Southwest Airlines Operations - A Strategic Perspective

Posted by reshavsingh on September 26th, 2015

Background:

Southwest Airlines is the largest airline measured by number of passengers carried each year within the United States. It is also known as a ‘discount airline’ compared with its large rivals in the industry. Rollin King and Herb Kelleher founded Southwest Airlines on June 18, 1971. Its first flights were from Love Field in Dallas to Houston and San Antonio, short hops with no-frills service and a simple fare structure. The airline began with one simple strategy: “If you get your passengers to their destinations when they want to get there, on time, at the lowest possible fares, and make darn sure they have a good time doing it, people will fly your airline.” This approach has been the key to Southwest’s success. Currently, Southwest serves about 60 cities (in 31 states) with 71 million total passengers carried (in 2004) and with a total operating revenue of .5 billion. Southwest is traded publicly under the symbol “LUV” on NYSE.

Facts:

* The first major airline to fly a single type of aircraft (Boeing 737s)

* The first major airline to offer ticketless travel system wide including a frequent flier program based on number of trips and not number of miles flown.

* The first airline to offer a profit-sharing program to its Employees (instituted in 1973).

* The first major airline to develop a Web site and offer online booking. In 2001, about 40 percent (.1 billion) of its passenger revenue was generated through online bookings. Southwest's cost per booking via the Internet is about , compared to a cost per booking through travel agents of to .

Key competitive advantages:

* Low Operational costs / High Operational Efficiency

* Award winning customer service

* Human Resource practices / Work culture

Operations Analysis – Competitive Dimensions:

Southwest clearly has a distinct advantage compared to other airlines in the industry by executing an effective and efficient operations strategy that forms an important pillar of its overall corporate strategy. Given below are some competitive dimensions that will be studied in this paper.

1. Operational Costs and Efficiency

2. Customer Service

3. Employee/Labor Relations

4. Technology

1. Operational Costs and Efficiency

After all, the airline industry overall is in shambles. But, how does Southwest Airlines stay profitable? Southwest Airlines has the lowest costs and strongest balance sheet in its industry, according to its chairman Kelleher. The two biggest operating costs for any airline are – labor costs (approx 40%) followed by fuel costs (approx 18%). Some other ways that Southwest is able to keep their operational costs low is - flying point-to-point routes, choosing secondary (smaller) airports, carrying consistent aircraft, maintaining high aircraft utilization, encouraging e-ticketing etc.

Labor Costs

The labor costs for Southwest typically accounts for about 37% of its operating costs. Perhaps the most critical element of the successful low-fare airline business model is achieving significantly higher labor productivity. According to a recent HBS Case Study, southwest airlines is the “most heavily unionized” US airline (about 81% of its employees belong to an union) and its salary rates are considered to be at or above average compared to the US airline industry. The low-fare carrier labor advantage is in much more flexible work rules that allow cross-utilization of virtually all employees (except where disallowed by licensing and safety standards). Such cross-utilization and a long-standing culture of cooperation among labor groups translate into lower unit labor costs. At Southwest in 4th quarter 2000, total labor expense per available seat mile (ASM) was more than 25% below that of United and American, and 58% less than US Airways.

Carriers like Southwest have a tremendous cost advantage over network airlines simply because their workforce generates more output per employee. In a study in 2001, the productivity of Southwest employees was over 45% higher than at American and United, despite the substantially longer flight lengths and larger average aircraft size of these network carriers. Therefore by its relentless pursuit for lowest labor costs, Southwest is able to positively impact its bottom line revenues.

Fuel Costs

Fuel costs is the second-largest expense for airlines after labor and accounts for about 18 percent of the carrier's operating costs. Airlines that want to prevent huge swings in operating expenses and bottom line profitability choose to hedge fuel prices. If airlines can control the cost of fuel, they can more accurately estimate budgets and forecast earnings. With growing competition and air travel becoming a commodity business, being competitive on price was key to any airline’s survival and success. It became hard to pass higher fuel costs on to passengers by raising ticket prices due to the highly competitive nature of the industry.

Southwest has been able to successfully implement its fuel hedging strategy to save on fuel expenses in a big way and has the largest hedging position among other carriers. In the second quarter of 2005, Southwest’s unit costs fell by 3.5% despite a 25% increase in jet fuel costs. During Fiscal year 2003, Southwest had much lower fuel expense (0.012 per ASM) compared to the other airlines with the exception of JetBlue as illustrated in exhibit 1 below. In 2005, 85 per cent of the airline’s fuel needs has been hedged at per barrel. World oil prices in August 2005 reached per barrel. In the second quarter of 2005 alone, Southwest achieved fuel savings of 6 million. The state of the industry also suggests that airlines that are hedged have a competitive advantage over the non-hedging airlines. Southwest announced in 2003 that it would add performance-enhancing Blended Winglets to its current and future fleet of Boeing 737-700’s. The visually distinctive Winglets will improve performance by extending the airplane’s range, saving fuel, lowering engine maintenance costs, and reducing takeoff noise.

Point-to-Point Service

Southwest operates its flight point-to-point service to maximize its operational efficiency and stay cost-effective. Most of its flights are short hauls averaging about 590 miles. It uses the strategy to keep its flights in the air more often and therefore achieve better capacity utilization.

Secondary Airports

Southwest flies to secondary/smaller airports in an effort to reduce travel delays and therefore provide excellent service to its customers. It has led the industry in on-time performance. Southwest has also been able to trim down its airport operations costs relatively better than its rival airlines.

Consistent aircraft

At the heart of Southwest's success is its single aircraft strategy: Its fleet consists exclusively of Boeing 737 jets. Having common fleet significantly simplifies scheduling, operations and flight maintenance. The training costs for pilots, ground crew and mechanics are lower, because there's only a single aircraft to learn. Purchasing, provisioning, and other operations are also vastly simplified, thereby lowering costs. Consistent aircraft also enables Southwest to utilize its pilot crew more efficiently.

E-Ticketing

The idea of ticketless travel was a major advantage to Southwest because it could lower its distribution costs. Southwest became electronic or ticketless back in the mid-1990s, and today they are about 90-95% ticketless. Customers who use credit cards are eligible for online transactions, and today Southwest.com bookings account for about 65% of total revenue. The CEO Gary Kelly thinks that this idea would grow further and that he wouldn't be surprised if e-ticketing accounted for 75% of Southwest’s revenues by end of 2005. In the past, when there was a 10% travel agency commission paid, it used to cost about a booking. But currently, Southwest is paying between 50 cents and per booking for electronic transactions that translate to huge cost savings.

2. Employee and Labor Relations

Southwest has been highly regarded for its innovative management style. It maintains a relentless focus on high-performance relationships and its people-management practices have been the key to its unparalleled success in the airline industry.

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