Swa Case

Southwest Airlines



Introduction Although the airline industry is no longer experiencing the rapid growth it exhibited before 1990; commercial air travel in the U.S. remains the preferred method of transportation for a majority of Americans due to cost-effectiveness and timesaving characteristics. From 1980 to 1990 the number of passengers traveling by air increased by approximately 72%,in contrast, in the 1990-1998 period, the airline industry only experienced 36% growth. Furthermore, during 1965-1978, the government regulated the airline industry by forcing artificial wage increases and artificial price levels. In the postderegulation era, labor negotiations were the cause of many labor strikes. The big carriers have tried to cut costs, but have been constrained by strong unionopposition. For example, “Unions have fought against moves to shift unprofitable routes to lower cost regional jets with lower paid pilots.” Confronted with cut-throat competition, particularly from low-cost rivals such as Southwest, now America's fourth largest carrier in terms of traffic flown, the big airlines have found themselves caught traditional fare wars that cut into their already slimprofit margins. The domestic airline industry in the United States is characterized by intense rivalry and low profit margins. Through product differentiation and a strategy of low cost and no frills, Southwest has been successful in distinguishing itself from its competitors in order to sustain profitability in this aggressive industry. Industry Analysis Since the Airline Deregulation Act of 1978,the airline industry has endured a number of years of low profitability. “Deregulation sent airline fares tumbling and allowed many new firms to enter the market. The financial impact on both established and new airlines was enormous.” 1 In order to understand the consequences of deregulation, it is important to examine Porter's Five Forces as well as the influence of complements to the airlineindustry. Rivalry The extent to which rivalry exists will influence the overall profitability of the industry. Market concentration remains a significant factor affecting rivalry. In 1989, no

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single airline solely dominated the industry, but the eight largest carriers retained a total market share of 92%. Routes, airports, and hubs served by many carriersexperienced intense rivalry. Profitable hubs are those set up in high traffic cities with high demand for air travel. In order to gain profits, airlines must beat out the competition by offering as much or more flights with time flexibility to a variety of destinations. Other factors contributing to rivalry include high fixed costs, excess capacity, low differentiation, price wars, and readilyavailable prices via the Internet. Due to the nature of the industry, high fixed costs are expected. “The airline industry’s extremely high fixed costs made it one of the worst net profit margin.” 2 Contributions to fixed costs in the airline industry include the costs of planes, fuel, pilots, flight attendants, and additional staff for baggage and customer service. The need to meet governmentregulations and hire experienced employees can cost an airline company millions of dollars. Another high cost includes high-tech computer systems that are capable of tracking frequent flier miles, differentiating between advance purchase and last-minute purchased tickets, accommodating customer flight changes, and offering an efficient operation schedule of departure and arrival times. To help recover thesefixed costs, airlines must maximize their load factor by increasing revenue for passengers per miles. Currently there has been excess capacity on many routes; as a result, airlines have been participating in price wars in order to attract customers at all costs. Minimal differentiation among airlines and switching costs for passengers also magnify rivalry. An example of switching cost is the...