Southwest Airlines Strategy: I/O Model, RBV, and Growth

Introduction

Southwest Airlines has been one of the aviation industry's great success stories. Founded in 1967, the airline pioneered the low-cost carrier model and grew organically by leveraging a first-mover advantage (Morrison, 2001). The airline now operates approximately 3,600 flights every day, employs 45,009 staff, and with the acquisition of AirTran in 2011 became the largest domestic U.S. carrier (Southwest Airlines, 2014). The airline has grown substantially, but in recent years the industry has seen significant constraints on growth due to the maturity of the domestic U.S. market and broader economic pressures (IATA, 2014). However, this does not mean there is no room for further growth. To assess ways in which the firm may improve and to understand its competitive position, it is beneficial to examine how it competes and how it is influenced by external forces.

Globalization and Technology

Globalization and technology have had a major impact on Southwest Airlines. The globalization effect may be considered fairly subtle, as until recently the company operated only within the United States. Nevertheless, globalization has shaped a worldwide travel culture, making airline travel more popular and increasingly seen as a normal mode of transportation rather than an uncommon one — a marked shift from the situation 30 to 40 years ago (Belobaba, Odoni, & Barnhart, 2009). The globalization of the industry has also enabled increased knowledge sharing and the development of safer technology and practices, with lessons from air crashes being shared internationally and international aviation standards being developed as a result (Belobaba et al., 2009).

Technology has had, and continues to have, a significant impact on the airline. As Southwest adopted the low-cost carrier strategy, one of its underlying approaches has been to control operating costs and create value through efficient underlying systems (Gittell, 2005). A major change occurred with the adoption of the internet: the booking system was gradually migrated online, proving to be a cost-effective medium that could also be integrated with the dynamic pricing software used to forecast demand and set seat prices for each flight (Gittell, 2005). This automated system empowered passengers while reducing costs associated with call centers. The process was highly successful — by 2000, more than 25% of all revenues were generated online; today that figure exceeds 80% (Southwest Airlines, 2014). Online check-in has further increased efficiency, reducing costs and improving convenience for passengers (Southwest Airlines, 2014; Gittell, 2005).

Marketing has also benefited from technology. The "Ding" program — a small application passengers could install on their computers — notified users with a pop-up alert whenever special fares were released (Southwest Airlines, 2014). Technology also plays an important role in flight operations. Cockpit software across the Southwest fleet has been upgraded, creating smoother landings and improving fuel efficiency, a change that took three years to prepare and required extensive pilot retraining (McCartney, 2014).

However, technology can also present constraints, particularly when the firm outgrows its systems or when existing technology becomes outdated and costly upgrades become necessary. This was evident with the booking system, which could not accommodate international reservations. Following the acquisition of AirTran and the decision to expand into international flights, the existing Amadeus reservation system proved insufficient, requiring a significant investment in a replacement platform (Maxon, 2014; Carey, 2014). Technology thus remains both a major enabler and an ongoing area requiring continuous investment.

Improving Returns: The I/O Model

Two general approaches have emerged within strategic planning, each offering a different framework for assessing how a firm may achieve superior returns (Thompson, 2007). These are the industrial organization (I/O) model and the resource-based view (RBV) (Thompson, 2007).

The I/O model operates under the assumption that to gain superior profits, a firm must examine the forces shaping its industry — looking outward rather than inward — and use that information to identify suitable strategic choices (Lieberman & Asaba, 2006). Applying this model to Southwest Airlines requires examining the external characteristics of the airline industry.

There are numerous industry-wide pressures. The ongoing economic recovery has increased demand for air travel, though the rate of growth remains constrained. For the entire industry in August 2014, the year-on-year increase was 5.9%, but this growth was not evenly distributed. The U.S. domestic market grew by only 4.5% in revenue per passenger kilometer (RPK), compared to 6.7% RPK for international flights (IATA, 2014). Latin America recorded the fastest regional growth rate at 8.2% RPK, followed by Africa at 7.5% RPK and Europe at 6.8% RPK (IATA, 2014).

At the time of writing, concerns about the Ebola outbreak appeared likely to dampen demand for flights into and out of Africa, while also increasing associated costs as airlines implemented measures to prevent the spread of infection. Political uncertainty in Eastern Europe and the Middle East was similarly creating potential headwinds, both for demand and operations. Fewer passengers were likely to travel to regions experiencing unrest, and airlines were increasingly rerouting aircraft away from airspace over conflict zones — an issue brought sharply into focus following the downing of Malaysia Airlines Flight MH17 over Ukraine in July 2014 (Walker, Salem, & Luhn, 2014).

Drawing from these environmental factors, a strategy focused on increasing international flights appears well-supported, given the constraints on domestic market growth. Specifically, expanding into Latin America would allow the airline to target the region with the highest current growth rate while avoiding politically unstable or health-affected areas. Latin America also offers promising long-term demand growth, particularly as many of its economies continue to develop (IATA, 2014).

Conclusion

Overall, Southwest Airlines is in a very strong strategic position. The different elements of its operations are tightly and coherently aligned. An examination of the company through both the I/O model and the RBV model points toward similar strategic conclusions: that the most promising path to improving performance and enhancing profitability lies in leveraging existing internal resources and capabilities while taking advantage of favorable environmental conditions to pursue international expansion.