Southwest Airlines business model and operations

Southwest Airlines

Southwest's emphasis on corporate culture as a source of competitive advantage derives from its philosophy that the employees are the most important driver of success at the airline. The culture is positive, with a strong team orientation. But the culture at Southwest is also aggressive, with a highly-competitive, slight underdog mentality. The airline leverages their culture to competitive advantage in a number of different ways. The first is that the employees are in a service business and the underlying philosophy is that satisfied, engaged employees will give the best service. The second way is that the underdog/warrior mentality that has been cultivated is utilized to drive employees to aid in cost reduction. For a firm with a cost leadership strategy, engaging employees in cost reduction is a critical step, since they can identify the minor incremental steps that can add up to long run cost advantages.

Southwest's financial performance has been relatively strong, in particular for an airline, a historically cyclical industry. The gross margin in 2007 was 24.5%, in 2006 it was 28.9% and in 2005 it was 30%. The operating margin in 2007 was 8.2%, in 2006 it was 10.5% and in 2005 it was 9.8%. The net margin in 2007 was 6.7%, in 2006 it was 5.6% and in 2005 it was 6.5%. The sales, general and administrative expenses are rolled into the gross margin. This has been declining steadily over the past three years, which indicates that cost controls may not have been utilized. However, given that the price of a key input -- oil -- is included even in the gross margin, the cost control program may have little bearing over the organization's ability to contain costs. That the net margin was at a high in 2007 despite the gross and operating margins being at a low indicates that the company was able to curtail at least some of the "other" expenses.

The return on equity in 2007 was 15.2%, in 2006 it was 12.2% and in 2005 it was 11.6%. The return on assets in 2007 was 6.3%, in 2006 it was 5.8% and in 2005 it was 5.5%. This indicates that the company has steadily increased its returns over the past three years. These measures of managerial efficiency are indicative of long-term cost cutting, in particular with respect to a reduction in superfluous assets. There is some indication, then, that efforts to contain costs have improved return on assets.

There is little evidence in the past three years' data that the corporate culture has had a positive impact on the company's performance. In the short run, the firm has improved its return on assets each year, but other measures have been less impressive. Margins have fluctuated and are down, indicating short run cost control failure. However, company performance in the long run is strongly attributable to the corporate culture. Southwest has had consistent performance since its inception, despite many swings in the fortunes of the industry overall. This indicates that management fostered a culture that over the long run will drive customer loyalty and will drive steady, incremental cost reductions. Success for Southwest is not measure in short-term results so much as long-term and on that measure the culture has contributed to a long run of success for Southwest.

One of the strategic decisions in the case is how to deal with the declining revenue environment. The airline industry has struggled in recent years leading to industry-wide cost reductions. To address this issue it is recommended that Southwest simply ride it out. The corporate culture has been a source of value for the company, and layoffs could compromise that culture. Therefore layoffs will cost more than doing nothing even as revenues drop. The second recommendation is to use the opportunity to find new routes. As other carriers reduce capacity, space may become available at airports that would allow Southwest to drop less profitable routes for ones that are more sustainable over the long-term.