09 southwest air

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Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.

Southwest Airlines2011

Forest David

A. Case Abstract

Southwest Airlines is a comprehensive strategic management case that includes the companys year-end

2010 financial statements, organizational chart, competitor information and more. The case time setting is

the year 2011. Sufficient internal and external data are provided to enable students to evaluate current

strategies and recommend a three-year strategic plan for the company. Headquartered in Dallas, Texas,

Southwests common stock is publicly traded under the ticker symbol LUV.

Southwest Airlines operates only Boeing 737s and let passengers sit anywhere they like as long as they get

there first. Southwest has expanded its low-cost, no-frills, no-reserved-seats approach to air travel

throughout the US to serve almost 70 cities in more than 35 states. Now among the leading US airlines,

Southwest still stands as an inspiration for scrappy low-fare upstarts the world over. The carrier has

enjoyed 38 straight profitable years, amid the airline industry's ups and downs. Southwest's

fleet numbers about 550 aircraft. The company acquired AirTran Holdings, the parent company of AirTran

Airways, in May 2011 for about $3.2 billion.

B. Vision Statement(proposed)

To become the number one airline in market share in the world.

C. Mission Statement(proposed)

At Southwest we hire innovative people (9) dedicated to delivering and growing (5) the best domestic and

international (3) flying (2) and working experience in terms of safety and service (self 7, 6) to our

employees and smart travelers (1). Striving every day to keep our promise of not only safety and customer

service (8), but also leaving a small footprint in the environment through advances in mechanical

technology (4) everyday.

1. Customers2. Products or services3. Markets4. Technology5. Concern for survival, growth, and profitability6. Philosophy7. Self-concept8. Concern for public image9. Concern for employees


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D. External Audit

Opportunities

1. According to World Travel and Tourism Council, world travel and tourism is expected to grow 4.3%annually.

2. Down cycle of economy has increased potential profit because people are more cost sensitive.3. Lower interest rates.4. Year-to-date 2010 travel stats for industry show passenger revenues rose 7.3%.5. Oil prices have dropped from $150 a barrel to under $100 a barrel.6. Regional jets have transformed short haul markets previously abandoned by major airlines.7. Repeal of the Wright Amendment.8. ATA Domestic Code-Sharing Agreement.9. Cancun, Mexico, and the Caribbean markets, accessible from AirTran merger, offer first international

opportunities.

Threats

1. Fuel accounted for 26% of revenues in 2010.2. Mergers among the largest airlines.3. Delta announced that it would add or expand service to 36 cities for NYC flying from both JFK and

LaGuardia.

4. Continued threat to industrys human relations concerning displeasure over carbon dioxide emissions.5. In 2010, labor accounted for 25% of revenues.6. Cost of investment in sophisticated satellite-based GPS Technology has halted replacement of outdated

air traffic control systems, thus forecasting congestion problems to continue.

7. Security measures implemented in airports since 9/11 have made flying less convenient and less idealfor travelers.

8. Fees on airlines for keeping passengers on the tarmac for extended periods of time.9. Internet has led to more competitive pricing and more price sensitivity to industry.10. Many new carriers have adopted Southwests model.Competitive Profile Matrix

Weight Rating Score Rating Score Rating Score

0.08 4 0.32 3 0.24 2 0.16

0.08 2 0.16 3 0.24 4 0.32

0.05 4 0.20 1 0.05 2 0.10

0.10 2 0.20 3 0.30 4 0.40

0.05 1 0.05 4 0.20 3 0.15

0.05 3 0.15 1 0.05 2 0.10

0.12 3 0.36 4 0.48 2 0.24

0.11 4 0.44 2 0.22 1 0.11

0.10 2 0.20 3 0.30 4 0.40

0.07 2 0.14 3 0.21 4 0.28

0.07 4 0.28 3 0.21 2 0.14

0.12 4 0.48 2 0.24 1 0.12

1.00 2.98 2.74 2.52

Financial Profit

Advertising

Market Penetration

Customer Service

Airports Used

Business Class

Totals

Price Competitivenes s

Customer Loyalty

Market Share

Product Quality

Top Management

Critical Success Factors

Southwest Delta UAL

Employee Dedication


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EFE Matrix

E. Internal AuditStrengths

1. 38 consecutive years reporting positive net income.2. Airtran merger provides access to the busiest airport domestically- HJI in Atlanta.3. Multi-functional and interactive website competes favorably to competitive pricing and demand.4. Fly to more than 100 airports.

Opportunities Weight Rating Weighted Score

1. According to World Travel and Tourism Council, world travel

and tourism is expected to grow 4.3% annually.

0.05 3 0.15

2. Down cycle of economy has increased potential profit because

people are more cos t sens itive.

0.06 3 0.18

3. Lower interest rates. 0.07 4 0.28

4. Year-to-date 2010 travel stats for industry show passenger

revenues rose 7.3%.

0.06 3 0.18

5. Oil prices have dropped from $150 a barrel to under $100 a barrel. 0.03 2 0.06

6. Regional jets have transformed short haul markets previously

abandoned by major airlines.

0.05 2 0.10

7. Repeal of the Wright Amendment. 0.04 3 0.12

8. ATA Domestic Code-Sharing Agreement. 0.04 3 0.12

9. Cancun, Mexico, and the Caribbean markets, accessible from

AirTran merger, offer first international opportunities.

0.03 4 0.12

Threats Weight Rating Weighted Score

1. Fuel accounted for 26% of revenues in 2010. 0.10 1 0.10

2. Mergers among the largest airlines. 0.05 1 0.05

3. Delta announced that it would add or expand service to 36 cities

for NYC flying from both JFK and LaGuardia.0.02 2 0.04

4. Continued threat to indus trys human relations concerning

displeasure over carbon dioxide emissions .0.03 2 0.06

5. In 2010, labor accounted for 25% of revenues. 0.10 2 0.20

6. Cost of investment in sophisticated satellite-based GPS

Technology has halted replacement of outdated air traffic

control systems, thus forecasting congestion problems to

continue.

0.03 2 0.06

7. Security measures implemented in airports since 9/11 has made

flying less convenient and less ideal for travelers.0.04 2 0.08

8. Fees on airlines for keeping passengers on the tarmac for

extended periods of time.0.05 4 0.20

9. Internet has led to more competitive pricing and more price

sensitivity to industry.0.05 3 0.15

Many new carries have adopted Southwest's model. 0.10 2 0.20

TOTALS 1.00 2.45


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5. Company was able to stimulate a significant amount of demand through fare sales, through its BagsFly Free advertising campaign.

6. Low cost structure relative to large carriers.7. Operational efficiencies relative to large and low-cost carriers.8. High number of established, high frequency discount routes.9. Merger with AirTran Holdings Inc.10. Southwest plans to add as many as 200 pilots and 300 flight attendants in 2011.Weaknesses

1. As a result of a significant decline in fuel prices at the end of 2008, the Company significantly reducedits net fuel hedge position in place for 2009 through 2013, leaving it with less protection against futureincreases.

2. Credit rating recently downgraded from a BBB+ to a BBB, based on lower demand, especiallyamong business travelers, and continued volatility in fuel prices.

3. Execution of Freedom 09 resulted in a one-time charge of $66 million creating to offset capacityreduction in 2009.

4. Aircraft type versus long trans-continental routes limits market growth and potential revenues.5. Most of the employees are members of the employee union, who are responsible for spikes in labor

costs.6. It has not offered any segmented seating (business class or 1st class seating arrangement).7. A minority of its tickets are purchased through agents.8. Addition of 86 Boeing 717s through AirTran merger abandons its single jet type strategy aimed

towards cutting maintenance and training costs.9. Merger with AirTran creates overlap in on 32 markets, more than twice as many as United-Continental

merger.

Financial Ratio Analysis

Growth Rate Percent Southwest Industry S&P 500

Sales (Qtr vs year ago qtr) 35.10 24.80 14.50

Net Income (YTD vs YTD) NA NA NA

Net Income (Qtr vs year ago qtr) -168.30 -47.60 48.60Sales (5-Year Annual Avg.) 9.80 13.50 8.30

Net Income (5-Year Annual Avg.) -1.06 12.07 8.72

Dividends (5-Year Annual Avg.) 0.00 9.45 5.61

Profit Margin Percent

Gross Margin 18.4 25.2 39.5

Pre-Tax Margin 1.9 7.5 18.2

Net Profit Margin 1.1 6.0 13.2

5Yr Gross Margin (5-Year Avg.) 22.6 26.0 39.7

Liquidity Ratios

Debt/Equity Ratio 0.65 0.70 0.98

Current Ratio 0.9 1.0 1.3

Quick Ratio 0.8 0.9 0.9

Profitability Ratios

Return On Equity 2.5 17.2 26.0

Return On Assets 1.0 4.6 8.8

Return On Capital 1.3 6.2 11.8

Return On Equity (5-Year Avg.) 6.2 16.7 23.8

Return On Assets (5-Year Avg.) 2.6 4.3 8.0


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Return On Capital (5-Year Avg.) 3.3 5.9 10.8

Efficiency Ratios

Income/Employee 4,498 28,998 126,792

Revenue/Employee 420,160 425,198 1 Mil

Receivable Turnover 42.3 43.0 15.2

Inventory Turnover 32.9 261.1 12.4

Net Worth Analysis (in millions)

IFE Matrix

Stockholders' Equity 6,237.00$

Net Income x 5 2,295.00$

(Share Price/EPS) x Net Income 17,857.29$

Number of Shares Outs tanding x Share Price 6,356.26$

Method Average 8,186.39$

Strengths Weight Rating Weighted Score1. 38 consecutive years reporting positive net income. 0.07 4 0.28

2. Airtran merger provides access to the busiest airport

domestically- HJI in Atlanta.0.04 4 0.16

3. Multi-functional and interactive website competes favorably to

competitive pricing and demand.0.04 4 0.16

4. Fly to more than 100 airports. 0.05 4 0.20

5. Company was able to stimulate a significant amount of demand

through fare sales, through its Bags Fly Free advertising

campaign.

0.05 4 0.20

6. Low cost structure relative to large carriers. 0.04 4 0.16

7. Operational efficiencies relative to large and low-cost carriers. 0.05 4 0.20

8. High number of established, high frequency discount routes. 0.04 4 0.169. Merger with AirTran Holdings Inc. 0.10 4 0.40

10. Southwest plans to add as many as 200 pilots and 300 flight

attendants in 2011.0.07 4 0.28


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F. SWOT

SO Strategies

1. Expand into 10 new airports along the East Coast (S4, S6, O6).2. Hire a marketing research firm to determine when to offer the lowest rates and when higher rates can

be charged (S5, S6, S7, S8, O2, O6).

WO Strategies

1. Reduce overlap in the 32 markets acquired in the AirTran merger (W9, T6).2. Increase fuel hedge to protect against rising fuel costs (W1, O5).ST Strategies

1. Continue to let bags fly free and offer free refreshments on all flights (S5, S6, S7, S8, T10).WT Strategies

1. Increase fuel hedge to protect against rising fuel costs (W1, T1).

Weaknesses Weight Rating Weighted Score

1. As a result of a significant decline in fuel prices at the end of

2008, the Company significantly reduced its net fuel hedge

pos ition in place for 2009 through 2013, leaving it with less

protection against future increases.

0.06 2 0.12

2. Credit rating recently downgraded from a BBB+ to a BBB,

based on lower demand, especially among busines s travelers,

and continued volatility in fuel prices.

0.07 1 0.07

3. Execution of Freedom 09 resulted in a one-time charge of $66

million creating to offset capacity reduction in 2009.0.04 2 0.08

4. Aircraft type versus long trans -continental routes limits market

growth and potential revenues.0.05 1 0.05

5. Most of the employees are members of the employee union, who

are responsible for spikes in labor costs .0.10 1 0.10

6. It has not offered any segmented seating (business class or 1st

class seating arrangement).0.02 1 0.02

7. A minority of its tickets are purchased through agents. 0.02 2 0.04

8. Addition of 86 Boeing 717s through AirTran merger abandonsits single jet type strategy aimed towards cutting maintenance

and training costs .

0.04 1 0.04

9. Merger with AirTran creates overlap in on 32 markets, more than

twice as many as United-Continental merger.0.05 2 0.10

TOTALS 1.00 2.82


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G. SPACE Matrix

7

6

5

4

3

2

1

-7 -6 -5 -4 -3 -2 -1 1 2 3 4 5 6 7-1

-2

-3

-4

-5

-6

-7

IPCP

Defensive

AggressiveConservativeFP

CompetitiveSP

Internal Analysis: External Analysis:

Financial Position (FP) Stability Position (SP)

1 -2

1 -3

4 -2

3 -6

4 -3

Financial Position (FP) Average 2.6 Stability Position (SP) Average -3.2

Rate of Inflation

Technological Changes

Price Elasticity of Demand

Competitive Pressure

Barriers to Entry into Market

Return on Equity (ROE)

Return on As sets (ROA)

Debt/Equity Ratio

Gross Margin

Current Ratio

Internal Analysis: External Analysis:

Competitive Position (CP) Industry Position (IP)-3 4

-3 5

-1 3

-3 5

-5 5

Competitive Position (CP) Average -3.0 Industry Position (IP) Average 4.4

Growth Poten tial

Financial Stab ility

Ease of Entry into Market

Resource Utilization

Profit Potential

Market Share

Product Quality

Customer Loyalty

Technological know-how

Control over Suppliers and Distributors


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H. Grand Strategy Matrix

Southwest

Strong

Competitive

Position

Slow Market Growth

Weak

Competitive

Position

Quadrant III Quadrant IV

Rapid Market Growth

Quadrant II Quadrant I


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J. QSPM

Opportunities Weight AS TAS AS TAS

1. According to World Travel and Tourism Council, world travel

and tourism is expected to grow 4.3% annually.0.05 4 0.20 2 0.10

2. Down cycle of economy has increased potential profit because

people are more cos t sens itive.0.06 3 0.18 2 0.12

3. Lower interest rates. 0.07 4 0.28 2 0.14

4. Year-to-date 2010 travel stats for industry show passenger

revenues rose 7.3%.0.06 3 0.18 2 0.12

5. Oil prices have dropped from $150 a barrel to under $100 a barrel. 0.03 2 0.06 4 0.12

6. Regional jets have transformed short haul markets previouslyabandoned by major airlines.

0.05 0 0.00 0 0.00

7. Repeal of the Wright Amendment. 0.04 0 0.00 0 0.00

8. ATA Domestic Code-Sharing Agreement. 0.04 0 0.00 0 0.00

9. Cancun, Mexico, and the Caribbean markets, accessible from

AirTran merger, offer first international opportunities.0.03 4 0.12 2 0.06

Increase fuel

hedge

Expand into

10 new

airports

Threats Weight AS TAS AS TAS

1. Fuel accounted for 26% of revenues in 2010. 0.10 2 0.20 4 0.40

2. Mergers among the largest airlines. 0.05 0 0.00 0 0.00

3. Delta announced that it would add or expand service to 36 cities

for NYC fl in from both JFK and LaGuardia.0.02 4 0.08 2 0.04

4. Continued threat to indus trys human relations concerningdispleasure over carbon dioxide emissions.

0.03 0 0.00 0 0.00

5. In 2010, labor accounted for 25% of revenues. 0.10 0 0.00 0 0.00

6. Cost of investment in sophisticated satellite-based GPS

Technology has halted replacement of outdated air traffic

control systems, thus forecasting congestion problems to

continue.

0.03 0 0.00 0 0.00

7. Security measures implemented in airports since 9/11 has made

flying less convenient and less ideal for travelers.0.04 0 0.00 0 0.00

8. Fees on airlines for keeping passengers on the tarmac for

extended periods of time.0.05 0 0.00 0 0.00

9. Internet has led to more competitive pricing and more price

sensitivity to industry.0.05 0 0.00 0 0.00

10. Many new carries have adopted Southwest's model. 0.10 4 0.40 2 0.20


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Strengths Weight AS TAS AS TAS

1. 38 consecutive years reporting positive net income. 0.07 0 0.00 0 0.002. Airtran merger provides access to the busiest airport

domestically- HJI in Atlanta.0.04 4 0.16 2 0.08

3. Multi-functional and interactive website competes favorably to

competitive pricing and demand.0.04 0 0.00 0 0.00

4. Fly to more than 100 airports. 0.05 4 0.20 1 0.05

5. Company was able to stimulate a s ignificant amount of demand

through fare sales, through its Bags Fly Free advertising

campaign.

0.05 0 0.00 0 0.00

6. Low cost structure relative to large carriers. 0.04 1 0.04 3 0.12

7. Operational efficiencies relative to large and low-cost carriers. 0.05 0 0.00 0 0.00

8. High number of established, high frequency discount routes. 0.04 3 0.12 1 0.04

9. Merger with AirTran Holdings Inc. 0.10 4 0.40 1 0.1010. Southwest plans to add as many as 200 pilots and 300 flight

attendants in 2011.0.07 4 0.28 1 0.07

Expand into

10 new

airports

Increase fuel

hedge

Weaknesses Weight AS TAS AS TAS

1. As a result of a significant decline in fuel prices at the end of

2008, the Company significantly reduced its net fuel hedge

position in place for 2009 through 2013, leaving it with less

protection against future increases.

0.06 1 0.06 4 0.24

2. Credit rating recently downgraded from a BBB+ to a BBB,

based on lower demand, especially among bus iness travelers,

and continued volatility in fuel prices.0.07 0 0.00 0 0.00

3. Execution of Freedom 09 resulted in a one-time charge of $66

million creating to offset capacity reduction in 2009.0.04 0 0.00 0 0.00

4. Aircraft type versus long trans-continental routes limits market

rowth and otential revenues.0.05 0 0.00 0 0.00

5. Most of the employees are members of the employee union, who

are respons ible for spikes in labor costs .0.10 0 0.00 0 0.00

6. It has not offered any segmented seating (business class or 1st

class seating arrangement).0.02 0 0.00 0 0.00

7. A minority of its tickets are purchased through agents. 0.02 0 0.00 0 0.00

8. Addition of 86 Boeing 717s through AirTran merger abandons

its s ingle jet type s trategy aimed towards cutting maintenance

and training costs.

0.04 4 0.16 1 0.04

9. Merger with AirTran creates overlap in on 32 markets, more than

twice as many as United-Continental merger.0.05 2 0.10 1 0.05

TOTALS 3.22 2.09


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K. Recommendations

1. Expand into 10 new airports along the East Coast at cost of $150M.2. Hire a marketing research firm to determine when to offer the lowest rates and when higher rates can

be charged at cost of $20M.

3. Reduce overlap in the 32 markets acquired in the AirTran merger at cost of $20M.4. Increase fuel hedge to protect against rising fuel costs at cost of $50M

L. EPS/EBIT Analysis(in millions)

Amount Needed: $240MStock Price: $7.64Shares Outstanding: 778Interest Rate: 5%Tax Rate: 38%

M. Epilogue

Southwest Airlines third quarter 2011 results revealed a net loss of $140 million compared to net income

of $205 million for third quarter 2010. The companys operating income was $225 million for Q3 2011,

compared to $355 million for Q3 2010. The companys Q3 operating revenues reached an all-time

quarterly record of $4.3 billion. Passenger revenues were driven by strong load factors, revenue yields, and

unit revenues, which were all third quarter records. Third quarter passenger unit revenues increased

approximately six percent, compared to third quarter last year. Also, the companys Q3 2011 Other

revenues grew approximately 18 percent, compared to Q3 last year, largely due to the All-New Rapid

Rewards program and continued growth in the EarlyBird Check-In revenues.

Recessio n Normal Boo m Recessio n Normal Boo m

EBIT $300 $1,000 $2,000 $300 $1,000 $2,000

Interest 0 0 0 12 12 12

EBT 300 1,000 2,000 288 988 1,988

Taxes 114 380 760 109 375 755

EAT 186 620 1,240 179 613 1,233

# Shares 782 782 782 778 778 778

EPS 0.24 0.79 1.59 0.23 0.79 1.58

Common Stock Financing Debt Financing

20 Percent Stock 80 Percent Stock

Recessio n Normal Boo m Recessio n Normal Boo m

EBIT $300 $1,000 $2,000 $300 $1,000 $2,000

Interest 10 10 10 2 2 2

EBT 290 990 1,990 298 998 1,998

Taxes 110 376 756 113 379 759

EAT 180 614 1,234 185 619 1,239

# Shares 779 779 779 781 781 781

EPS 0.23 0.79 1.58 0.24 0.79 1.59


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AirTran became a wholly-owned subsidiary of Southwest Airlines on May 2, 2011. Southwests total

operating revenues for Q3 2011 increased 35.1 percent to $4.3 billion, compared to $3.2 billion for Q3

2010. Operating unit revenues increased 3.6 percent, compared to third quarter 2010. Operating unit

revenues increased 6.7 percent from third quarter 2010's combined unit revenues.

Operating income for Q3 2011 was $225 million, compared to $355 million in third quarter 2010.

Excluding special items in both periods, operating income was $285 million for Q3 2011, compared to

$389 million for third quarter 2010, and compared to $447 million for Q3 2010 on a combined basis.

Southwests total operating revenues for the nine months ended September 30, 2011 increased 28.5 percent

to $11.6 billion, while total operating expenses increased 33.9 percent to $11 billion, resulting in operating

income of $546 million, versus $772 million for the comparable period in 2010. The companys net

income for the nine months ended September 30, 2011 was $26 million, or $.03 per diluted share,

compared to $328 million, or $.44 per diluted share, for the same period last year.

Southwests passenger revenues jumped 32 percent y-o-y in Q3 2011 with over 60 percent growth coming

from AirTrans results. The airline witnessed strong passenger demand during Q3 with no softening in

business travel, which helped implement fare hikes. Also during Q3, Southwests Rapid Rewards program

was revamped in favor of expenditure-based earnings system where points are awarded based on the

amount of money spent on the carrier rather than the miles flown as in the earlier system. The improved

program contributed to revenues by increasing business partner income as well as the premium in fares

paid by Rapid Rewards members. Southwest is also enjoying excellent results from its EarlyBird product,

which allows customers to automatically obtain a reserved boarding position before general check-in

begins and has recorded over $100 million in revenues, year-to-date.

09 southwest air

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