FLORIDA INSTITUTE OF TECHNOLOGY. Southwest Airlines

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1 FLORIDA INSTITUTE OF TECHNOLOGY Southwest Airlines Leveraging operational resourcefulness and an engaged workforce to adapt to future competitive dynamics in the airline industry Jose Sola 3/25/2018 Southwest Airlines has managed to achieve the second largest market share amongst domestic United States airline industry while consistently maintain profitability. Focusing on maintaining low operating costs through aircraft maximization and efficiency, it has also focused on employee engagement which has allowed it to pursue a cost leadership strategy with enough differentiation in the form of its staff friendliness. Its success has spawned other low-fare competitors and, more recently, ultra-low-fare carriers. As it deals with increased competition and a changing competitive landscape, it will need to leverage and enhance its existing competencies as it seeks to retain and expand on its market share.

2 1 Swimming in the oceans of a highly competitive airline industry, Southwest Airlines has profitably navigated through stormy waters better than most companies in the industry. Just as dolphins use their intelligence to adapt and survive in an environment with threatening predators such as sharks or whales; Southwest Airlines has successfully risen against larger competitors by making the most of the opportunities presented by its external environment. A major reason s for Southwest Airlines success rests in its low-fare business model which focuses on servicing a concentrated group of terminals, operating a single fleet, and offering every passenger the same product level. Similar to dolphins that conserve energy by surfing the wakes of ships, Southwest Airline model allows the company to minimize its costs and operate more efficient, timely flights. While its competitors have focused on pursuing differentiation strategies such as larger airplanes, more destinations, and enhanced features, Southwest s model of low-fares and a simplified experience with acceptable but differentiated levels of quality have propelled it as the second largest US domestic airline in terms of market share, which stands at 21.5 percent, only slightly lagging American Airlines which has 22.8 percent. This success has prompted similar low-fare airlines such as JetBlue and Spirit Airlines to enter the market, while also having to sustain established competitors who try to improve their value propositions to regain their lost share of the market. As it increases in size and market share, competitors will try to imitate its features to eliminate Southwest s competitive advantage (Hitt, Ireland, & Hoskisson, 2017). To continue its success, Southwest Airlines will need to carefully monitor its external environment to find areas of opportunity while leveraging the competencies of its current model and reputation to exploit those opportunities. General Environment Analysis The airline industry has bright prospects largely driven by demographic, economic, and technical trends that have a positive effect on demand (Wang & Song, 2010). Population growth rates coupled with mass migration of the world population toward cities and the emergence of millennials show promising signs for future customer demand. The world s population is expected to grow steadily at 1.09 per year, while the United States will continue to see moderate growth of.7 percent leading to more likely customers ( Current ). Much of this growth is expected to concentrate in cities, which see about 3 million people moving to cities globally (Boyd, 2018). Increased density of population would likely lead to more customers needing to travel further distances to see each other; increasing the value proposition of air travel relative to

3 2 other methods. Also, as millennials replace baby-boomers as the largest customer segment, the sociocultural importance they place on travel will further have a positive effect on demand (Fromm, 2017). In addition to demographics, economic activity is expected to continue to increase as the economy exists the recession, leading to greater number of customers able or willing to pay to travel faster and more conveniently by air to reach their destinations (Chi & Baek, 2013). Furthermore, technological advances such as the automation of the baggaging process will offer airline companies the opportunity to further achieve cost savings while reducing errors (Rijsenbrij & Ottjes, 2007). Of less impact but equal concern; political, global, sociocultural and environmental trends will likely create challenges for the airline industry. Among the political factors include possible changes in airline regulations concerning greater fuel efficiency and safety. Potential global concerns involve isolationist economic trends that might lead to less travel among certain destinations and interest rate fluctuations in international markets which has made it more expensive to travel to the US and has hurt legacy carriers with international reach (Trefis, 2015). Environmental concerns involve the increasing concern of climate change and the role played by airplane emissions. Not only would this create pressure for companies to buy newer fuel-efficient models, but also could have sociocultural implications by making people opt for eco-friendly competitors. Ultimate, these trends do not have as direct of an impact because they develop over more time, making them easier to mitigate. Industry Analysis With its intense rivalry, high bargaining buyer and supplier power, the airline industry has low attractiveness providing opportunities to companies that successfully establish themselves the benefits of low threat of substitute products and entrants. With high capital requirements, extensive regulations, and complex logistics, the airline industry is shielded from new entrants by its entry barriers. With almost 4 companies controlling almost 80 percent of the market share, retaliation would be expected from established competitors who would have advantages of economies of scale and could price more aggressively before sustaining losses (Hitt. et. al., 2017). While demand is expect to increase, fare prices have not which further deters entrants. While its low threat of entrants is appealing, airlines are highly influenced and dependent on suppliers. While competition is increasing amongst airplane manufacturers, fuel prices have a direct influence in fare costs as companies need to charge higher fares before they

4 3 can make profits (Chi & Baek, 2013). However, development of better fuel efficient engines has the potential to mitigate the impact of supplier power toward more moderate levels. Customers have a high amount of power over airline companies. Not only do companies rely on fares as their source of profits, customers often have the ability to travel by other means if costs are too high and with the popularity of e-commerce they can easily shop online for the best fares or use a different competitor if they have a bad experience (Moreno-Izquierdo, Ramón-Rodríguez & Ribes, 2015). As the fastest and furthest mass method of transportation, airline travel is unlikely to be substituted by other forms of travel. While some customer might choose alternatives during economic downturns, demand returns because there are no other technologies with the same mass transportation capacities. Intensity among rivals is high due to the several variety of competitors, lack of differentiation (for casual customers), high fixed costs, and exit barriers (Hitt et. al., 2017). With high bargaining buyer and supplier power coupled with intense rivalry, the airline industry has low attractiveness. On the other hand, high entry barriers and low threat of substitutes are appealing for companies that can successfully manage to establish themselves. Competitor Analysis As the largest domestic United States airline by market share, accounting for 22.8 percent of the market, American Airlines pursues a differentiation strategy concentrating on maximizing the number of destinations and the luxuriousness of the experience. This is evidenced by their mission statement which states the company s intention to modernize its fleet, while retaining the largest reach with the goal of becoming the most profitable airline (Walters & Grovers, 2015). The company s core competencies rest on their established brand name, fleet quality, and destination reach. Additionally, it has taken recent steps to introduce basic economy fares in attempts to appeal to customers attracted by low-fare carriers as it attempts to regain market share and increase profits ( Coming soon, 2018). Delta Airlines is the second largest domestic competitor with 21 percent of market share. It pursues a differentiation/cost leadership strategy by providing customers with different flight accommodations ranging from basic economy (low-fare), main cabin (traditional economy) and first class. Its core competencies lie in operation efficiencies as it operates a fleet of airplanes nearing retirement. This allows the company to rely on a greater ratio of variable to fix costs, which enables them to respond more quickly to changes in demand (Levine-Weinberg, 2015).

5 4 While it only has 4 percent share of the domestic market, JetBlue is the largest competitor operating a similar low-fare cost leadership model. Founded 32 years after Southwest by one of its former executives, JetBlue has largely imitated Southwest s model of concentrating on maximizing usage by focusing on popular destinations and offering a simplified experience while offering slightly better differentiated features with more customer appeal such as free Wi- Fi and snacks (Trefis, 2015). Their core competencies lie in a more advanced fleet with high fuel efficiency, which has somewhat insulated them from variable changes in fuel costs relative to competitors ( JetBlue, 2017). As described in their vision to bring humanity to air travel by delivering value, service, style and comfort, JetBlue has focused on cost leadership with enough differentiation and it is now leveraging their success by expanding its geographic reach to additional high-potential destinations and providing premium fare options to increase its market reach by catering to more demanding flyers (Trefis, 2015). Internal Analysis As large part of Southwest s success is derived from its ability to offer competitive fares, its operating activities have focused on efficiency and minimizing costs. As part of this strategy it has operated a single airplane model, often purchasing and fixing older planes in order to reduce expenses (Ross, 2015). While most competitors place emphasis on aircraft technology, Southwest s approach has enabled it to avoid having large capital expenditures while affording it greater flexibility, as all workers are familiar with the same equipment maintenance crew is quicker to fix potential problems, and pilots are able to operate all routes interchangeably. Another core competency rests in its logistics, as it operates gate-to-gate routes; it is able to more efficiently and quickly manage the baggage process and reduce errors arising from diverting luggage to connecting flights (Zane & Reyes, 2010). Due to its value in providing flexibility and its rareness, these capabilities provide Southwest Airlines with a temporary competitive advantage which could last until the cost of new airplanes, in combination with their fuel savings rivals that of the savings afforded by older planes. In such scenario, its model would become a weakness and a competitive disadvantage because it wouldn t be able to compete by using its focal low cost strategy. Another core competency includes its customer service activities which have allowed the company to consistently be ranked amongst the top in various customer service surveys. This is largely driven by its simplified flight experience and its investment in its human capital as it has

6 5 shared profits with employees for the last 43 years and has avoided having to lay off (Dhal, 2017). These conditions have contributed to Southwest Airlines reputation for having a friendly and engaged workforce and are indicative of strong Human Resources and Management support activities. Should customer taste become more demanding, the company would be at a competitive disadvantage because it would require large capital investments and would have to reconsider its competitive strategy. SWOT Analysis Cost efficient gate-togate model Flexible fleet and operational capacity Customer Service Engaged Workforce Older Airplane Fleet Single supplier reliance Limited differentiation capacity Strenghts Weaknesses Opportunites Threats Population shifts toward cities Millenial customers and product preferences High traffic, proximal international destinations Competitive Rivalry Supplier and fuel costs Environmental demands When considering the trends of population shifts toward cities and millennial trends placing less emphasis on features, Southwest airline s current model is well positioned because it focuses on gate-to-gate popular destinations. While its operating activities provide strength due to flexibility and cost efficiencies, it should be concerned with sociocultural trends placing larger priority on eco-friendliness which might lead customer to opt for airlines with the latest most fuel-efficient fleet. Additionally, it has reason to be concerned with additional low-fare airlines such as JetBlue and newer ultra-low-fare entrants such as Spirit or Frontier entering the

7 6 market. With millennial generations replacing baby-boomers as the largest flying segment, Southwest Airlines should focus on leveraging its customer service reputation to add low-cost, high perceived value features, allowing it to maintain differentiation from imitating rivals while continuing to improve its value proposition to potential customers. Lastly, the company should leverage its operating competencies to gradually replace older models with a new generation of higher fuel-efficient models that would help it further lower operating costs in the long-term while strengthening its operating model against potential threats. Strategy Formulation Strategic Alternatives Considering the importance the cost leadership business level strategy has played in its success, Southwest s Airlines could continue its focus around further cost competitiveness. As it attempts to appeal to a greater customer base, it must adopt some differentiation while being unable to solely pursue differentiation strategies that represent a dramatic change from its existing model (Hitt. et. al., 2017). Not only would it not be able to take advantage of its competencies, it also would be at a disadvantage with larger competitors with modern fleets, larger distribution channels and destinations. On the other hand, implementing an integrated cost leadership/differentiation strategy would help Southwest Airlines pursue operational efficiencies to be price competitive while it simultaneously engages in activities to differentiate its product and appeal to a broader market segment. As its share of the domestic market has reached a saturation point, corporate level strategies of diversification could help add new value and growth. Among its options, it could maintain low diversification levels by focusing on the domestic US market. Additionally, it could maintain its dominant business design and pursue value-adding diversification by expanding to international markets or offering complementary services to customers (Hitt. et. at., 2017). Among the strategies, it can pursue mergers of acquisitions of firms where it seeks to enter new markets; it can form strategic alliances such as codeshare agreements with other airlines, or it could also open its own terminal. It can manage its international strategy through a global strategy, which maintains central control of operations; or pursue a transnational strategy which maintains central strategic control and adds local market input through regionalization of the company s management structure. Alternative Evaluation

8 7 From an internal strengths perspective, the cost leadership strategy would allow Southwest Airlines to leverage a historical core competency of operational efficiency and simplified processes and it would require the least changes to its organizational culture. On the other hand, it has the potential to leave the company exposed by failing to meet the needs of more demanding customers. Adhering to a cost leadership strategy, could also limit its appeal to value seeking customers and fail to take advantage of higher paying or more frequent-flying business travel segments. With an integrated cost leadership/differentiation strategy, Southwest Airlines would maintain focus on operational efficiencies and cost competitiveness in the lowfare model, while also pursuing opportunities that add customer value without having an adverse effect on its cost leadership capabilities. Using its customer service competencies and its simplified flight experience, it could leverage these capacities to add low-cost features that make the customer s experience more comfortable and pleasant, without focusing on luxury. Low diversification would allow Southwest Airlines to use its current capabilities with the gate-to-gate model and single distribution channel to focus on its current low-fare model to achieve economies of scale. Because of the importance of achieving economies of scale in the airline industry, the single-business diversification strategy would help Southwest leverage the operational benefits from the single-model fleet and its focus on high transit cities to achieve greater economies of scale than possible by competitors pursuing more diversified strategies. On the other hand, a dominant business strategy would involve Southwest s continued presence in the domestic US, while expanding into international markets or increasing cargo flights. As the degree at which it is able to expand share of the domestic US market decreases, increasing diversification will the firm make the greatest use of the opportunities presented by its competitive environment. Additionally, maintaining a dominant business design would help mitigate risks from new markets, while pursuing value creating diversification with operational and corporate relatedness would help transfer its capabilities in service and operations to gain growth and new knowledge of international markets. As it seeks to enter new markets, choosing a global strategy would allow Southwest Airlines to maintain central control and management of its operations. Employing a gate-to-gate model with select destinations and a single fleet, it can take advantage of the standardization of its operations because they are less complex and easier to manage in a global strategy than those of competitors with more complex destinations and fleets. Because of the fairly similar demands

9 8 and expectations of travelers toward airlines, a global strategy also takes advantage of its external environment because it doesn t need to be as concerned about local responsiveness, allowing greater economies of scale. A transnational strategy would involve central management and control of activities, but it would also involve the regionalization of operations to allow for greater responsiveness. Diversifying its managerial inputs would also allow Southwest Airlines to benefit from increased transfer of knowledge (Hitt. et. al., 2017). On the other hand, it would incur greater staffing costs which could have a detrimental impact on its current low cost operational core competencies. In pursuing diversification, it has the option to pursue cooperative strategies, merger and acquisition strategies, and organic growth strategies. While cooperative strategies provide Southwest an opportunity to achieve strategic agreements with other carriers with codeshare agreements that might help it provide a differentiated product, it would not incur the same rewards it would through acquisitions or new ventures (Hitt. et. al., 2017). While acquisitions provide a quick entry and a bypass to entry barriers, they are often risky and difficult to implement. On the other hand, organic expansion to new destination take longer than acquisitions but offer greater control and are easier to manage. Alternative Choice As it must transform from a low-fare carrier to meet the changing needs of its customer base, Southwest Airlines should adopt a business level integrated cost leadership/differentiation strategy because it allows it to leverage its existing operational capacitates to pursue price competitive strategies. Additionally, it is able to leverage its service and organizational culture competencies in pursuing differentiation strategies that further improve its customer s flight experience as a direct response to environmental demands posed by high customer power and high competitive rivalry. In turn, this helps the firm differentiate from competitive imitators who match its cost appeal. Because it has limited domestic growth opportunities, it must simultaneously pursue a corporate level dominant-business international diversification strategy; involving destinations that help the company maintain corporate relatedness and sharing of activities because they in turn are essential to its business level strategies of cost leadership. Strategic Alternative Implementation Action items

10 9 As it shifts from a cost leadership strategy to an integrated one, it will need to carefully manage and balance new features so that they do not compromise the firm s cost leadership appeal and drive away loyal customers at the expense of pursuing new ones. Another challenge rests in transferring its core competencies of organizational culture across international destinations. Furthermore, the acquisition of new terminals, new staff and equipment also requires increased capital investments. Because it also relies on a single distribution channel (except for business sales), it also must consider increased advertising costs as it is not able to use the publicity provided by third-party distribution channels. In implementing its strategy, it would be best facilitated by a functional structure. Because it will continue pursuing a cost leadership strategy, the functional structure would help the firm maintain a lower cost structure through centralized coordination (Hitt. et. al., 2017). While it also will pursue differentiation, it will do so by leveraging its workforce and service competencies in developing features that are process related and experience related, following similar examples as maintaining no check bag fee policy, no re-scheduling fees and frequent flyer rewards program. Because its international diversification strategy will be reliant on its dominant business and incremental expansion to international destinations, the functional model can help the company emphasize its operational cost efficiencies capabilities without disrupting the synergy of operations by adopting a multidivisional structure. Action plan Using a combination of strategic and financial controls, Southwest Airlines could monitor its strategic direction using a balanced scorecard based on strategic and financial objectives in order to evaluate its performance and consider any necessary changes (Hitt. et., 2017). In measuring its strategic success, it would include the goals of becoming the leading domestic US airline by market share, Maintain or surpass current customer service levels, and double its international reach over the next five years. In measuring its financial success, it would include sustaining above-industry profit margins, operating margin, fuel efficiency rating, and cost per seat.

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