Southwest Airlines:
Business Evaluation
Submitted by:
D. Dill
March 13, 2006
EXECUTIVE SUMMARY
Purpose, Method and Scope
Southwest Airlines began business over 30 years ago in Dallas, Texas, to provide customer
with a low-cost way to fly and has grown to the third largest airline in the nation. To
evaluate whether Southwest has good investment potential, there must be an evaluation of
the airline industry and Southwest. The industry will be evaluated using Porters Five
Forces Model. Southwest will be evaluated using a
strengths-weakness-opportunities-threats (SWOT) analysis. After the assessments are
complete, they will determine if Southwest stock should be purchased as in investment.
Strategic Analysis Findings
First, Porters Five Forces Model showed the airline industry to be high risk, but not to be
discounted if held as part of a diversified portfolio. Second, a comparison between
segments determined the U.S. airline market is more stable and faces fewer threats than the
European market, so any investment will be made with a U.S. based carrier. Third,
Southwest was shown to have outperformed other U.S. carriers. Fourth, Southwest
business level analysis shows its functional strategies offset the threats and weaknesses
revealed by the SWOT analysis and Porters Five Forces Model; it also shows Southwest is
well positioned to take advantage of the strengths and opportunities showcased in the
SWOT analysis. Lastly, Southwest has excellent organizational structure, controls and
corporate culture to adapt to industry changes in the future.
Solutions and Recommendations
Although the airline industry is unpredictable, some airline carriers are more dependable
and have better historical achievements than others. Southwest shows superior
performance and implementation of business strategies. Therefore, the recommendation is
to invest in Southwest.
INTRODUCTION
Southwest Airlines was established over 30 years ago by Rollin King and Herb Kelleher to
provide customers with low fares, to ensure on time flight arrivals and departures, and
create a fun experience for passengers. This novel approach to airline service was a critical
event in Southwests founding. King and Kelleher used these ideas to develop and select
the business and functional level competencies they pursued to become the fourth largest
airline in the U.S. Southwest continues to pursue an aggressive low cost strategy which has
helped it gain and maintain market share. However, with costs rising, Southwest has an
almost Herculean task of maintaining low fixed and variable costs to retain its leadership
position; it also needs to sustain growth into new service markets amid ever present
competition.
To evaluate how well Southwest is pursuing its strategies and to determine whether it has
good investment potential, there are multiple factors to review. First, the airline industry as
a whole will be evaluated using Porters Five Forces analysis. Second, how U.S. airlines
compare to European carriers will be studied. Third, an examination of Southwest
compared to other U.S. carriers should be completed to determine how well Southwest is
positioned in the industry. Finally, a detailed strengths-weaknesses-opportunities-threats
(SWOT) analysis will be done, how strategies are enacted, and what controls Southwest
uses to determine its current and future potential.
STRATEGIC ANALYSIS
Airline Industry
Overview
The consumer airline industry experienced a severe slump in ticket sales due to the
terrorist attacks of September 11, 2001, “a weak economy, the war in Iraq, and the deadly
SARS virus; [these events] have conspired to slam demand for airline tickets” (“Airlines,”
2003). The airline industry still has not completely recovered to the sales volume it had
prior to these events. Global losses since the terrorist attacks have totaled $30 billion US
dollars which has had lasting effects on airline financing, manufacturers and lessors.
(“Airlines,” 2003). Over the past four years, several airlines have been forced into
bankruptcy Chapter 11 reorganization in an effort to stay in business, e.g. Delta Airlines,
Northwest Airlines, United Airlines, US Airways, and ATA Airlines.
According to Richard Bittenbender, senior credit analyst at Moodys, there would be no
recovery in the airline industry until several factors were mitigated consumer fear of flying
during wartime, the slow economy, and the cutback in airline capacity due to forced
bankruptcy. Mr. Bittenbender forecasts that airline liquidity would not recover until 2004
or 2005; airline industry earnings and cash flow wouldnt recover until 2005 (“Airlines,”
2003). Overall, the airline industry has high business and financial risk, and this risk
mixture causes most of the industrys profit unpredictability (Gritta, Chow, and Freed,
2003). While these industry risks are a concern for any investor, if an airline industry stock
is purchased as part of a well diversified portfolio, the risks can be softened.
Porters Five Forces Model
Michael Porters Five Forces Model is used to describe the forces that shape competition
within an industry and to identify any strategic opportunities and threats. The airline
industry can be evaluated using this model; it will determine how established companies in
the industry will be affected by microenviromental several factors.
First, the threat of potential companies entering the industry will be limited to those
companies who can raise enough capital to purchase planes, gates at airport terminals, and
a hub to conduct business. Entry will also require getting government approval to start an
airline, which may be complicated. These barriers to entering the airline industry are fairly
high due to high startup costs, but the high costs alone havent prevented new airlines from
attempting a business venture into the airline industry.
Second, once a company has entered the market, there is limited differentiation between
companies and typically low switching costs. This leads to strong rivalry in the airline
industry and encourages alliances. This intricate co-operative structure, an attempt to
consolidate the industry, still does not prevent companies from lowering prices to gain
market share. Overall, this actually tends to lower prices and raise costs which constitute a
threat to established airlines (Hill, 2004).
Third, the bargaining power of buyers will impact airlines if the buyer is viewed as a
competitive threat. There are a large number of buyers (consumers) in the airline industry
with the ability to easily switch between airline companies; it gives them a certain power
in the market. This “buyer power” can force prices down or it can force costs up by
demanding better services or quality. The airline industry has had price wars, in part
because the industry was more consolidated due to the alliances. With the airlines now
interdependent, when one company changes its competitive strategy and lowers prices, the
other airlines are forced to follow suit in order to keep market share. This has confirmed
interdependence can be considered major threat (Hill, 2004).
Fourth, the bargaining power of suppliers will impact airlines if they become a competitive
threat by forcing prices up the airline must pay for goods or if the supplier reduces quality
(Hill, 2004). Suppliers in the airline industry have some power because they produce
goods that dont have a substitute, e.g. airplane parts and aviation fuel. Airlines have a low
cost associated with switching between suppliers, but the number of suppliers is limited. In
addition, each plane requires specialized labor to fly; the pilots labor union has very strong
supplier power” because there is no substitute.
Lastly, there is a threat of substitute products to the airline industry. Alternate
transportation is available but not always practical for most travelers because of time
constraints. This means substitution between taking a plane and resorting to other travel
methods isnt very high. However, the airline industry is fairly homogeneous, consolidated,
and has low switching costs; this makes substitution between airlines a very real threat. As
airline industry competition has increased, it has also increased substitution risk and the
need to reduce this risk.
In summary, Porters Five Forces Model illustrates several points. The airline industry has
high barriers to entry and significant rivalry. The power of suppliers is high, and the power
of buyers is moderately high. It also shows substitution between transportation modes is
low, but substitution within the airline industry is high.
Domestic vs. European Airline Carriers
Because the airline industry is subject to several influences, there are aspects that make the
U.S. market more appealing than international segments. The U.S. currently provides
39.7% of the global industrys value while Europe accounts for another 33.8% of the
industrys global value. Because Europe and the U.S. contribute so much of the global
airline market, it provides good information for investors to compare the two market
segments. For example, European airlines are besieged by “high oil prices, new safety
rules, environmental concerns, tax-for-aid, state aid restrictions, [and] passenger rights –
the pressure is piling up with no apparent policy co-ordination” (“As bankruptcy looms,”
2006). The European airlines “have had to compete in a far more complex, crowded
environment where flag-carriers have pushed for protectionist policies” (Boles, 2004).
Table 1. *
Region Passenger traffic RPK** million Passenger traffic RPK** change
Domestic USA 58,636 2.6%
North Atlantic 10,627 -2.9%
Latin America 4,169 3.9%
Trans Pacific 6,789 -3.3%
All International 21,584 -1.8%
Total Month 80,220 1.4%
* provided by Airline Business, December 2003
** RPK is an abbreviation for “revenue passenger kilometer.” It is one benchmark for
measuring airline size.
In spite of the intricate milieu, the growth in the European markets has been fantastic. In
1980, there were only five European Commission member airlines operating 16 aircraft.
Today, there are 70 airlines operating 1,300 aircraft. Passenger volume has increased from
58,000 passengers per year in 1980 to 83 million per year today. Once the catalyst for
