A Case Study by: Benjamin Sanders

Southwest began scheduled service on June

18, 1971 as a low-fare, high frequency

airline committed to exceptional customer

service.

They utilized a short-haul, point-to-point

aviation system

In the beginning…

Southwest’s co-founder Herb Kelleher had this to say about the employees

he wanted working for Southwest, “What we are looking for, first and

foremost, is a sense of humor. Then we are looking for people who have to

excel to satisfy themselves and who work well in a collegial environment…

We can train people to do whatever they have to. We hire attitudes.”

A note from our co-founder…

Prior to 1978, the U.S. airline industry was

regulated by the federal government through the

Civil Aeronautics Board (CAB)

The CAB regulated airline fares, routes, and

company mergers

A change in routes or fares charged by a carrier

had to be approved by the CAB

Price competition was suppressed

U.S. Flight Regulation

In 1978, the Airline Deregulation Act was passed

This act allowed airlines to set their own fares and enter

or exit routes without the approval of the CAB

As far as jurisdiction for mergers was concerned, it was

first passed to the U.S. Department of Transportation;

then again transferred to the U.S. Justice Department in

1985

Aeronautical Deregulation

The Civil Aeronautics Board

was dissolved in 1985

Two Major Changes Occur

The Times, They Are a Changin’

Major carriers turned their attention to serving non-stop

“long haul” routes, which had been very profitable during

the Civil Aeronautics Board regulation era

Consequently, major airline carriers reduced service on

the “short haul” routes that were much less profitable (if

not costly) during the time of aeronautic regulation

Change #1

This void created by major carriers was

filled with smaller domestic carriers

In 1978, America had 36 regional carriers

By 1985, the number of regional carriers

had grown to 100

Effects of Change #1

The manner in which carriers executed their

routes was no longer regulated and quickly

changed.

Almost all the major carriers dropped their

previously used point-to-point system, and

adopted a hub-and-spoke system which featured

“feeder flights” from outlying cities to a central

hub city.

Change #2

The point-to-point system that was abandoned

involved non-stop flights between city-pairs and would

often shuttle flights back and forth between city-pairs

The key to the hub-and-spoke system was to schedule

numerous feeder flights into the large hub airports

that coincided with the highly profitable long-haul

flights, with each spoke adding more passengers to

the aircraft flying the longer distances.

Flight Systems in a Nutshell

The major carriers did not enjoy the success they had

forecasted with their hub-and-spoke system.

Potential increased revenue and some cost economies from

flying more passengers longer distances were offset by

increased costs resulting from reduced utilization of aircraft

as they waited to collect passengers, the capital investment

in hub facilities, and the need for a larger ground staff.

Effects of Change #2 on Large Carriers

Conversely, the small newly formed airlines along with previously existing regional carriers were experiencing company growth and profit.

Since the industry was deregulated, these smaller carriers expanded both the number and the length of their routes.

They did this by maintaining the point-to-point system that was more economical to operate than hubs.

Effects of Change #2 on Regional Carriers

First, they did not bear the higher costs of

operation present in the spoke-and-hub system.

Also, the regional carriers had much lower debt

than that which the major carriers had assumed

during the regulation era.

Subsequently, the newly formed airlines and

regional carriers had an immediate cost

advantage.

Factors in Regional Carrier Success

This cost advantage allowed these carriers to offer lower fares on both

long-haul and short-haul flights.

This created price competition among all airlines, which were

scrambling to fill their seats.

This price competition also lowered the average fare paid on long-haul

flights, which caused further damage to the major airline’s already

dwindling profits, whose cost on the long-haul flights remained high.

Effects of Regional Carrier Success

As the price war raged on, major carriers engaged in

acquisitions of smaller carriers at a feverish pace.

One of these acquisitions was Pacific Southwest

Airlines being acquired by USAir.

By the late 1980’s, 91 percent of U.S. traffic was

controlled by eight major airlines.

Acquisitions

However, the financial condition of these eight major carriers

was not stable due to a decade of marginal profitability.

The 1990’s were a dismal decade for airline carriers due to

recession, a doubling of fuel prices during the Gulf War, and

excess capacity in the industry.

But the floundering of these major carriers only made things

easier for regional carriers and newly formed airlines…

Acquisition Status

Due to rampant bankruptcy among major carriers, “low-fare, low-

frill” carriers were successfully formed.

The new carriers were drawing on a pool of cheap, grounded

aircraft from major carriers, a wide availability of furloughed airline

personnel, and the cost economy provided by point-point route

systems.

These “low-fare, low-frill” carriers jumped from combined revenues

of $450 million in 1992, to $1.4 billion in 1994!

Results of Acquisitions & Bankruptcy

From 1990 through 1994, Southwest had more

than doubled its operating revenues and almost

quadrupled its operating income.

Southwest was so successful that the U.S.

Department of Transportation took note, “…As

Southwest continues to expand, other airlines will

be forced to develop low-cost service in short-

haul markets.”

Results Specific to Southwest

Many competitors started formulating operation

practices very similar to Southwest, if not identical.

The outcome of this effort was the airline-within-

an-airline concept.

The airline-within-an-airline concept involved

operating a point-to-point, low-fare, short-haul,

route system alongside a major carrier’s hub-and-

spoke route system.

Reaction from the Competition

In 1994, United Airlines was the world’s largest

airline.

They launched their own version of the airline-

within-an-airline concept on October 1, 1994.

United’s airline-within-an-airline was branded

“Shuttle By United”.

“Shuttle By United”

This initiative followed the employee buyout in the

summer of 1994 when employee wage cuts and more

flexible work rules made a point-to-point system

alongside United’s hub-and-spoke system possible.

“Shuttle By United” was designed to be a high

frequency, low fare, minimal amenity, short-haul

flight operation serving destinations in California and

adjacent states.

“Shuttle By United”

Beginning with eight routes, “Shuttle By United” had expanded to 14 routes by January of 1995, nine of these fourteen routes competed directly with Southwest.

“Shuttle By United”

“Shuttle By United” is intending to

discontinue some service and raise fares by

$10. What, if anything, do we do in

response?

The Issue

Southwest is a low-fare, high frequency airline committed

to exceptional customer service.

“We hire attitudes.” Our workers go above and beyond the

call of duty.

Customer service was so important to Southwest that they

literally wrote the book on it. Southwest released an

international publication titled The BOOK on Service: What

Positively Outrageous Service Looks Like at Southwest

Airlines

Strengths

In 1994 Southwest recorded a net income of $179.3 million, thus

making 22 consecutive years of profitable operations. No other

carrier matched that over the past two decades.

1994, Southwest won the annual “triple crown” of the airline

industry by ranking first among major carriers in the areas of on-

time performance, baggage handling, and overall customer

satisfaction. It is worth noting that no other airline had ever won

the “triple crown” for even a single month.

Strengths Continued

Southwest Airlines also created a strong bond between

the corporation and its workers. Kelleher referred to this

bond as “a patina of spirituality”. Kelleher stated, “I feel

that you have to be with your employees through all their

difficulties, that you have to be interested in them

personally… I want them to know Southwest will always

be there for them.”

Extra Strength

No hub-and-spoke system (although

considered by many to be a positive)

No first class seating

Not competitive on a national scale

Weaknesses

Electronic ticketing (ticketless travel system)

United charges 5-10% higher than the average Southwest

fare in the nine markets of direct competition in California

United’s withdrawal from the Oakland-Ontario market

(United previously had 32% market share in this market)

United charging higher fares in non-direct competition

markets

Opportunities

“Shuttle by United” was launched on October 1, 1994 by United

Airlines. By mid January of 1995, “Shuttle by United” was serving

14 routes in California and the surrounding area. Nine of these 14

routes were in direct competition with Southwest.

United’s CEO was quoted as saying, “We’re going to match them

(Southwest) on price and exceed them on service.”

Threats

Very few changes need to be made.

Market indicators seem to be in our favor. The system has already

ousted “Continental Lite” from the competition.

It is only natural that the world’s largest airline carrier (United)

would be able to hang in the airline-within-an-airline race longer

than Continental.

Their withdrawal from the Oakland-Ontario market along with raised

fares indicates they are already facing operating cost problems.

The Solution

Don’t rock the boat.

One thing that has made Southwest stand out from its competition-

consistency.

Consistently low fares with consistently exceptional customer service are an

integral part of what makes Southwest work so efficiently.

Changing our prices to match United’s will erase our competitive advantage

while driving overall fares down.

The “patina of spirituality” within the company offers advantages that

United does not possess.

Solution Continued… Stay the Course

A public relations campaign may be helpful to remind both new and loyal

customers that we (Southwest) have always been a leader in “low-fare, low-frills”

flights. PR would utilize low cost print ads, as well as in-airport advertisements.

Let it be known we’re not going to try and squeeze an extra buck out of them for

shareholder profits.

Implementation of electronic ticket technology would reduce airline expenses

even further.

If technology permits, I would also suggest a wide-spread social networking

public relations campaign.

Possible Considerations

Questions?

Codenamed “U2”, “Shuttle By United” was

dissolved by United Airlines in 2001 as it

folded the shuttle flights back into the main

fleet. United filed for bankruptcy in

December 2002.

By the way…