I wonder if that’s why Eastern went out of business.
Author’s Note: This was originally written and published as an academic paper early in 2010, before Southwest’s decision to purchase AirTran was announced. The material exists as it was originally written with only images added for the purposes of this blog.
Hailed as a scrappy, start-up, small-market airline, Southwest Airlines has taken an unconventional attitude toward the air travel industry and turned itself into the most profitable company in the business. Throughout its history, Southwest has had to fight tooth-and-nail, quite literally, for its very existence. It’s this warrior attitude that has developed into a tongue-in-cheek approach to marketing and a vehement sense of doing right by the customer; which has, in turn, developed into a business strategy that has kept the company growing for over thirty years.
Since its inception, Southwest’s mission has been a “dedication to the highest quality of Customer Service delivered with a sense of warmth, friendliness, individual pride, and Company Spirit.” The company focuses on this mission through an extremely selective hiring process that ensures all employees fit within the corporate culture believing that truly fun-loving and spirited employees bring superior customer service through their inherent attitudes that are allowed to shine without the confining regulations and propriety that so many other airlines practice. Southwest employees routinely go the extra mile to help a customer because—by and large—they genuinely care about making people happy. Just as most other wildly successful companies, Southwest’s philosophy agrees that happy employees translates into happy customers and happy stockholders.Plain and Simple
In 2004, when Gene Kelly took over as CEO from Herb Kelleher, he formally instituted the four factors and five strategic objectives that had become and, as he said, would continue to be the guiding principles of Southwest Airlines’ continued success. Hiring great people and “treat ’em like family” is the first factor which is illustrated through the airline’s extremely selective interview process and extremely generous wage and benefits schedule. Southwest employees have, on average, made more than their rival counterparts without taking massive pay cuts during hard economic times through a conservative financial plan as well as stock options that have grown as considerably as the company has over the years. Second, Southwest cares for customers “warmly and personally, like they’re guests in our home” because it only hires employees who genuinely care for people. Third, Southwest pledges to keep fares lower than anyone else through safety, efficiency, and operational excellence. The company’s 25-minute turnaround goal can only be achieved through efficiency and teamwork where ground and flight crews all work together to have a plane ready to board within the specified time limit. When faced with glaring safety violations tarnishing the company’s near-perfect safety record, Southwest acts with integrity by alerting and working with federal inspectors to make sure aircraft are repaired and maintenance is brought current—despite the possibility of fines and other potential penalties (lost revenue, for example), which is far outweighed by the potential company-ending disaster that could occur otherwise. Finally, staying prepared for hard times has helped the company weather the economic recessions and skyrocketing fuel costs. Southwest maintains strong liquidity and aggressive fuel hedging which keeps them afloat while other, larger airlines are haemorrhaging money, raising fares, declaring bankruptcy, and merging out of existence. Southwest’s five strategic objectives build and restate the four factors while adding the goal of offering customers a convenient flight schedule to places that they actually want to go. This has allowed Southwest to realise its goal of bringing the American public the “Freedom to Fly” almost anywhere, at any time, and for a low price.
By utilising aggressive cost-cutting measures, such as their trademark no-frills flight service, point-to-point route structure, single-model fleet, and fuel hedging, Southwest Airlines currently enjoys one of the lowest operating costs per passenger seat mile—13.85 cents in first quarter of 2008, a feat that can not be duplicated by other airlines (the closest, America West, reports 15.58 cents per passenger seat mile). In addition, Southwest maintains large cash reserves ($16.77 billion in 2007) as compared to the industry average. The airline’s volume strategy of selling full planeloads for lower fares than selling fewer seats for higher prices has led to historically high revenues for the company as well, as less money is wasted flying full rather than empty seats. Not only boarding more passengers per flight, but also quicker turnarounds leads to more available seat miles, which, after filling those seats, leads, again, to larger revenues. These elements have put Southwest in a position of being, financially, the strongest airline in the United States as of the fourth quarter 2008.
Due to the nature of how it conducts business, Southwest Airlines enjoys many competitive strengths. The airline has enjoyed unprecedented growth since 1971 driven by a simple fare structure, low costs, and impeccable customer service. The company also maintains a fleet of one aircraft type, which saves on parts inventories and maintenance training costs as well as provides them with incentives such as volume discounts and flexible financing options. Strong, simple loyalty programs help to build lasting relationships with repeat customers. Southwest’s desirable corporate culture also makes it able to be highly selective during its interview process for new hires, making sure the company hires only the best of the best applicants.
One major weakness in Southwest’s product is its lack of seating options. Passengers must arrive early to be more selective about their seating arrangements, which may aggravate some passengers and turn them off to the experience. Because it only flies smaller Boeing 737 aircraft, cargo space is limited, and increased revenues from less price-elastic cargo transport must be foregone in favour of highly price-elastic passenger miles. Also, being reliant on one producer for aircraft creates some level of dependency on Boeing that may prove a strategic weakness if aircraft prices change. Southwest also does not offer any international flights, even to popular tourist destinations in Canada, Mexico, and the Caribbean—missing out on the very lucrative vacationing market segment.
Southwest has always been a leader in incorporating advanced technologies into their business model. The airline was among the first to utilise electronic ticketing as well as adding winglets to improve efficiency in their aircraft fleet. By continuing to seek advanced technologies, Southwest has the opportunity to gain significant competitive edges against its competitors during the adoptive phase of the new technologies (which can last upwards of ten years, in some cases). Southwest can also consider expanding into markets not already served by the airline, especially smaller markets in the southeast and central United States with little or no competition.
Several threats face Southwest Airlines, as well as their competitors. Chief among these is the price of jet fuel and other petroleum derivatives that are essential in aircraft maintenance. Currently, a slowing domestic economy has reduced the amount of leisure travelers while commute alternatives such as teleconferencing have reduced the need for business travel. Increasing federal regulatory action also threatens Southwest, especially in light of recent safety violations that caused a significant portion of the fleet to be grounded for inspections and repairs. Not only FAA regulatory action, but also ever-increasing demands for security protocols from the TSA threaten air travel by making it inconvenient for many people, either through outrageous screening processes or increased costs of passenger screening, which is then passed back onto the customer.
The bargaining power of the buyer in this market is quite high, as there are several options in each market on which a potential customer can choose to fly, and the services offered are relatively standard at this point. Typically, he who offers the lowest price is going to attract the most customers, which is where Southwest typically displays some advantage. In addition, the threat of substitutes is high as well for the same reasons—undifferentiated services and proliferation of competitors. Southwest has also set themselves in a situation where their suppliers have a high level of power as well. While maintaining a fleet of only one aircraft type significantly reduces the cost of warehousing parts and training mechanics as well as simplifying maintenance logistics, it puts all bargaining power in the hands of the manufacturer, Boeing. Any decision to increase prices of aircraft or parts can force Southwest to succumb to those extra costs under threat of grounding the entire fleet. Fuel suppliers also keep a choke-hold on the industry as a whole as they control the means of production (in this case, the distribution of fuel—without which, there can be no flights). However, Southwest has been able to mitigate the effect of fuel costs by their aggressive hedging strategy. Competitive rivalry is also quite high in the airline industry. There are many competitors and, such is the case in periods of slow economic activity, each one plays a price game to entice customers away from the others in order to keep their operations at sustainable levels.
One piece of good news for Southwest, considering Porter’s Five Forces model, is that the threat of new entrants is low. There is a lot of cost and capital investment associated with starting an airline, and, especially in periods of slow economic growth, the risk often far outweighs the reward. Established brand names—often legacy airlines—tend to survive the troughs better than small start-ups, especially when customers are not patronising as they do during peak economic times. Loyalty programs become paramount, discouraging changeover and promoting the strong brand names that already exist in the marketplace.
Southwest Airlines seems to be doing almost everything right, but, even still, there are two notable strategies that the company can implement for continued growth across all market segments. Currently, Southwest offers no partnerships with other air carriers for international or tertiary domestic markets. Southwest can “extend the LUV” to these smaller domestic markets by partnering with regional airlines that provide shuttle service to the larger markets. In addition, Southwest can partner with larger international carriers to enhance their global reach from entry ports such as LaGuardia (for European travel) and LAX (for destinations to and from Asia and Oceania). Such partnerships may seem counter-intuitive to Southwest’s self-reliant culture, but as the global community becomes smaller, airline partnerships will become inherently more important.
The other major consideration, and presently the most important, for Southwest’s continued expansion is the acquisition of rival airlines. This may be the most important step in enhancing Southwest’s domestic presence because it opens up previously-untapped markets to Southwest’s lower-cost, simplified structure. Utilising the company’s large war chest, motions to purchase AirTran or JetBlue can easily be made during the economic slowdown. Both of these airlines are of particular strategic interest because—by and large—they operate in markets that are not currently serviced by Southwest, including major presences in tourist destinations in the Caribbean and business travel destinations in Canada. Also of singular interest is the fact that both competitors operate a fleet of Boeing 737’s, which will—unlike Delta’s acquisition of Northwest’s “hodgepodge” fleet—ease transition costs by not forcing Southwest to retrain mechanics or attempt to unload unused aircraft inventory on an already saturated market as well as by keeping maintenance costs relative to the size of the fleet, thereby not negatively affecting overall costs per available seat mile.
Founded on the principles of simple, low fares and bringing all the comforts of a cozy den to air travel, JetBlue Airways has strived to make itself the premiere discount airline in the United States. JetBlue offers its customers a chance to save money while enjoying amenities such as leather seats, gourmet snacks, and live television. Also during its formidable years, the airline has sought to reduce or eliminate certain problems associated with airlines through the clever use of amenities. Leather seats, for example, are more durable and easier to clean than their cloth counterparts (and do not tend to get soaked with urine, as company founder David Neeleman discovered).
Beginning with a strong mindset of customer service, JetBlue began service in February 2000 using JFK airport in New York City as its primary hub, capitalising on being the first low-cost carrier in the market since People Express went out of business in 1986. This began an unprecedented period of growth through the early 2000’s when most other domestic carriers were circling the idiomatic drain of insolvency. In the first year, JetBlue flew two million passengers, and more than doubled that number the following year. After going public, the company utilised unprecedented newly-gained capital to acquire LiveTV, LLC, its provider of in-flight entertainment. The route network quickly expanded southward along the eastern seaboard and westward to Utah, California, and Washington, among several other large markets and began servicing point-to-point routes rather than finding another major hub.
JetBlue has consistently pushed the very idea of not sacrificing comfort and amenities for the sake of lower fares. Dunkin Donuts coffee, satellite entertainment systems, on-board email and instant messaging became the standard on all flights and other carriers have been forced to adopt practices such as these in order to stay competitive. These practices, however, were originally defined by JetBlue’s five steps: safety, caring, integrity, fun, and passion.
Safety, especially in aviation, is tantamount; millions of lives are placed in the care of a JetBlue flight crew every year, and if any one crewman fails, then the results can be catastrophic. From emergency medical assistance provided by Medaire Inc. to in-flight yoga cards courtesy of Bally Total Fitness and even being the first airline to install Kevlar doors and surveillance cameras on its airplanes in the wake of the terrorist attacks in 2001, JetBlue has maintained a policy of having every available resource for the health and safety of passengers and crew on hand in flight and on the ground.
JetBlue employs care for all of its crew members by, among other things, maintaining a no-layoff policy and a crisis fund available to any crew member in extraordinary need. The company shows integrity through its openness and ability to proactively admit to mistakes. For example, alerting customers whose personal information may have been compromised and offering to make amends through vouchers for free flights. Corporate officers have been known to personally assist anyone they have the means to as well.
Maintaining a fun work environment keeps employee morale high, especially in a traditionally high-stress setting like air travel. Impromptu airport barbeques with George Foreman grills and light-hearted punching bags help both crew and passengers let off a little steam and keep things running smoothly. High employee morale also fosters a sense of passion in crew members about what they do which leads to better customer service, happier passengers, and repeat business. As the saying goes, keep your employees happy, and they will keep your customers happy, which will keep your bottom line happy, and this is reflected in the company slogan: “You [the customer] above all.”
Despite the exponential growth and strong corporate culture, JetBlue has fallen victim to soaring fuel prices along with the rest of the industry. Even as the S&P 500 grows, the airlines, as a group, are falling sharply. Revenues have been growing consistently since 2000, rising some 185 percent through 2007, but costs have also risen—a whopping 222 percent—during the same period, owing to a 532 percent increase in the price of jet fuel from 2003 to 2007. Outside of jet fuel, operating expenses actually grew more slowly than revenues, to the tune of some 155 percent. Excluding fuel costs, this growth in operational expenses is quite consistent with a sustainable business model where the difference in revenues and operating expenses creates larger profits each year. JetBlue, historically, has not hedged fuel prices nearly as aggressively as its major competitor, Southwest Airlines. Reasoning behind this leads to a conclusion about overly conservative estimates about rising fuel costs and indecision regarding at which point to hedge those fuel prices. Despite the conservative fuel estimates, JetBlue has maintained strong financial liquidity into 2008, listing $713 million in cash and cash equivalents in the first quarterly report, but excluded $313 million in auction-rate securities. Due to a decline in the market, those securities were shifted from current assets to long-term investments. Because of such strong financial liquidity, JetBlue has been able to maintain lines of credit through 2008.
JetBlue has several strengths that differentiate it from competitors. First, JetBlue maintains a lower operating cost by owning its entertainment provider, LiveTV, by providing only snacks on flights, and operating a point-to-point route network that serves markets with lower landing fees. Over the life of the company, JetBlue has managed to build a strong brand that is associated with low fares and high service, which leads to strong customer satisfaction with the product. The airline also operates a fleet of two aircraft models that can be interchanged at the gate to provide more efficient service as well as save on maintenance costs from parts and labour training. JetBlue has also been a leader in utilising technology not only as an amenity in-flight, but to reduce costs in reservations, ticketing, and customer service calls—putting them ahead of the curve against legacy airlines and other discounters.
Somewhat offsetting their numerous strengths, JetBlue does suffer some weaknesses. Primarily, the fact that they are a relatively new company does provide some challenges in that they do not have the established presence in some markets that other carriers do—namely Delta and AirTran in Atlanta, prompting the retreat from that market. Maintaining only two different aircraft also limits passenger operations as only a maximum of 150 passengers can be carried across any route—reducing total available seat miles.
Some strategic opportunities exist within the industry for JetBlue, the first of which is route expansion. JetBlue currently operates in only 63 domestic markets, mostly in the Northeast and Caribbean with a lesser concentration on the West Coast. JetBlue is overlooking a significant segment of the travel population in the Midwest and Bread Basket states that may vacation in those more tropical destinations. In addition to expanding their own routes, JetBlue can build strategic alliances (especially to international markets) in order to provide seamless service to destinations not directly served by the airline. Also, by continuing to be a leader in technological implementation in the airline industry, JetBlue can reduce their long-term costs by investing in new innovations that will improve the efficiency of their aircraft as well as provide more services to customers both in-flight and on the ground.
The biggest threat faced by JetBlue at this time is the seemingly out-of-control fuel prices. These ever-increasing costs must be mitigated if the company is to stay solvent. In addition to soaring fuel costs, the ripple effect leads to reduced air travel spending by the general public. Economic downturns have encouraged “staycations” and other, lower-cost travel alternatives. Strong competition is also a major threat to JetBlue as fuel hedging has given Southwest Airlines and other major players a significant advantage in cost-cutting measures. Collective bargaining by union members in virtually every crew station (both in the air and on the ground) only serves to exacerbate the effect that a weak economy has on the airline. Without the ability to cut costs when and where they are needed, JetBlue management has to make difficult decisions as to violating their own “no layoff” policy.
The bargaining power of the buyer in this market is quite high, as there are several options in each market on which a potential customer can choose to fly, and the services offered are relatively standard at this point. Typically, he who offers the lowest price is going to attract the most customers. In addition, the threat of substitutes is high as well for the same reasons—undifferentiated services and proliferation of competitors. JetBlue has also set themselves in a situation where their suppliers have a high level of power as well. While maintaining a simple fleet of two aircraft eases logistics and simplifies maintenance, it puts all bargaining power in the hands of the manufacturers. Any decision to increase prices of aircraft or parts can force JetBlue to succumb to those extra costs under threat of grounding at least half of the fleet or not being able to purchase complementary aircraft. Fuel suppliers also keep a chokehold on the industry as a whole as they control the means of production (in this case, the distribution of fuel—without which, there can be no flights). Competitive rivalry is also quite high in the airline industry. There are many competitors and, such is the case in periods of slow economic activity, each one plays a price game to entice customers away from the others in order to keep their operations at sustainable levels.
One piece of good news for JetBlue, considering Porter’s Five Forces model, is that the threat of new entrants is low. There is a lot of cost and capital investment associated with starting an airline, and, especially in periods of slow economic growth, the risk often far outweighs the reward. Established brand names—often legacy airlines—tend to survive the troughs better than small startups, especially when customers are not patronising as they do during peak economic times. Loyalty programs become paramount, discouraging changeover and promoting the strong brand names that already exist in the marketplace.
JetBlue has several options available to it in order to weather the economic storm and begin a new period of growth. One option is to expand its airline partnerships. JetBlue already maintains partnerships with several international carriers, providing service to the British Isles, most of continental Europe, South Africa, the Middle East, and South America. JetBlue also has a partnership with Cape Air, providing regional service to tertiary markets in Massachusetts. JetBlue can consider partnerships with airlines providing service to Canada and Mexico to enhance their North American coverage (which is, surprisingly, lacking) as well as service to Asia and Oceania, the latter of which is quickly positioning itself as a popular tourist alternative to Hawaii or the Caribbean.
Rising fuel costs have virtually decimated the airline industry, and JetBlue’s lack of aggressive participation in fuel hedging practices compared to other airlines has put it at a significant disadvantage, forcing the company to resort to cost-cutting practices such as “tankering” and reducing overall weight to save on fuel costs. As analysts are predicting ever-rising fuel costs, JetBlue should hedge its fuel prices as soon as possible and for at least the next five (if not seven) years until a viable alternative can be developed. At the same time, JetBlue should use its prowess for ingenuity to design lighter seating materials and other weight-saving measures to reduce overall fuel on flights. Investments in companies developing alternative fuel sources may also be beneficial in the long run, providing a opportunity to “have their back scratched later” in the form of lower alternative fuel costs or some premium benefit for initial investment.
A final recommendation, and one that should be implemented with the utmost priority, is expanding JetBlue’s domestic route network. While commuter flights in the Northeast United States make up the majority of the route structure, low-cost transcontinental service can be a boon as there are currently very few players in that particular game. By expanding West Coast service, JetBlue can take advantage not only of vacation and business travelers having to fly from coast to coast, but also expand in the lucrative trans-California market. Flights between San Diego, the Los Angeles metropolitan area, and the San Francisco Bay Area as well as Portland, Seattle, Vancouver, and even Las Vegas can capitalise on tourist and business travel (especially flying out of San Diego, where the only destinations are on the East Coast). Midwest and Bread Basket states are also under-serviced (or overflown), missing out on tourist revenue not only to currently-serviced markets like Chicago, New York, Los Angeles, Florida, and the Caribbean, but also to areas like Sandusky, Ohio; Branson, Missouri, and Memphis, Tennessee. To facilitate this, a secondary hub-type facility can be developed at Chicago-O’Hare using a combination of existing capital and available credit which could easily be repaid within ten years based on the revenue generated by these developing markets that will see further economic growth due to enhanced air travel options.