SOUTHWEST AIRLINES

Situation Analysis Presentation: Southwest Airlines

1. Strategic Profile and Case Analysis Purpose

Southwest Airlines Inc. was founded under the name Air Southwest in 1960 by Herb Kelleher. The carrier changed its name to Southwest Airlines in 1971 and flew its first plane that year with six round trips between Houston and Dallas. The air carrier subscribes to the mission of connecting people to whats important in their lives through low-cost, reliable, and friendly air travel (Southwest Inc., 2022). Currently, Southwest Airlines serves 120 destinations scattered across 11 countries and is the second-largest air carrier in the US by market share (Southwest Inc., 2022). The airlines greatest source of competitive advantage is its low-cost business model, which helps it build brand loyalty. The airline industry was hit hard by the Covid19 pandemic. The purpose of this case analysis is to assess Southwest Airlines and the wider airline industrys performance in the post-pandemic period to identify effective strategies for enhancing growth and value.

2. Situation Analysis

a) General Environment Analysis

Political Factors

The airline industry is in a state of recovery from the Covid19 pandemic in 2020. Vaccines have become more readily available and governments, including the US government, have lifted most of the local and international travel restrictions set at the height of the pandemic in 2020. Further, in April 2022, the Transportation Security Authority lifted mask mandate directives requiring airlines to observe testing requirements, appropriate ventilation, physical distancing, and mask wearing among passengers. Southwest Airlines expects an economic upturn resulting from the lifting of these regulations. However, the Covid19 pandemic saw growing interest in customer protection regulations that compel airlines to compensate (through refunds) customers when flights are cancelled or when there are significant changes to scheduled flights (Department of Transportation, 2022). The new regulations impose an additional burden of compliance on the airline and the airline may need to onboard more employees as it expand its route network to reduce inefficiencies resulting from cancellations and significant flight changes.

Economic Factors

Inflation: The increase in crude oil prices as a result of the pandemic increased airline operational costs, pushing air ticket prices up (Holzhauer, 2022). The effects of the Covid19 pandemic resulted in depressed customer incomes globally (CBPP, 2022). Depressed incomes reduced customers purchasing power, resulting in reduced customer spending on certain segments such as leisure air travel. The federal payroll support program (PSP) received in 2020 and 2021 supported the airlines operations amidst falling profits. Southwest Airlines received $2.2billion in loans and $5billion in grants in 2020 and 2021 as a result of the PSP (Southwest Airlines Annual Report, 2021). Southwest Airlines ended 2021 with high liquidity as a result of the PSP despite falling revenues from its leisure segment.

However, crude oil prices remain volatile and higher than pre-pandemic levels (Holzhauer, 2022). In an attempt to curb inflation, the FED recently announced a rise in interest rates from 4 to 4.5%. In essence, this means an increase in the cost of financing. On the corporation front, profits are expected to grow in 2023 as governments lift Covid19 restrictions on domestic and international travel. However, investors are unlikely to want to invest in the airline industry. Southwest Airlines may have to deplete its reserves to fund most of its capital expenditure. The leisure business unit, which was most affected by the inflation, will record revenue growth as customer incomes slowly return to pre-pandemic levels. The business segment is, however, likely to record faster revenue growth because with depressed incomes, customers are more likely to travel for business purposes than for leisure.

Environmental Factors

The airline industry also faces regulations by the Environmental Protection Agency (EPA) around reducing the intensity of carbon emissions. Further, to enhance carbon neutral growth, Southwest Airlines may be forced to invest in more fuel-efficient aircrafts, quieter aircrafts, and to find ways to acquire adequate quantities of sustainable aviation fuels (SAF), which may be costlier than conventional fuels. On the business unit, this additional investment may increase operational costs. However, the effect on the corporation in the long-run would be enhanced positive reputation as a green entity, which would attract more investors.

Legal Factors

The main legal issues that could face Southwest Airlines relate to new regulations (in relation to labour) which call for the increment of the minimum wage for workers in the industry. Attempts to increase the minimum wage would impact the airlines bottom line given that the industry has not yet fully recovered from the effects of the pandemic. The effect on the business unit would be that the airline may need to review its business class prices upwards to raise additional cash inflows to finance the wage increments. Business-class customers are less sensitive to price changes. Minimum wage increments would improve the airlines employer-employee relations and enhance employee morale, thus increasing employee loyalty.

Global Factors

The most prominent global factor likely to affect the airline industry is changes in trade agreements. The trend would be the signing of Open Skies Agreements 2009 to 2017, which eliminate government interference in air carriers decisions about efficient air service, pricing, capacity, and routes (US Department of State, 2017). The impact of these agreements on the corporation is increased autonomy over prices and routes, which would facilitate expansion of airlines route networks globally.

b) Industry Analysis

Threat of New Entrants.

The airline industry has a small number of entities that control the market and enjoy scale economies because of their established presence and brand names. At the same time, entering the airline industry requires huge capital investments that makes it difficult for potential entrants to venture. Further, new entrants may encounter huge challenges competing with the existing brands that have already gained customer trust with regard to safety. These factors make the threat of potential entrants significantly low in the airline industry.

Threat of Substitutes

People have various options to choose from when they wish to travel, including air, ship, bus, train, etc. The cost of switching from one mode of transportation to another is low, which makes the threat of substitutes significantly high.

Buyer Bargaining Power

Customers have high bargaining power in the airline industry because they have a range of airlines to choose from and the cost of switching from one entity to another is low given the similarities in service offerings across airlines.

Supplier Bargaining Power

The main suppliers in the airline industry are aircraft manufacturers. Airlines are their main customers and, hence, they try to maintain good relationships and long-term contracts to keep their business going. To keep their business, these suppliers are forced to accept the terms set by airline customers, which gives them low bargaining power.

Rivalry among Existing Firms

Airlines face huge competition from other airlines - both locally and internationally. It takes huge capital investments and a long time for airlines to establish a brand presence, which makes them fight hard to maintain the same presence. Further, given the low switching costs between airlines, providers are constantly working towards developing their services to build an edge over the competition.

Generally,...…12

1 x 4 = 4

20

Flight Discounts and Deals (Market Penetration)

2 x 2 = 4

3 x 3 = 9

2 x 4 = 8

21

Better Service Quality (Product Development)

5 x 2 = 10

4 x 3 = 12

4 x 4 = 16

38

To distinguish between each option (and rate each of the three alternatives), a pre-determined scale of between 1 and 5 was used with 5 in this case being the best. Owing to the fact that some of the identified considerations (i.e. alignment to airline mission, long-term viability and cost implications) were more important than others, weights were assigned also ranging from 1 to 5, where 5 represents the most important consideration. Although the decision matrix above could help in the prioritization of alternatives, it is possible that the assignment of scores was influenced by some level of bias.

c) Alternative Choice

The optimal strategic alternative identified by the decision matrix would be better service quality (product development). This has to do with the enhancement of the airlines present offerings. However, financial considerations cannot be ignored in the formulation of strategic recommendations to management. The airlines return on equity ratio and return on assets ratios both indicate that the airline is better-off in as far as the generation of profits is concerned. It is also important to note that the airline does not, at present, face any challenge in as far as the settlement of its obligations is concerned. This is more so the case given that its liquidity as well as leverage ratios are within acceptable limits as indicated by current ratio and the debt-to-assets ratio. However, there may be need to refrain from aggressive, value-enhancement strategies at this time. This is particularly so given that financial experts foresee the likelihood of a global recession in 2023 that could affect peoples disposable incomes and purchasing power, leading to lower returns for most industries, including the airline industry. Further, the Fed recently announced an increase in interest rates from 4.5% to 5%. Given the hike in interest rates, it might be too expensive for the airline to access funds from commercial lenders at this moment in time. For this reason, route expansion via a strategic partnership would be the more viable strategic alternative for Southwest Airlines because it has minimal impact on the airlines bottom line.

5. Strategic Alternative Implementation

a) Action Items

i) A strategic alliance could result in a clash of both airlines cultures and/or have a negative impact on the airlines ability to effectively deploy and benefit from its low-cost strategic advantage

ii) How would Southwest Airlines fund the alternative without negatively impacting its bottom line?

b) Action Plan

The airline industry remains highly volatile from the effects of the Covid19 pandemic. Thus, investors may be unwilling to put in more equity to support expansion efforts at this time. At the same time, the recent move by the Fed to hike interest rates from 4 to 4.5% in an attempt to curb inflation makes it costlier to borrow from commercial lenders. Given the current situation, I would suggest defunding the value-enhacement program announced in December 2022, which seeks to plough in an investment of $3.5billion annually to improve passenger amenities, and directing the funds to route expansion. Among the measures announced include introducing power outlets and internet for every seat, increasing the size of overhead bins, increasing the number of movie offerings, and updating on-board drink options (Josephs, 2022). In my view, the enhancement program, which mainly targets business class travellers,…