it is hard to be

both” (Chopra & Lisiak, 2006).

While each airline has a choice, the focus of one is not necessarily better than the other.

Both systems of operation play a vital role in the aviation industry by complementing each other

and satisfying different portions of the market demand. According to Chopra & Lisiak,


low-cost carriers with point-to-point networks have an advantage in terms of

employees per ASM [Available Seat Mile] that allows them to lower cost. In

contrast, legacy carriers with hub-and-spoke networks have an advantage in terms

of revenue per RPM [Revenue Passenger Mile] and load factors that allow them

to grow revenue. (2006)

Southwest Airlines operates on a point-to-point route structure, which is supportive of

their low-cost company focus. The main airports served by Southwest Airlines include locations

such as Chicago (Midway), Phoenix, Denver, and Oakland (Table 1).

Table 1

Top Ten Airports- Southwest Airlines

Cities Daily

Departures

Number of

Gates

Nonstop

Cities Served Established

Chicago (Midway) 238 29 56 1985

Las Vegas 225 19 55 1982

Baltimore/Washington 195 22 48 1993

Phoenix 180 24 49 1982

Denver 162 17 51 2006

Houston Hobby 138 17 34 1971

Dallas (Love Field) 120 15 15 1971

Los Angeles (LAX) 109 11 21 1982

Oakland 106 13 19 1989

Orlando 102 12 33 1996

Source: Fact Sheet, 2011


Southwest Airlines Fleet: Operational Lease vs. Ownership

Currently Southwest Airlines has 574 active B737’s in their fleet (Table 2), with an

average age of 11.7 years (Fact Sheet, 2011). The majority of these aircraft are owned by the

company, with a small portion under operational lease contracts. Because of their focus on low-

cost, Southwest Airlines has typically held larger margins than their competitors. This enables

them to purchase aircraft as opposed to operational leasing. Southwest mangers realize the cost-

savings of ownership, and according to an article on aircraft leasing published in The Economist,

“in the long-term, buying is cheaper than renting” (Aircraft Leasing: Buy or Rent, 2012).

Table 2

Southwest Airlines Fleet Matrix

Aircraft

Type

Current Future Historic

Total Active Stored

On

Order Due

To other

Operator Stored

Scrapped

Written-

Off

Boeing

737 574

17

46 36 18 1 692

Boeing

737-200

45 12 5

62

Boeing

737-300 158

1 22 13 1 195

Boeing

737-500 23

2

25

Boeing

737-700 376

1

377

Boeing

737-800 17

16

33

Total 574 0 17 0 46 36 18 1 692

Source: Southwest Airlines Fleet Matrix, 2012


The operational lease is typically used with start-up companies, due to the

requirement for little or no down payment. Many legacy airlines lease their aircraft because

leasing protects against obsolescence and airlines “typically have low margins” and cannot

afford to pay cash for their fleet (Aircraft Finance, n.d.). Southwest Airlines’ most popular

aircraft, the B737-700, costs approximately $70.9 million, making a fleet of aircraft a very large

company expense (Table 3).

Table 3

Jet Prices

737 Family 737-600 737-700 737-800 737-900ER 737 MAX 7 737 MAX 8 737 MAX 9

Cost* 59.4 70.9 84.4 89.6 77.7 95.2 101.7

Source: Boeing Commercial Airplanes, 2011 *$ in Millions Average

Direct cost-savings excluded, there are additional company benefits to leasing aircraft.

According to Kimmel, Weygandt & Kieso, “operating leases allow the lessee to account for the

transaction as a rental, with neither an asset nor liability recorded” (2009). This is beneficial to

the company because, “reporting lower assets improves the return on asset ratio…reporting

fewer liabilities makes the company look less risky” (Kimmel, Weygandt & Kieso, 2009). For

Southwest Airlines, owning their aircraft means a balance sheet that accurately depicts the state

of the company, which is more appealing to potential investors.


Scheduling Considerations

Producing an airline schedule is a dynamic event that attempts to balance operations

between equipment, facilities, crew, market and other factors present in each airline’s operational

environment. The schedule is where efficiency is realized, and can either make or break the

airline. The scheduling considerations of Southwest Airlines are streamlined by the selection of a

single type of aircraft. Each aircraft can be substituted in any route, without major changes to

personnel, maintenance, or ground support equipment. This is in stark contrast to legacy airlines,

which use several types of aircraft with various maintenance schedules, and require multiple

crews trained on each type. Additionally, with point-to-point service there are no system-wide

delays such as those experienced in hub-and-spoke operations.

Although scheduling is streamlined at Southwest Airlines, there are several locations

which experience regular delays due to weather and other factors (Table 4). Because of the

anticipated airport delays, additional time must be added to flights scheduled during these events.

Southwest schedulers typically add ground time for expected weather delays, or schedule arrivals

30 minutes early to make an airport curfew.

Accurate scheduling is vital to meet the maintenance requirements of the aircraft and rest

requirements of the crew. Scheduling mistakes such as breaking an airport curfew are

accompanied by hefty fines; others may result in reduced asset utilization for the company. A

primary reason for Southwest Airlines’ success is the knowledge that the aircraft and the people

who provide operational support are its most important assets. The realization that reductions in

scheduling errors directly influence operating revenue keeps Southwest schedulers on their toes.


Table 4

Anticipated Delays Affecting Scheduling, Southwest Airlines

Location Type Delay Reason

San Francisco Weather Morning Fog

Burbank Weather High winds around mountains

Philadelphia Other Congestion/Ship crossing area

LaGuardia Other Congestion

San Diego Weather Evening Fog

Orange County Other Airport Curfew

Source: Inside Southwest Airlines: Schedule Planning, 2009

Southwest Airlines Marketing Strategy

Southwest Airlines has shown a profit for the last 39 consecutive years, a feat unmatched

in the airline industry. Their pricing strategy is simple and effective, charge the lowest possible

fare that still enables the airline to make a profit (YouSigma, 2008). While price is the major

competitive variable for the airlines post-deregulation, the unique marketing application of

product, price, promotion, and place distinguishes this airline from its competitors.

The product of Southwest Airlines is air transportation with no extra services (Hubpages,

2010). While first class seats and meals aren’t available, they do add value to the product by

providing excellent customer service, baggage handling, easier ticketing, flexible flight

schedules, and easier check-in and check-out at the airport (Hubpages, 2010). At first glance the

product may seem somewhat lacking, but with a high perceived value the customers keep

coming back.


Prior to introducing their product in a new place, Southwest Airlines does extensive

research and launches a public relations and awareness campaign to establish a positive image in

the minds of their customers (Hubpages, 2010). Upon entry into the market, they typically offer

fares that undercut prevailing rates by 50%, quickly launching into a price war with the

competing airline (Hubpages, 2010). With rapid expansion of existing flights, the “Southwest

effect” takes over, causing airfares to go down and tourist traffic to increase (YouSigma, 2008).

Southwest Airlines is able offer lower fares by continually finding ways to cut operating

costs. They run ads which direct people to their website for the best online deals, offer ticketless

travel, and skip paying booking fees by not using travel comparison websites such as Orbitz.com

(The Pricing Journal, 2011). The point-to-point system of operations produces greater on-time

reliability, as a single aircraft delay in the hub-and-spoke system can result in a chain reaction

which affects multiple connecting flights. By encouraging passengers to check bags with their

“bags fly free” campaign, they are able to turn planes at the gate faster. Not linking with other

carriers eliminates any disparity in luggage accommodation due to aircraft type, luggage tracking

errors due to mismatched networks, and ensures more people are reunited with their luggage

(Joiner, 2010). Greater on-time reliability means Southwest planes are able to spend more time in

the air, which equates to more flights per day and more revenue for the company.

Because they offer short-haul flights, Southwest Airlines not only competes with other

airlines, but also with ground transportation. Current competition includes legacy airlines such as

Delta and United, which went bankrupt and restructured their operations, and new low-cost

copycats such as Jet Blue and AirTran (Stock: Southwest Airlines Company, 2012). Recently

Southwest Airlines purchased AirTran Holdings, the parent company of AirTran Airways, for

$1.4 Billion, which includes several international flights (The New York Times, 2010).


Personnel

While most companies put the customer first, Southwest Airlines has experienced great

success in putting their employees first. The concept is to satisfy the employees, and they will

satisfy the customers (Lin, 2008). The end result is a lower employee turn-over rate, which

reduces time spent training, and contributes to a healthy bottom line. Additionally, keeping good

employee relations also adds to the success of the company, as approximately 77% of Southwest

Airlines is unionized (Southwest Airlines Co. Annual Report, 2008).

Labor costs at Southwest are significantly lower than their competitors, mostly due to the

ability of employees to accomplish cross-functional tasks (Braginsky, 2010). Unless specifically

restricted by the requirement of a license, employees in one job can assist employees in other

jobs. This allows for greater labor productivity, which translates to a more cohesive team and

reduces labor costs.

Asset Utilization

According to an article published in USA Today, “the U.S. airline industry is undergoing

a major alteration in the way the carriers compete” (Airline’s Swap Assets in New York,

Washington, D.C., 2012). Legacy airlines are striking mutually beneficial deals for slot

ownership, which has become a significant tradable asset for many airlines (Airline’s Swap

Assets in New York, Washington, D.C., 2012). In trading slots, the airlines have the opportunity

to restructure their operations and improve their asset utilization ratio. “The asset utilization ratio

calculates the total revenue earned for every dollar of assets a company owns. This ratio

indicates a company's efficiency in using its assets” (Southwest Airlines Asset Utilization, 2012).

As of March, 2012, Southwest Airlines’ asset utilization is 0.8761 (Southwest Airlines Asset


Utilization, 2012). In comparison to other low-cost carriers, such as Jet Blue (0.6683) and

Ryanair (0.481), Southwest Airlines has optimal asset utilization (Southwest Airlines Asset

Utilization, 2012).

AirTran Acquisition: Additional Assets

With the recent acquisition of AirTran Airways, Southwest Airlines has added 52 B737-

700’s to their fleet, along with 88 B717-200’s. However, because of the standardization enjoyed

by a single type of aircraft, Southwest Airlines has decided to lease the all of the B717’s to Delta

Airlines (Delta Plans to Lease 717s From Southwest, 2012). In addition to 140 aircraft, the 8,000

former employees of AirTran are also being integrated into Southwest Airlines (2011 Southwest

Airlines One Report, 2011). The complete integration of personnel and aircraft is expected to

take 2-3 years (2011 Southwest Airlines One Report, 2011). Because of the AirTran acquisition,

Southwest Airlines now has entry into several new markets, including slots in Atlanta and New

York LaGuardia, and access to near-leisure markets in the Caribbean and Mexico (2011

Southwest Airlines One Report, 2011). One major challenge with this acquisition will be

converting AirTran’s hub-and-spoke operations into Southwest’s point-to-point service.

International Operations

Southwest Airlines acquired several international flights with the purchase of AirTran,

and plans to establish international service from Houston’s Hobby Airport (Fly2Houston-

Houston Airport System, 2012). Currently AirTran and Southwest operate under a single FAA

operating certificate, but are still run as separate companies. With approval from the city of

Houston, Southwest Airlines is taking full financial responsibility for the construction of an

international terminal and immigration facility at Hobby (Seagraves, 2012). After construction is


complete, the city of Houston will own the terminal, and Southwest will pay no rent for use of

the facilities (Seagraves, 2012).

Southwest Airlines also has plans to incorporate a travel-reservation system for its new

international flights, as the reservation system for domestic flights won’t support international

operations (CBS DFW, 2012). The travel-reservation system, from Amadeus IT Group, is

scheduled go online in 2014, when AirTran’s international flights become integrated into

Southwest (CBS DFW, 2012). The planned integration of services is expected to take 2-3 years,

putting the launch of international flights around 2015. AirTran’s international flights include

Aruba, Cancun, San Juan, and Montego Bay (Table 5).

Table 5

AirTran Nonstop Flights

Domestic U.S. Cities International Destinations

Atlanta Aruba, Cancun, Nassau, Montego Bay, Punta Cana,

San Juan

Austin Cancun

Baltimore/Washington,

D.C.

(BWI)

Aruba, Bermuda, Cancun, Nassau, Montego Bay,

San Juan

Chicago Midway

(MDW)

Cancun*

Ft. Lauderdale San Juan

Denver Cancun

Milwaukee Cancun

Orange County Cabo San Lucas/Los Cabos, Mexico City

Orlando Aruba, Montego Bay, San Juan

San Antonio Cancun, Mexico City

Tampa Bay San Juan

Source: Southwest Airlines, 2012


Cargo Management

Southwest Airlines not only provides passenger services, they also run a very successful

air cargo business. In 2009, revenue from air cargo totaled $118 Million (AfA Member Profile,

2010). Shipping to 83 destinations, Southwest offers three types of air cargo services:

Next Flight Guaranteed, where the shipment is 100 percent guaranteed to be on

the next available flight; Rush Priority Freight, where the shipment is guaranteed

to be at its final airport destination within 24 hours from the time it is tendered;

and Freight, where shipments move on the next flight with available space. (AfA

Member Profile, 2010)

Although air freight has been popular in recent years, ocean container freight has grown

at twice the rate of air cargo, and domestic trucking has also seen an increase (Inbound Logistics,

2007). One factor that may contribute to the declining trend in air freight is “long-term price

deflation”, which will create “challenge for these companies to continue using air freight on a

planned basis” (Inbound Logistics, 2007). According to Matt Buckley, senior director of cargo,

Southwest Air Cargo, “carriers that want to stay in business must invest in the resources to

provide cargo customers high service levels” (Inbound Logistics, 2007).

Southwest Air Cargo is no stranger to providing excellent service, and has been

recognized with several prestigious awards over the years. In 2010, they took home Logistic

Management’s Quest for Quality Award for the 14th consecutive year, with the highest scores of

any airline (Southwest Cargo, 2010). Critical categories included: Ontime Performance, Value,

Information Technology, Customer Service, and Equipment and Operations (Southwest Cargo,

2010). They were also awarded the Airforwarders Association’s “Domestic Air Carrier of the

Year” award for 2010 and 2011 (Nuts About Southwest, 2011).


Southwest Air Cargo has several opportunities to expand operations and improve their

services. As a result of the AirTran acquisition, Southwest Air Cargo will begin servicing the

Atlanta area, and has added a “26,000-square-foot cargo facility” in Atlanta’s north cargo

complex (Hartsfield-Jackson Atlanta International Airport, 2012). Another new addition is the

use of Descartes Air Messaging Service, which provides real-time shipping messages to their

cargo customers (Descartes, 2011).

Financial Status

In 2011, Southwest Airlines had a net income of $178 million and total operating revenue

of $15.7 billion (Fact Sheet, 2011). Operating 574 B737 jets, with service to 73 cities in 38

states, they are currently the largest U.S. carrier, based on domestic passengers boarded, as

reported by the U.S. Department of Transportation (Fact Sheet, 2011). Over the last ten years,

Southwest Airlines has experienced a steady increase in Revenue Passenger Miles (Table 6). The

RPM for 2002 was 45 billion, with a Load Factor (LF) of 65.9% (Southwest Airlines, 2010). In

comparison, the RPM for 2011 was 98 billion, with a LF of 80.9%, which reveals a drastic

increase in operational efficiency (Fact Sheet, 2011).

The strategic management decisions of the company’s leadership have consistently

resulted in more efficient methods of operation. A prime example is hedging 70% of their fuel

needs, as compared to the 20% hedging of their competitors (Pae, 2008). This strategy reduces

the impact of fuel spikes that can undercut profit, and allows them advance notice in budgeting

for a major operating expense.

Additionally, Southwest only flies the B737, which reduces training and maintenance

costs, and ensures they can always make aircraft substitutions when the situation dictates


(Strategic Report for Southwest Airlines, 2006). With standardized aircraft, gate turn-around

time is improved, and with only one set of procedures to master, the crew has greater opportunity

to discover and implement time-saving techniques. Faster turn-around at the gate means more

flights per day, and point-to-point service paired with the use of less congested airports

contribute to increased profit (Enhancing Service at Southwest Airlines, 2009).

First Quarter 2012

Financial results of the first quarter in 2012 show Southwest Airlines with a net loss of

$18 million, which was a result of a $478 million increase in first quarter economic fuel costs,

over the first quarter of 2011 (Southwest Airlines Reports First Quarter Results, 2012). As fuel

hedging contracts expire, the operating costs of Southwest Airlines will rise, decreasing the

profit margin enjoyed in previous years. However, according to CEO Gary Kelley, “Energy

price increases continue to pressure costs, which only serve to reinforce our commitment to

eliminate waste and maximize efficiency throughout our Company” (Southwest Airlines Reports

First Quarter Results, 2012).

Conclusion

Southwest Airlines specializes in doing more with less, and this is the driving force

behind the strength of their company. With a unique business model and innovative application

of the marketing mix, Southwest Airlines has established a very successful marketing strategy

that continues to usher in profits. This company is a prime example of using persistence,

innovation, and appropriate risk taking for entrepreneurs world-wide. However, as fuel prices

consistently rise, the business savvy leaders at Southwest will be tested in their ability to keep

costs down.


With a solid track record of successful operations, this company is a first look for

investors. Because of their continued profits, many businesses have tried to model their

operations after Southwest. However, the unique combination of leadership present in this

company is rare, and without the right leadership, any comparable service looks like a cheap

imitation.


Table 6

Southwest Airlines Ten-Year Summary



Table 6

Southwest Airlines Ten-Year Summary Continued



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The New York Times. (2010). Southwest, Determined to Expand, Buys AirTran. Retrieved from

http://www.nytimes.com/2010/09/28/business/28air.html

The Pricing Journal. (2011). “Southwest Airlines Pricing Strategy: Creating a Unique Value

Proposition via Upfront Pricing.” Retrieved from

http://thepricingjournal.com/2011/06/06/southwest-airlines-pricing-strategy-how-bags-

fly-free-and-no-change-fees-has-created-a-unique-value-proposition/


YouSigma. (2008). "Southwest Airlines Marketing Strategies." Retrieved from

http://www.yousigma.com.

Documents

Southwest Airlines Portfolio