Download Session 8 Southwest

Southwest
James Oldroyd
Kellogg Graduate School of Management
Northwestern University
[email protected]
801-422-7888
650 TNRB
Where would you recommend?
Baltimore
Detroit or
Dayton?
1
Years of Profitability Since 1938
Cumulative Net Profit of Scheduled US Airlines:
1970 – 2.2 billion profit
1980 – 5.8 billion profit
1989 – 8.2 billion profit
1997 – 5.4 billion profit
1998 – 10.3 billion profit
1999 – 15.6 billion profit
2000 – 18.1 billion profit
2001 – 12 billion profit
8 Years out of 64
Years
UGLY!
2
World’s Largest Airlines
1. AMR
2. UAL
3. Delta
4. JAL
5. Lufthansa
6. British Airways
7. All Nippon Airways
8. Northwest Airlines
9. Continental Airlines
10. Air France
3
Stock Performance
4
The Relationship between Price and
Cost
Cost/Unit (Constant Dollars)
EXPERIENCE CURVES COMPANY PROFITABILITY)
Industry
Price
A
B
C
Cost
Accumulated Experience (units of experience)
•
Different companies within an industry will have similar prices but will
have accumulated different amounts of experience
Predictable Unit Cost Differences
Predictable Profitability Differences
5
American’s Volume Advantage?
Costs
American
Cost
Southwest
Time
Advantage for
American
Cost Per Industry
Unit
Price
Cost
Disadvantage
For Southwest
Number of Units
American Has First Mover Advantage and
Crosses into Profitability First.
6
Why don’t we
see the results
we expect?
How does Southwest do it?
7
Correct Measures
Number of Aircraft?
Number of Employees?
Number of Flights?
Number of Passengers?
Number of Destinations?
8
Where are the Majority of
Southwest’s Costs?
Where are Majority of
Honda’s Costs?
9
Costs 2001 Airlines
Fourth Quarter 2001
(Source: DOT Form 41)
LABOR (Passenger / Cargo)
Index
(1982 =
100)
% Change
Yr/Yr
(Same
Quarter)
% Change
Qtr/Qtr
(@ Annual
Rates)
Share of Total
Op. Expense
(%)
183.0
2.1
12.9
36.4
68.3
(23.2)
(49.2)
11.0
290.1
9.2
40.7
11.8
51.4
(4.1)
20.3
2.7
INSURANCE
129.4
233.0
576.5
1.0
MAINTENANCE MATERIAL
163.0
(20.8)
(42.4)
2.4
LANDING FEES
215.1
12.7
24.2
2.1
54.5
(30.0)
(13.9)
2.3
161.5
17.9
49.0
1.6
49.0
(13.7)
(22.0)
0.9
PASSENGER FOOD
104.5
(3.7)
(8.6)
2.2
ALL OTHER COSTS
165.7
1.8
(0.3)
25.7
COMPOSITE
154.6
(0.5)
0.2
100.0
FUEL
AIRCRAFT FLEET
INTEREST
TRAFFIC COMMISSIONS
COMMUNICATION
ADVERTISING & PROMOTION
10
What does your chart
look like?
Profits
Market Share
11
Measuring Success
Airline Profitability
Profitability = [yield X load factor] - cost
In order to survive and profit in this tough environment,
airlines attempt to manipulate three main variables:
Cost, calculated as total operating expenses divided by available seat
miles (ASM)
Yield, calculated as total operating revenues divided by the number of
revenue passenger miles (RPM)
Load Factor, calculated as the ratio between RPMs and ASMs, which
measures capacity utilization.
12
Southwest Airline’s Focus
CEO
Herb Kelleher, a Connecticut attorney turned Texan,
had the best labor relations in the industry and an excellent
company culture.
Company
vision was to provide low cost airline service to an
increasingly larger number of people.
Lowest
cost structure in the industry.
Objective
to minimize reservation costs.
13
Wal-mart’s Distribution Model
A key to their success
Airlines use the same model.
Does this make sense?
14
Point to Point Vs. Hub and Spoke
Southwest
The National Carriers
VS.
Commuter
airline that concentrates on city pairs. (Average
flight is 400 miles or less and takes less than one hour)
15
COST ADVANTAGE AT SOUTHWEST
“Airlines don’t have revenue problems, they have cost problems.” Southwest.
Conventional Strategy: Meals, pre-assigned seats, membership in airline
reservation system, travel agents, and hub & spoke system
are key to success.
Southwest Strategy:
Sales/Marketing
• Offer direct flights to busy
cities of less than 500 miles
• No pre-assigned seats
• Little reliance on travel
agents (saves 5-10%)
• Snacks rather than meals
• Prices 20-50% lower than
the competition
Lowest cost operations and lowest prices.
Operations
• Fly only Boeing 737s
(smallest, most fuel efficient craft)
• Train pilots & mechanics only on
737s
• Fly to cheaper, less congested
airports (i.e. Love Field Dallas;
Midway, Chicago)
• Don’t transfer baggage to other
airlines
• Fast turnaround of aircraft
(20 minutes vs. 50 minutes
for industry)
Human Resource Mgmt.
• Initially non-union, now
partially union labor
• Cross training, flexible
workforce
• Employees receive same
pay per job hour
regardless of location
(low turnover overall but
accept high turnover in
high cost areas; i.e. Calif.)
COST ADVANTAGE AT SOUTHWEST
CONTINUED…
• Airfares in Southwest markets are roughly 25 percent lower than in
non-Southwest markets.
• Southwest has an average 65 percent marketshare compared with
less than 40 percent for other airlines in their top 100 markets.
• Unit costs of other airlines are 50-60 percent higher than Southwest’s,
except for America West with unit costs that are 20 percent higher.
•Southwest has been the most profitable U.S. airline from 1980-1995.
Source: U.S. Dept. of Transportation
Southwest Profitability vs Industry:
1988-1996
10
5
0
-5
PanAm
TWA
USAir
Continental
Delta
United
Northwest
-15
American
-10
Southwest
Operating
profit as
a percent
of sales
United Flight 815- Chicago to LA
Oct 31, 2000
204 tickets were sold and 186 people showed up.
68 passengers originated in Chicago and 118 were from
connecting flights.
97 passengers terminated at LAX, 89 continued on another
flight.
Of the 33 passengers that were only Chicago-LAX there were 27
different fares:
• A frequent flyer passenger paid nothing.
• A 1st class passenger paid $1,248.51 on the day of the flight.
• A coach passenger paid $102.26 on the day of the flight.
• A cash fare passenger paid $87.21 twenty-nine days in advance .
19
Quiz - No Need to Discount?
What % of
Customers fly
at discounts
above 60% of
listed prices?
> 90%
20
Industry Problems – Not Labor Costs
Sadly, many in the industry misidentify the cause of their firms'
inability to deliver services at affordable prices, that can attract and
hold the new demand. Those in denial label as a "labor cost problem"
what is in truth structural inefficiency. It is the low-hanging fruit of
wage rates and work rules that gets all their attention, when it is
structural change that offers the greatest leverage on success.
Southwest Airlines is a highly profitable, heavily unionized and among
the highest-paying airlines. Paradoxically, Southwest is also the
industry's acknowledged low-cost producer and its unabashed price
leader. It is Southwest's business strategy and operating structure
that produces these very affordable, easily marketed costs.
Traditional work rules and above-market wage rates do not interfere
with Southwest's ability to compete in and grow the markets they
serve. Their employees are recognized for their contributions, well
paid and their customers well served.
Source: R.W. Mann & Company, Inc.
21
Key Differences
The key difference between Southwest and most other air
carriers is its structural productivity. New entrants achieve
startling productivity, in various fashions. No low cost
producer/low fare carrier follows industry structural conventions,
which have caused productivity to decay.
Regrettably, instead of focusing on how to become more
productive structurally, most debate revolves around regressive
demands for labor subsidies. How much of a wage rate
reduction is required to close the gap with this high productivity
carrier? How much to come to parity with a low productivity
carrier that managed to extract subsidies from labor and other
suppliers through bankruptcy (or threats of same as an
alternative to achieving concessions)?
22
Understanding the truth
We must look at the world as it
is versus how airlines would
like it to be.
Robert L. Crandall
Former CEO
American Airlines
And as government officials, politicians
and consumers would like it to be.
23
This industry is always in the
grip of its dumbest competitors.
Robert Crandall
24
The National Commission to Ensure a
Strong Competitive Airline Industry
A Report to the President and
Congress August 1993
It questioned whether the
airline industry has basic structural
problems or if it is just a collection
of poorly managed companies.
25
Commission Reports
• The Airline Industry is more competitive than before
deregulation in 1978.
• Travelers and shippers are charged less than in 1978.
• The Airline Industry has never made a sustained,
substantial return on investment.
• It lost huge amounts of money from 1990 to 1993.
• It canceled many aircraft orders shortly after an
unprecedented buying binge.
• Its freedom to compete in international markets is
uncertain because of government restrictions.
26
Commission Conclusions
For the U.S. to prosper in a global marketplace
the airline industry must:
• Be efficient and technologically superior.
• Have the financial strength to respond to rapid
change and opportunity.
• Efficiently move people, products and services
to markets, wherever they exist.
27
Commission Recommendations
Efficiency: Reinvent the FAA.
Financial Health: Deal with factors that impact the
financial health of the industry.
Access to Foreign Markets: Replace the current bilateral
system with a multi-national regime.
28
Continued…
To return their balance sheets to
respectability, most airlines would
have to achieve profit margins that
are almost unprecedented in their
history, and sustain those margins
for years.
29
Do you agree?
The shock of September 11th has forced
airlines to face an awkward fact: in some
respects, aviation is a declining industry.
Nov. 22, 2001
The Economist
30
Problems or Symptoms
Despite cutting capacity, the big American airlines are
still flying with planes barely 60% full—a figure that
would be much lower were it not for hefty discounts.
Boeing and Airbus, the two manufacturers of large
jetliners, are offering airlines special financing deals to
pay for their purchases in order to stave off outright
cancellations.
31
Ouch!
American and United, bleed cash at a rate of
$10m-15m a day.
In the third quarter 2001, they lost a combined $2.6
billion, even after receiving government aid worth
over $2 billion.
American carriers are estimated to lose a total of
$9 billion-10 billion in 2001, even after receiving
$5 billion or more of aid.
32
Air Safety
Fatalities by Transportation Mode
Airline
12
Railroad
530
Passenger Car
20,818
0
5000 10000 15000 20000 25000
33
Four Consistently Profitable Airlines
1. Singapore Airlines
2. Cathay Pacific
3. British Airways
4. Southwest Airlines
34
Singapore Airlines
Consistently
profitable but experiencing profit pressures.
Winner of multiple awards for “airline excellence.”
An extension of the country strategy to be the business and
travel gateway to Southeast Asia.
An impressive travel infrastructure.
Leader of the Orient Airlines Association (OAA)
– Abacus reservation system.
– Price collusion on major routes.
Nervous regarding U.S. carrier price competition.
35
Why isn’t Southwest an International
Airline?
Its workhorse Boeing B737 aircraft (a
single fleet type offers efficiencies) does
not have the range to fly the longer-haul,
transcontinental markets. However, its
aircraft order portfolio (an updated B737)
does contain such capabilities, creating
growth possibilities for Southwest and
even greater challenges for its higher
cost/higher fare long-haul competitors.
36
STRATEGIC IMPLICATIONS OF THE EXPERIENCE CURVE
First movers in a fast growing market will secure a widening cost
advantage. Firm’s must grow as fast, or faster, than rivals or be
at a cost disadvantage.
Understanding the behavior of costs allows for more sophisticated
pricing strategies. The experience curve can be used:
• As a basis for pricing a production run or contract
• As a basis for market share based pricing strategy
• As a basis for planning future prices
Experience curves can be plotted for a company and its competitors
to assess how well each company is managing its costs.
Companies with the greatest cumulative experience should have
the lowest costs (if business is properly defined).
Product life cycles influence how you use the experience curve for
pricing. Products with a short product life cycle (rapid
development of new models) need to be priced to make money
more quickly because they can’t count on a long learning curve
and long productions runs.
37