Southwest Airlines Strategic Analysis: Post-Pandemic Outlook

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, offering six round trips between Houston and Dallas. The airline subscribes to a mission of connecting people to what is important in their lives through low-cost, reliable, and friendly air travel (Southwest Airlines, 2022). Currently, Southwest Airlines serves 120 destinations across 11 countries and is the second-largest air carrier in the United States by market share (Southwest Airlines, 2022). The airline's 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 Covid-19 pandemic. The purpose of this case analysis is to assess Southwest Airlines' and the wider airline industry's performance in the post-pandemic period, and to identify effective strategies for enhancing growth and value.

General Environment Analysis (PESTEL)

The airline industry is in a state of recovery from the Covid-19 pandemic. Vaccines have become more readily available, and governments — including the US government — have lifted most of the local and international travel restrictions imposed at the height of the pandemic in 2020. In April 2022, the Transportation Security Administration also lifted its mask mandate directive, which had required 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 Covid-19 pandemic sparked growing interest in customer protection regulations that compel airlines to compensate customers — through refunds — when flights are cancelled or when there are significant changes to scheduled flights (Department of Transportation, 2022). These new regulations impose an additional compliance burden on the airline, and Southwest may need to onboard more employees as it expands its route network in order to reduce inefficiencies arising from cancellations and significant flight changes.

The increase in crude oil prices resulting from the pandemic raised airline operational costs, pushing air ticket prices up (Holzhauer, 2022). The effects of the Covid-19 pandemic also depressed customer incomes globally (CBPP, 2022), reducing purchasing power and leading to lower consumer spending on discretionary segments such as leisure air travel. The federal Payroll Support Program (PSP) received in 2020 and 2021 supported the airline's operations during a period of falling profits. Southwest Airlines received $2.2 billion in loans and $5 billion in grants in 2020 and 2021 as a result of the PSP (Southwest Airlines Annual Report, 2021), ending 2021 with high liquidity despite falling revenues from its leisure segment.

Crude oil prices, however, remain volatile and higher than pre-pandemic levels (Holzhauer, 2022). In an attempt to curb inflation, the Federal Reserve announced a rise in interest rates from 4% to 4.5%, effectively increasing the cost of financing. On the corporate front, profits are expected to grow in 2023 as governments lift Covid-19 restrictions on domestic and international travel, though investors may remain reluctant to commit capital to the airline industry. Southwest Airlines may therefore need to draw on its reserves to fund most of its capital expenditure. The leisure segment, most affected by inflation, will see revenue growth as customer incomes slowly recover toward pre-pandemic levels. The business segment is likely to record faster revenue growth in the near term, as customers with constrained incomes prioritize business travel over leisure.

The airline industry faces regulations from the Environmental Protection Agency (EPA) aimed at reducing the intensity of carbon emissions. To support carbon-neutral growth, Southwest Airlines may be required to invest in more fuel-efficient and quieter aircraft and to secure adequate quantities of sustainable aviation fuels (SAF), which can be more costly than conventional fuels. While this additional investment may increase operational costs in the short term, the long-run effect on the company would be an enhanced reputation as a green entity, which would attract environmentally conscious investors and customers.

The main legal issues likely to affect Southwest Airlines relate to new labor regulations calling for increases in the minimum wage. Attempts to raise the minimum wage would affect the airline's bottom line at a time when the industry has not yet fully recovered from the pandemic. On the business side, the airline may need to adjust business-class pricing upward to raise additional cash flows to finance wage increases. Business-class customers are generally less sensitive to price changes. Nevertheless, minimum wage increases would improve employer-employee relations and enhance employee morale, thereby increasing workforce loyalty.

The most prominent global factor likely to affect the airline industry is the evolution of international trade agreements. A significant trend has been the signing of Open Skies Agreements from 2009 to 2017, which eliminate government interference in air carriers' decisions regarding air service, pricing, capacity, and routes (US Department of State, 2017). The impact of these agreements on carriers is increased autonomy over pricing and route selection, which facilitates the global expansion of airline networks.

Industry and Competitor Analysis

Threat of New Entrants. The airline industry is dominated by a small number of entities that enjoy scale economies due to their established presence and brand recognition. Entering the industry also requires substantial capital investment, and new entrants face significant challenges in competing with established brands that have already earned customer trust regarding safety. These factors make the threat of new entrants relatively low.

Threat of Substitutes. Travelers have various options when choosing how to travel, including air, sea, bus, and rail. The low cost of switching between modes of transportation makes the threat of substitutes relatively high.

Buyer Bargaining Power. Customers have high bargaining power in the airline industry because they can choose among a range of carriers, and switching costs are low given the similarities in service offerings across airlines.

Supplier Bargaining Power. The main suppliers in the airline industry are aircraft manufacturers. Because airlines are their primary customers, manufacturers seek to maintain good relationships and long-term contracts to preserve business continuity. This dynamic compels suppliers to accept terms set by airline customers, resulting in relatively low supplier bargaining power.

Rivalry among Existing Firms. Airlines face intense competition both domestically and internationally. Establishing a brand presence requires substantial capital investment and time, which motivates existing carriers to defend their market positions vigorously. Given low switching costs between airlines, providers continuously work to differentiate their services and build competitive advantages.

Overall, the airline industry is attractive due to the low threat of new entrants and low supplier bargaining power. Southwest Airlines has already established its brand through a low-cost strategy, which gives it an edge over competitors and makes it easier to win customer loyalty.

American Airlines. American Airlines is the largest airline in the US by passenger capacity and fleet size, controlling over 19% of the domestic market share and representing Southwest's greatest competitive threat. Its primary strategic strength is a marketing approach that incorporates cross-selling tactics, guaranteeing an impressive experience and maximum benefits for customers. With over 6,700 daily flights, American Airlines' main competitive advantage over Southwest is its worldwide network and strong brand presence in global markets. To counter this threat, Southwest could consider gradually introducing low-cost flights to international destinations.

Delta Airlines. Delta Airlines is the third-largest airline by market share. Its greatest competitive advantage is vertical integration, which allows it to control all aspects of its business and enhance the customer experience through lower rates. Delta outdoes Southwest in international coverage, with 325 destinations in over 50 countries compared to Southwest's 100. Delta expands its international reach by forming strategic alliances with international carriers.

United Airlines. Like Delta, United Airlines boasts a large fleet with over 111 destinations across 79 countries (Hughes, 2022). The airline builds its international coverage through strategic partnerships with other global carriers.

Spirit Airlines. Spirit Airlines operates a low-cost business model similar to Southwest's. It competes for domestic market share through a customer-centric approach emphasizing fast check-ins, flexibility, low fares, and customizable carry-on baggage and itinerary options (Hughes, 2022). Spirit differentiates itself from mainstream airlines through its low-cost pricing model, and from other low-cost carriers through the digitalization of the customer experience, cost-efficient operations, and a strong focus on green practices.

Alaska Airlines. Alaska Airlines is a low-cost carrier serving the domestic market, similar to Southwest. The airline differentiates itself through a digital customer service model that ensures a personalized experience with a particular focus on business customers (Hughes, 2022). However, to compete effectively against Southwest, Alaska Airlines needs to enhance both its cost efficiency and revenue per seat mile (Hughes, 2022).

Southwest Airlines holds the position of top low-cost carrier in the domestic market. The airline maintains its low-cost pricing by flying only Boeing 737 aircraft, which minimizes pilot training time and reduces crew time spent on maintenance. Southwest also reduces costs by using secondary airports rather than major hubs, cutting docking fees and minimizing delays. To compete against other low-cost carriers, Southwest seeks to deliver a unique customer experience through flexible policies — for example, allowing flight cancellations up to ten minutes before departure without additional charges or hidden fees (Hughes, 2022). The airline also differentiates itself by prioritizing eco-friendly practices. However, the airline could cement its competitive position further by offering low-cost flights to international destinations (Hughes, 2022).