Southwest Airlines' acquisition of AirTran and integration challenges

¶ … 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.

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.

Strategic Issues/Priority Issue

While there are a number of different issues facing Southwest, including the ongoing fuel price increases, competition, the neverending Wright Amendment circus, the major strategic issue at present is how to integrate AirTran's route and people into Southwest, turn them into Southwest people with Southwest values and do so without disrupting operations or the power of the Southwest brand. Failure to make such an integration could be catastrophic for the company's reputation and could result in significant write-downs in the future (the failure of FedEx to bring Kinko's into the fold comes to mind when considering downside risk).

Strategic Alternatives and Recommendations

Southwest doubtless has a plan for integrating AirTran. Operationally, this is as simple as implementing Southwest's systems on AirTran's assets. Culturally, this is a bigger challenge. The enculturation process needs to begin immediately, so that AirTran employees are welcomed into the Southwest family, but trained as though they are new employees. AirTran's internal leaders should be identified as quickly as possible and given advanced training that they can take back to their units. Points of resistance should be identified early and then strategies to overcome them should be implemented as quickly as possible.

It is recommended that the cultural integration of Southwest and AirTran be the focal point. The temptation is to worry about the operational issues first and let the culture sort itself out later, but so much of Southwest's strength comes from its culture. The culture supports everything else that the company does, that Southwest simply could not do what it does without its unique culture. By implementing Southwest culture among AirTran employees, Southwest will increase buy-in for the different operating elements of Southwest's culture and reduce resistance to change initiatives.

Beyond this, other strategic initiatives should be put on hold. Implementing an acquisition such as this is can be an overwhelming task, and it would be nearly impossible to juggle this with other strategic initiatives such as international expansion. Southwest should probably sell off AirTran's international routes because international does not fit with the company's current business model. In addition, it is recommended that Southwest also strike hard at its competitors. Since Southwest is now the largest airline by passenger volume, it has more leverage than it ever has, with a key rival like American on the ropes, now is the time to aggressively work to eliminate the political power than airline has lorded over Southwest for the past three decades.

Works Cited:

Chang, K. (2011). How Southwest Airlines beat the Wright Amendment. CNBC. Retrieved March 12, 2012 from http://www.cnbc.com/id/43714139/How_Southwest_Airlines_Beat_the_Wright_Amendment

Jacksonville Business Journal. (2012). Union slowing AirTran, Southwest merger. Jacksonville Business Journal. Retrieved March 12, 2012 from http://www.bizjournals.com/jacksonville/news/2012/02/27/union-slowing-airtran-southwest-merger.html

MSN Moneycentral. (2012). Southwest Airlines. Retrieved March 12, 2012 from http://investing.money.msn.com/investments/stock-balance-sheet/?symbol=us%3ALUV&stmtView=Ann

Mutzabaugh, B. (2012). Southwest's new routes begin to blend in AirTran cities. USA Today. Retrieved March 12, 2012 from http://travel.usatoday.com/flights/post/2012/01/southwest-new-routes/610164/1

Peterson, K. & Daily, M. (2011). American Airlines files for bankruptcy. Reuters. Retrieved March 12, 2012 from http://www.reuters.com/article/2011/11/30/us-americanairlines-idUSTRE7AS0T220111130

Southwest 2010 Annual Report. Retrieved March 12, 2012 from http://southwest.investorroom.com/download/2010+Annual+Report.pdf