TABLE OF CONTENTS INTRODUCTION .......................................................................................................................... 1 STRENGTHS ................................................................................................................................. 1 Strong Customer Satisfaction ...................................................................................................... 1 Correlation of Customer Service Through Low Bag/Airport fees .............................................. 2 Historically Strong Financials and Leadership ........................................................................... 2 WEAKNESSES .............................................................................................................................. 2 Lack of Revenues from Non-passenger Operations .................................................................... 2 Dependent on Boeing as Sole Supplier ..................................................................................... . 3 OPPORTUNITIES .......................................................................................................................... 4 Strong Travel Growth Forecast ................................................................................................... 4 Exploiting the Acquisition of AirTran and Future Mergers ........................................................ 4 THREATS....................................................................................................................................... 5 Intensifying of Rivalry Due to Mergers and Acquisitions .......................................................... 5 FAA Regulations Increasing Costs in the Industry ..................................................................... 6 RECOMMENDATIONS ................................................................................................................ 7 Introduce Bag Fees ...................................................................................................................... 7 Emphasizing the Value of Flying Southwest During Transition ................................................ 8 Modernization of the Fleet & Cost Savings ................................................................................ 8 CONCLUSION ............................................................................................................................... 8 BIBLIOGRAPHY ........................................................................................................................... 9 ILLUSTRATIONS Figure 1 ....................................................................................................................................... 3 Figure 2 ....................................................................................................................................... 7 Executive Summary Southwest Airlines Prepared by Stephen Barton Southwest Airlines, founded in 1967 is the largest low fare airline domestically. In 2008, the airline industry was hit hard by the economic downturn. However, Southwest has reported a profit every year since the 1970’s while other airlines have declared or flirted with bankruptcy. Southwest’ management prowess has been key for growth and strategic decisions to gain market share and profitability. Within the past decade airlines across the industry have adopted bag fee policies to boost revenues. Our CEO, Bob Kelly recently stated that Southwest may charge baggage fees in the future. After in depth research, this report analyzes whether Southwest should follow suit with the industry or still maintain the policy of no bag fees for the 1st and 2nd checked bags. This report weighs the Strengths, Weaknesses, Opportunities, and Threats that face Southwest and recommendations to be implemented. Southwest’ business level strategy from inception has been a cost leadership strategy. The value that the customer receives from Southwest includes exceptional customer service, low fares, and a corporate culture that is fun and rubs off on the customer experience. These characteristics have created a strong brand image and a loyal customer base. The value customers have benefited from has earned Southwest a strong reputation and loyalty. The strengths that Southwest has include strong customer satisfaction, low bag/airport fees, and historically strong financial leadership in the industry. Weaknesses include lack of revenue from non-passenger operations, and dependence on a Boeing as the sole supplier of aircraft. Externally, Southwest has the opportunity to reap the benefits of a strong travel growth forecast, utilizing the acquisition of Airtran Airways, and potential future acquisitions to attain a stronger market share domestically. Threats that could hamper Southwest’ opportunity for growth include intensity of rivalry due to mergers and acquisitions, From this analysis, three recommendations should be considered and employed by upper management, namely introduction of bag fees, emphasizing value to customers during the policy change, and attaining potential cost savings and increased revenues through Boeing and USPS. The introduction of bag fees may initially cause customer dissatisfaction initially. However through a heavy marketing campaign to remind customers of the overall value and cost compared to competitors most will stay loyal. Southwest can still maintain a cost leadership strategy through opportunities such as a contract with Boeing for a new series of 737 aircraft that is significantly more fuel efficient than other aircraft. An additional revenue stream includes contracting through USPS to provide shipping. Overall our aircraft need to fly closer to capacity not only people wise, but packages as well. As the industry consolidates and becomes more competitive it is important to maintain our cost advantages through economies of scale with full aircraft. RECOMMENDATION REPORT: SOUTHWEST AIRLINES Prepared for: Southwest Airlines Executives Prepared by: Stephen Barton November 25, 2013 RECOMMENDATIONS Introduce Bag Fees Emphasizing the Value of Flying Southwest During Transition Modernization of the Fleet & Cost Savings CONCLUSION BIBLIOGRAPHY ILLUSTRATION Figure 1 Figure 2 1 Introduction Recently Bob Kelly, The CEO of Southwest Airlines has been contemplating the idea of joining the majority of the airline industry with adding bag fees in the near future. Southwest Airlines is in a crossroads as to whether or not to adopt this policy and the risks and benefits with going forward with this decision. Southwest Airlines’ internally has strong customer satisfaction, and a strong track record for profitability. However some internal weaknesses include the lack of revenues from non-passenger operations and a pending class action lawsuit from acquiring Tran Airlines. These weaknesses pose the risk of financial instability. Opportunities to alleviate current weaknesses and increase strengths are a strong travel growth forecast and utilizing the acquisition of Air Tran into new previously unreached markets. Potential threats that could hamper Southwest airlines expansion and growth include the intensifying of rivalry due to mergers and acquisitions in the industry, potential fuel price increases, and potential FAA regulations increasing costs in the industry. All of these threats adversely affect Southwest profit margins. In order to stay competitive in the airline industry and maintain a strong reputation among customers Southwest should institute bag fees that are lower than the competition based upon distance of flights and weight. Strengths Strong Customer Satisfaction Although increased competition has emerged Southwest Airlines has maintained a strong track record for customer satisfaction. Dr. Dean Headley’ 2013 Airline Quality Report reveals that Southwest ranks number eight for customer satisfaction (Forbes). Dr Headley compiled data from the U.S department of Transportation that analyzes the quality of each Airline on four factors. These factors include “On-time arrivals, denied boardings, mishandled bags, and customer complaints”(Forbes). These factors are essential to Southwest’ management to measure how well or poorly they are perceived. These reports are solid data that can support or diminish the validity of internal reports and forecasts. Southwest Airlines tested well above industry average on all of these factors except a mediocre 3.07 mishandled bags per 1,000 (Forbes). However, Southwest’ complaint rate of .25 people per thousand is substantially lower than industry averages. From analysis of airlines that scored higher than southwest there is a common finding. Most of those airlines fly in regional and smaller airports such as Frontier, Alaskan Airlines, and Air Tran Airways. Delta was the only high volume carrier that out performed Southwest from this report. http://southwest.investorroom.com/2013-11-12-Southwest-Airlines-Cargo-Honored-forOutstanding-Performance Highlights baggage handling awards 17 years in a row Correlation of Customer service through low bag/airport fees A reason why Southwest and other smaller airlines are able to charge lower or free bag fees is through a Cost Leadership business level strategy. Cost Leadership is enhanced by Southwest 2 and smaller airlines due to the fact they travel to smaller airports in close proximity to larger ones, yet avoid the higher costs due to taxes, and FAA fee’s. (Professor Paul Dowling Lecture) For example, in Houston, Texas where there are two commercial airports. The first is George W. International where large airlines such as Delta, and United Fly. Second is Hobby Airport where Southwest Flies along with the smaller airlines to utilize these lower taxes and fees. There is a very minor inconvenience in metropolitan areas such as Houston to fly to a smaller airport that is made up through the value realized by the customer through lower air fare prices. Maintaining excellent customer relationships are a competitive advantage that fuels Southwest’s cost leadership strategy in the industry. Part of this competitive advantage is due to the airline not charging bag fees. As stated above, most of the airlines that scored ahead of Southwest on quality also do not charge bag fees or we significantly lower than industry standards. For example, Jetblue ranked #2 in quality offers a 1st checked bag free policy. AirTran Airways ranks #3 and charges $20 for the 1st checked bag. Other larger airlines, who scored worse had a common denominator of average 1st bag fees, and expensive second and third bags. (Airlinebagfees) Historically Strong Financials and Leadership Southwest Airlines has consistently reported profits on the annual 10-k reports filed with the SEC since the 1970’s. No other airline can make this claim through economic downturns, fuel prices, and overall uncertainty in the industry (Dowling). Management has historically navigated these problems due to their capability to hedge these risks. Southwest’ management is valuable, rare, and hard for other airlines to imitate based upon performance. Southwest’ CEO Bob Kelly has successfully maintained a fun corporate culture where management and employees are happy with their employment. Employee enthusiasm and happiness makes them more effective performers to pass along that experience for travelers. David M. Ewalt, contributor, “America’s Best Airlines”, Forbes Magazine, 4/08/2013 Weaknesses Lack of revenues from non-passenger operations Southwest Airlines for fiscal year 2011 only received 5.9% of its’ income from operations not related directly to the passenger (datamonitor). Only a measly .9% of revenues come from bag fees. Southwest currently does not charge bag fees for the 1st and 2nd checked bags, and only $50 the third bag (Airline Bag Fees). Southwest’ stance of not charging bag fees hurts profitability for the company. A consequence of decreased revenue and profit margins creates uneasiness with stockholders who support operations with their capital. Other companies in the industry have realized billions of dollars in revenues that boost their profit margins while southwest’ are dwindling. According to the Department of Transportation bag fee revenues were $800 for the first quarter of 2013 (CNBC). Of that Amount Southwest received $42.7 million dollars due to either 3rd bag fees or oversized bags. The chart below illustrates bag fee revenue for this time period. 3 Bag Fee Revenues 1st quarter 2013. Obtained from CNBC.com “Airline Reservation and Bag Fees Soar Above $1 Billion” LeBeau, Phillip, 06/27/2013. Accessed 10/29/2013. http://www.cnbc.com/id/100850079 Dependent on Boeing as sole supplier One of the weakness that threatens Southwest Airlines is they only fly one type of plane from one supplier, Boeing. Southwest only flies a Boeing 737 due to perceived cost savings of only having to purchase parts and repair a single type of plane. The problem is however that Southwest doesn’t have relationships with other aircraft manufactures in case Boeing has issues of their own that could affect supply of planes or parts (datamonitor). By not diversifying their suppliers for their fleet, Southwest also faces the threat of competitors signing contracts with Boeing that could cut off or limit future supply. Southwest is trying to become a cost leader through this strategy but it is extremely risky. Student SWOT http://bus690-airlines.wikispaces.com/file/view/Airline+Industry-Southwest+Final+Paper.pdf Opportunities Strong travel growth forecast The Federal Aviation Administration recently forecasted airline travel domestically. In 2011 roughly 700 million people flew on domestic flights, and in 2032 they project 1.2 Billion 4 (Marketline). This forecast creates a strong opportunity for Southwest Airlines to attain a stronger market share. Management at Southwest needs to create a strategic plan and implement a strategy to exploit internal strengths and prey upon weaknesses of other firms. The issue of instituting bag fees as well as other internal policies within Southwest is important. Historically, managerial performance is an advantage for Southwest due to their ability to analyze and make decisions as evidenced by strong economic performance. From Southwest’ management capabilities there exists strong potential for rapid growth. In 2011, Southwest Airlines served approximately 100 million domestic passengers (Southwest). Based on the above FAA report and Southwest’ numbers they have 14% of the domestic market. As an example If Southwest can expand that market share to 20% by 2032 they can realize more efficient economies of scale through volume ticket sales. If southwest can expand domestic market share to 20% by 2032 with the FAA’s projections then Southwest’ annual domestic passenger flights would be 240 million. This increase of roughly 240% in passenger ticket sales outpaces the 171% growth projection for the industry. Exploiting the acquisition of AirTran and future mergers To gain market share as suggested above Southwest acquired AirTran Airways as a subsidiary in late 2011(Southwest). However the transition has not been a smooth one due to various lawsuits regarding AirTran’ contracts with companies that Southwest did away with. One example is AirTran’ contract with Gogo was abolished by Southwest after the merger, violating a contract. (Apex). Southwest was able to settle the claim, albeit time and costs to move on to incorporate the airline. Southwest can use this experience for future acquisitions so the transitions are smoother. Two years after the merger AirTran and Southwest are finally integrated in ways such as retrofitting of Airtran planes, connecting flights between the airlines, and fixing logistical issues to create a Southwest experience for AirTran flights. In regards to enacting bag fees, when Southwest chooses to merge with other companies in the future it is important to integrate the logistical issues and solve them so that customers bags are not lost. If Southwest and its’ subsidiaries can achieve this and maintain a customer service culture then they are more likely to enact bag fees without strong customer opposition. Bag fees are less likely to be a sticking point in the future as the industry consolidates and fewer alternative airlines can be chosen. http://blog.apex.aero/cabin-interior/southwest-replace-gogo-row-44-inflight-wifi-airtran-airwaysfleet/ Transition of airtran planes and retrofitting them to have the southwest experience. Threats Intensifying of rivalry due to mergers and acquisitions 5 Southwest is trying to create market share through mergers and acquisitions. However they are not alone in this method of acquiring market share. In early 2013 a proposed merger was blocked between American Airlines and US Airways (Dallas news). Joseph Alioto, lawyer in the lawsuit against the merger stated “This merger will result in nothing more than skyway robbery. It would complete the airline cartel, giving the top four airlines over 90% control of the airline industry in the US” (Dallas News). The threat of consolidation of the market would significantly hamper Southwest’ ability to obtain market share and be competitive. Recently, after completion of this recommendation report the American/US Airways merger has been approved by the Justice Department (dallas news). This is worrisome due to the government allowing potential monopolies in the industry. Southwest needs to either have a strong voice against mergers in the industry, or do it themselves. In order to grow as a company management needs to analyze this threat and counter with strategic moves. Another threat that a consolidated Airline industry could impose on Southwest Airlines is that larger firms can tacitly collude with one another. One such example is a large firm raises ticket fares to signal to other competitors to raise theirs as well to boost industry profits. Southwest’ cost leadership strategy may be strained to keep up with vast profits these firms garner. These large firms with higher profit margins could use the excess cash to upgrade aircraft, services, customer service, etc at a faster, more efficient rate than Southwest. If Southwest’ management tries to enact a bag fee policy to boost revenues, they could lose their niche of the cheap shopper in lieu of customers switching to one of the other large firms with better features or services realized from increased revenues. FAA regulations increasing costs in the industry A threat that looms across the entire industry, but hits Southwest harder is the Federal Aviation Administrations’ ability to change regulations. Since Southwest only flies one type of Aircraft, the Boeing 737, there is a greater risk of costs to fix potential problems with just one type of aircraft. The FAA on November 4, 2013 issued a new Airworthiness Directive for certain models of the 737 that Southwest flies. The directive was filed due to cracks found on certain components of the aircraft (FAA 11/4/13AD). As part of the directive to fix the problem Southwest as well as other Airlines “require repetitive...inspections for cracking of the skin around the eight fasteners..and corrective actions and preventive modification if necessary. We are issuing this AD to detect and correct fatigue cracking in the skin, which can result in rapid decompression of the cabin” (FAA 11/4/13AD) If there is a major problem with the 737’s that Southwest flies then their entire fleet would be affected. This could be devastating to the company, if just one 737 is seen to have a problem then an investigation can be started and the FAA has the power to make Southwest repair or inspect the entire fleet more thoroughly, drastically increasing costs. It would be a harder transition for Southwest than other airlines to obtain different types of aircraft from Boeing and other Aircraft manufacturers on a short term notice if there was a fatal flaw that can’t be easily fixed, or taken care of in a timely manner. 6 The above instance has not been felt on a drastic level as stated in the FAA report as follows. “AirTran/Southwest Airlines stated that the inspection threshold and intervals will fit within its planned scheduled maintenance checks… the number of man-hours… will not impact the overall span-time of its planned scheduled maintenance check. (FAA 11/4/13AD)” This directive, although not on a serious financial burden to Southwest and AirTran still poses the threat of future, labor intensive, and costly regulations the FAA enacts to maintain safety. The FAA is not limited to inspections of planes; they also have the power to increase taxes and fees at airports for customers, increasing costs for the airline industry. One such fee is called the Passenger Facility Charge, currently charging $4.50 to support the FAA’s mission to keep the public safe and administer policies and regulations (FAA PFC). Adverse conditions that affect the safety or security of airports could be significant costs for the Airline industry. Recommendations Introduce Bag Fees In order for Southwest to gain market share as the industry is consolidating, bag fees must be utilized to boost profits. For 2012, Southwest garnered only a 2.46% (Southwest 10-k) profit margin compared to the industry average of 3.7% (LA times). As stated earlier, Southwest currently flies around 100 million domestic passengers per year. If southwest charged $20 for the first and second checked bag for every passenger net income would have almost doubled from $421 to $821 million. Net profit margin would have increased from 2.46% to 4.8%, thus opening up more cash to finance expansion, acquisitions of future airlines, and services offered. Net Profit Margin 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Industry Average Proposed fees Southwest Airlines 1st bag fee $20 Southwest 2012 2nd bag fee $20 Southwest 2012 w/ bag fees Net increase in revenue $400,000,000 7 Bag fly free 500 miles or less A small, yet significant portion of Southwest’s market includes short hop flights of 500 miles or less. Many of these customers fly frequently on business trips in between destinations such as Dallas, Houston, and San Antonio. In order to reduce the threat of substitute methods of transportation such as driving or rail, Southwest should make an exception for fees on these types of flights. This niche market is price sensitive and would be adversely affected by bag fees. These short flights of 500 miles or less are typically $69-$99 each way. If a passenger was charged $20 per bag then Southwest would lose customers to competitors or alternate methods of transportation. As an example, a one way flight from Dallas to San Antonio, Texas on December 24th is $69. If a customer drove it would be about a five hour, 275 mile trip. Assuming the customer got 25 miles per gallon, and $3.20 per gallon for gas the cost of driving would be about $35. If customers were charged $20 per bag on this flight, many would walk away from Southwest. The price sensitivity of these types of customers is too strong. The selling point of these short flights is the convenience. Customers with flights over 500 miles are less likely to choose alternate airlines, or other methods of transportation due to bag fee charges. Use of bag fees revenue for future acquisitions Southwest reported $132 million in acquisition and integration expenses for AirTran in 2011, and $183 million in 2012 (Southwest 10k). Investment in acquisitions is capital intensive and takes time to utilize new assets effectively. As part of the learning curve, management will be able to handle more frequent acquisitions if the capital is there. Bag fees will be a major benefit in achieving the goal of obtaining more market share in a high growth industry projected over the next twenty years. As the industry continues to consolidate, airlines will become more competitive. Delta and JetBlue will have to follow suit in the near future with adding bag fees or focus on niche markets. With the recent announcement of the US/American airways merger Acquisitions for Southwest are more important. The competitive environment in the domestic flight industry will become an oligopoly in the near future. Emphasizing the Value of Flying Southwest During Transition The initial effect of introducing bag fees is losing a small portion of consumers that are sensitive to this subject. Some of these customers may switch loyalties to JetBlue or Delta, who still offer a free first bag. However, extensive marketing will remind customers that it is still cheaper to fly on Southwest then at competing airlines. In order to maintain a large customer base, marketing expenditures should increase by 50% for the upcoming year. The marketing messages to customers should be sensitive and involve careful planning to maintain customer relations. A key part of the marketing message should involve Southwest winning the 2013 Quest for Quality award (Southwest Investor room) for the 17th year in a row. This award highlights Southwest’ Logistical expertise for handling luggage, and will be a powerful tool to help 8 alleviate customer disdain over the added baggage fees. Customers with flights over 500 miles will be less price sensitive to the price increase than shorter flights. (statistics on average cost per flight compared across companies?) Modernization of the Fleet & Cost Savings Strong relationships with Boeing yield the potential of cutting costs. In 2017 Southwest will receive 150 new Boeing 737MAX’s with 10-11% better emissions than any other like aircraft on the market (10k pg 49). New, fuel efficient aircraft can become a source of competitive advantage over competitors. In 2012, $6.12 billion was spent on fuel (10k pg47). As the fleet is updated with industry leading fuel efficient aircraft, Southwest will save hundreds of millions of dollars a year. These cost savings benefits are an advantage in the short term until other airlines catch up. Relationships with Boeing and attaining more fuel efficient aircraft will save Southwest over $500 million over the next five years (aviation week). The extra capital saved over the short term will be an added buffer to support the marketing efforts for the upcoming year. Also, Southwest is upgrading their fleet along with Airtran to enhance customer comfort and satisfaction. These upgrades will keep be effective for the next few years until the new aircraft arrives. CEO Bob Kelly emphasizes a newer fleet by saying that the fleets’ age should be 8-9 years. Bob Kelly’s stance of a modern fleet will boost the overall image and value of flying Southwest. http://www.aviationweek.com/Article.aspx?id=%2Farticle-xml%2Favd_05_16_2013_p01-01579390.xml Create Revenue through Strategic Alliance with USPS To boost revenue and have full aircraft, Southwest needs to develop a relationship with USPS to provide support with the superior logistical and package handling services it has to offer. Because of a strong track record for logistics over the past two decades, Southwest needs to utilize this potential strategic advantage and offset the weakness of relying on most of its revenues from passengers. A goal by 2018 should be to increase non-passenger revenues from 5% to 15% over five years. Over the first two years, Southwest needs to negotiate with USPS on a small scale. After two years of success in limited markets USPS will expand their relationship with Southwest on a larger scale. It is important for Southwest to hire experienced management with knowledge carry out this expansion and viability of this potential revenue stream. Conclusion Obstacles and opportunities face the future of Southwest Airlines in a volatile industry, affected by economic downturns and overall uncertainty. Through careful analysis and implementing the strategies of enacting bag fees and maintaining customer loyalty, Southwest can fiscally be able to expand and develop cost saving opportunities. The opportunity of obtaining a fuel efficient 9 fleet through Boeing minimizes the expenditures of fuel, and savings can be passed on to customers where other airlines can’t compete on. Through continued excellence of the managerial prowess Southwest has enjoyed, these strategies, as well as unforeseen opportunities will be exploited to create value for the customer Aero News Network, “Southwest CEO Says Baggage Fees may be In The Airline’s Future”, 10/29/2013, http://www.aero-news.net/index.cfm?do=main.textpost&id=89cc30c5-4dc9-4d288a82-e1cb9b27d15e, accessed on 10/30/2013 Dallas News “Merger Opponents file lawsuit to block American Airlines US Airways “Marraigehttp://aviationblog.dallasnews.com/2013/07/merger-opponents-file-lawsuit-to-blockamerican-airlines-us-airways-marriage.html/?nclick_check=1 Southwest Airlines Airtran Airways Start Connecting Flights http://www.dallasnews.com/business/airline-industry/20130218-southwest-airlines-airtranairways-start-connecting-flights.ece final transition of airtran in feb 2013. 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