Strategic management concepts and frameworks

¶ … Southwest Airlines. The case is set in 2010, and Southwest has emerged as one of the leading U.S. airlines (#1 by passenger volume) through a combination of unique culture, sound management practice and focus on the consumer. While most of the legacy airlines have struggled, Southwest continues to succeed. This case examines why the company has been so successful, and what it should do going forward.

The biggest issue facing Southwest is its purchase of AirTran, another discount carrier. AirTran was a good fit in terms of its route networks because it was based out of Hartsfield, the largest airport in the U.S. where Southwest did not currently operate. There are challenges, however, in that AirTran was never run as well as Southwest, did not have the same corporate culture and it also had international routes to the Caribbean. Southwest had never operated an international route before. Integrating AirTran was going to be the major strategic thrust for Southwest during the 2011-year, and it had never acquired such a large competitor before.

Company Introduction

Southwest Airlines began life with a mission to win business with convenient schedules, a good flying experience, on time flights and low prices. The company began by servicing secondary airports, including its home base of Love Field in Dallas. By 2010, Southwest was able to secure the top place in the U.S. airline industry, with greater passenger volume than any other carrier. The company's strategy is comprehensive, with the different elements working together well. The corporate culture was strong and constantly reinforced, and it contributed to both the high levels of customer service and to the maintenance of low costs. Southwest, however, was now faced with integrating a fairly large competitor into its operations.

Situation Analysis

A major acquisition poses a number of different problems for the acquiring firm. Typically, the merger will come at a cost that is higher than the intrinsic value of the acquired firm, in order for the deal to appeal to the shareholders of the takeover target. This means that for Southwest to make this acquisition profitable, it must add more value to the assets of the target firm than it added in extra value to the shareholders. The acquisition cost was $1.4 billion. The acquisition must be integrated on multiple levels in order to work. The operations must be merged, but so too must the corporate culture. AirTran employees, therefore, must very quickly become Southwest employees.

On the operational side, the first changes that Southwest made involved the AirTran route network, as it began thinning out the less profitable routes and the duplicate routes (Mutzabaugh, 2012). The company also needs to bring in AirTran's workforce. Whereas Southwest manages its culture in part through its selection process, the company now must bring in thousands of employees how have not gone through the selection and enculturation process at Southwest. Worse, the unions became involved in the merger process, and in the selfish pursuit of their interests appear to be causing problems with the integration of the two workforces (Jacksonville Business Journal, 2012).

Strategic Objectives and Goals

For Southwest, the merger represented a shift in strategy, which through the company's history had been focused on organic growth. However, it is reasonable to assume that the company's overall strategic objectives have not changed as the result of the merger, but rather than the merger represents a new approach to achieving those strategic objectives. Southwest has shifted its objectives somewhat from the 1970s, when it was an underdog just looking to survive, to the present day, when it carries more passengers than any other airline in the United States. The company still seeks to win with its discount model, offering superior customer service, maintaining low operations costs and using a number of tactics to support this. Clearly, gaining access to Hartsfield is one of the main operational benefits of buying AirTran, but the size that the company gives Southwest serves to further enhance the company's route network. Thus, Southwest is going to try to integrate AirTran into its operations, and apply the culture, operating efficiency and customer service orientation of Southwest to the AirTran staff and route network, all while folding AirTran into the Southwest brand.

Industry Analysis

The airline industry is a challenging one in which to operate, something that has made Southwest's track record of success all the more remarkable. Airlines have only moderate bargaining power over suppliers. The two major costs for airlines are labor and fuel. Labor costs are often subject to union bargaining, so the airlines face union bargaining power. Jet fuel prices are decided on global markets, and no airline has the buying volume to be a price-setter. As a response to this, Southwest engages in fuel price hedging. The company notes that fuel expense increased $626 million in 2010 and was expected to increase a further $1.3 billion in 2011 (2010 Southwest Annual Report). Highly volatile fuel prices have compelled the company to reduce its hedging program, but the lack of control that the company has over fuel price regardless of hedging is something that represents an operating challenge for Southwest, particularly as it pertains to the company's pricing strategies.

The bargaining power of buyers is generally high. Most consumers are price sensitive, and in fact it was Southwest's ability to tap into price sensitivity with respect to a key substitute (driving) that allowed it to get its start. After deregulation, airline industry competition in the United States has been intense, and few routes are without significant competition. This implies that airlines must be able to serve routes at a very low cost in order to be profitable. The threat of substitutes is also high. Although there is a correlation between airline demand and the use of cars over the same routes (related to prices of both being correlated to fuel costs), the threat of substitution is high, diminishing only as distances become greater. This means that the threat of substitutes is higher on, say Tampa to Fort Lauderdale than Tampa to Albuquerque.

The threat of new entrants is also high. Despite the high costs and inherent challenges associated with starting an airline, there appears to be no shortage of people with the resources and desire to try. Some of these new entrants, such as JetBlue, become significant competitors, while others often do not. The intensity of rivalry is very high in this industry. Southwest's experience starting the airline, and the inability of the airline to kill the absurdly anti-capitalist Wright Amendment illustrates how intense the rivalry can be, and willingness of Southwest's rivals and their political cronies to undermine America's commitment to capitalist values makes the intensity of rivalry a clear threat to firms in this industry (Chang, 2011). All told, there is little opportunity for airlines to make money, something that is evidenced in the number of bankruptcies among the legacy players (Peterson & Daily, 2011). That said, Southwest seems to have good understanding of the different factors influencing its ability to turn a profit and has been able to set a strategic course around these obstacles, delivering profits consistently over its life.

SWOT Analysis

Southwest succeeds in this challenging industry on the basis of having more major strengths than weaknesses. The Southwest cost control program is essential to success in its industry. That the program is ingrained in different parts of the company is essential. Whether the company is keeping labor costs low, turning around its planes faster than the competition or controlling costs associated with fuel prices, that every aspect of the operations is subject to this scrutiny helps the company be profitable on more routes. Another key strength is the corporate culture. While cost is part of the culture, it is more critical that the company's sense of "fun" and "love" are essential to fostering customer loyalty. Southwest's customers are more loyal than those of other airlines, and it does not require expensive loyalty programs to make that happen.

Another strength of Southwest is the route network. The point-to-point approach that Southwest uses is unique among major carriers, but has significant appeal to customers, who prefer not to fly out of their way in order to change planes. In addition, using many smaller airports is important because the flying experience is often significantly better at the smaller airports. With its current size, Southwest reaches most major markets and this allows it to have strong route networks that can compete even with the hub-and-spoke capabilities of the legacy carriers. Lastly, the marketing programs at Southwest have been effective for essentially the company's entire existence. Southwest's marketing slogans and promotions are quirky, and resonate with consumers as a result. That the marketing is backed up by the company's product/service is also important. The additional marketing dollars that Southwest spends pay off in growth for the company.

There are a few weaknesses that the company has. Right now, AirTran represents a weakness, because Southwest must implement a failed airline into its successful operations. This brings issues with unions, issues with routes and issues with culture, all of which must be resolved before AirTran becomes a source of strength for Southwest. Another issue is the legal/political power that Southwest has (or does not have, in relation to its rivals). Ultimately, the company has suffered as the result of the Wright Amendment, and it needs to leverage its current size to fight back against American Airlines over this legislation. Not only should Southwest fight for the amendment to be repealed in its entirety and immediately, but it should fight for punitive action against American Airlines and DFW airport. A civil suit against these parties for the financial harm caused to Southwest could prevent them from undertaking such illegal and unethical actions in the future and could help Southwest to put AA out of its misery. Lastly, Southwest has had problems with its maintenance. The company spends a lot less than any of its rivals on maintenance, and while its accident in Chicago was ruled the result of pilot error, concerns over the maintenance practices of Southwest are common and the company could face a problem with its planes at some point in the future.

Southwest has a number of opportunities in the environment. The company has still not saturated the domestic market, despite its size. It just entered Atlanta, and remains out of many major airports, such as Miami, and has only a minor presence in many more. This means that there is still room for growth domestically. There is also room to grow internationally, should Southwest choose to do so. Mexico, the Caribbean and Canada are all available markets, in particular the Caribbean destinations that AirTran was flying to. There are complications to operating internationally that could prevent Southwest from entering these markets, but they are a potential source of growth for the company if it finds opportunities in the domestic market limited.

Because the airline industry is a challenging one in which to operate, there are a number of threats that Southwest faces. The most important of these relates to the demand function -- the economy and security threats both have reduced air travel passenger counts at times during the past decade or so. For example, both 2008 and 2009 saw passenger reductions due to the economic downturn. Corporate customers in particular cut flights during difficult economic times.

There are also threats from competition, including new discount carriers like JetBlue and from the existing legacy carriers. Competitive response is typically very strong, which creates a perpetual risk of losing market share and customers to these other airlines. As noted, there is also a high threat of substitutes on some routes as well. A third major threat comes in the form of fuel prices. These are very volatile, and that volatility makes them difficult to hedge. In addition, the hedges are imperfect, as the airlines need to hedge crude oil prices instead of jet fuel, and there is always a strong correlation between the two.

Internal Audit of the Firm's Resources

Southwest still has strong resources with which to work. Although the acquisition of AirTran weakened the company financially, Southwest still has a decent financial position, including $3.1 billion in cash and equity that has grown over the past four years (MSN Moneycentral, 2012). The company has good leadership, and more importantly has been able to enjoy strong leadership steadily over its history. This indicates that there is probably a good leadership pipeline at Southwest that forms a core resource.

Beyond these resources, the company's resources include landing rights, which are not only valuable but provide the basis for the airline's business model. The fleet is also an asset that must be taken into consideration. The staff and its culture are strong resources that Southwest has utilized extensively to gain competitive advantage, and it appears that these are competitive advantages that are sustainable, having been in place for four decades without the competition being able to match them.

Financials

Southwest earns lower profit margins than its industry peers, as part of its discount pricing strategy that seeks to combine low prices with high volumes. Its gross margin is 17%, compared with an industry average of 24%, for example. By comparison to other airlines, however, Southwest has a healthy balance sheet. Its debt/equity ratio is 0.55, compared with an industry average of 1.42. While most legacy carriers have been forced to reorganize under Chapter 11 in recent years, Southwest has had no such need. That said, the company's current ratio is a little bit tighter than that of the industry in general, probably in part due to the cash component of the AirTran deal. Southwest has slow receivables and inventory turnover ratios, but does well on a revenue per employee basis, due to the high level of efficiency that the company has. Its returns on equity, assets and capital are positive, but significantly below the industry averages (MSN Moneycentral, 2012). It should be noted that the past year was relatively good for the airline industry. In general, in good years other firms in the industry perform better while in down years Southwest tends to outperform.

Overall, it is this stability that is the key to the financials of Southwest. The company is not nearly as volatile as the industry as a whole, having recorded steady profits and paid steady dividends. While the company is susceptible to changes in the external environment, it is definitely the case that Southwest has relatively healthy -- if unspectacular -- finances.

Competitive Advantages/Distinctive Competencies

These are the strengths from the SWOT section. The key in business is to create sustainable competitive advantage, because those are difficult for competitors to emulate. Southwest has a few of those, including its leadership, its culture and the reputation of its brand. The legacy carriers have been unable to match the corporate culture or leadership of Southwest, nor have they been able to match what that culture and leadership brings to the organization -- tight cost controls, lower turnover, higher staff and customer satisfaction and a more stable client base. The culture and the leadership are also built into the brand, which resonates strongly with the customers. Indeed, just adding the Southwest brand to AirTran flights is likely to increase traffic volume on those flights. There are indications that JetBlue -- founded by a team of people who spent time at Southwest -- has been able to implement many of these same competitive advantages. However, that other airlines have been unable to do so after forty years indicates that they are mostly sustainable, and certainly that the Southwest brand is itself a source of sustainable competitive advantage.