An Analysis of Southwest Airlines

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Executive Summary

Problem Statement- This report is a study of Southwest Airlines, considering its strategies, strengths, weaknesses and the recent acquisition of AirTran.

Analysis

Southwest faces problems of drastic weather changes, natural calamities and inflation. These problems also apply to the industry as a whole.
The strongest force among the Porter’s five forces in the US Airline industry is the barrier to entry. This is attributed to the large capital requirements.
Southwest airline has an open office culture, which has ensured good labour relations.
The low cost strategy pursued by Southwest has been its core competence. Though this is a relatively simple concept, copying it would not be so straightforward.
Southwest airlines are doing very well in financial terms. This conclusion has been reached form the comparison made with its competitors.
The acquisition of AirTran is well timed.
The synergy management strategy if well implemented can result in great financial gain for Southwest Airlines.

Alternatives

Southwest Airlines could continue acquire more competitors in future to increase market share and ensure revenue growth.
The company has the option of focusing on being the best low cost airline in the industry.

Recommendation

Southwest airlines should continue with the merging and acquisition strategy as it guarantees huge market share and economies of scale. This will also increase barriers to entry for any potential competitors.

Implementation

Southwest Airlines has the capital base required to acquire most of its smaller competitors. The management team in place has also proved to be effective. The company also has a good reputation with its creditors. This will enable it to get any financial assistance needed for its expansion plans.

Problems Facing Southwest Airlines

Southwest airlines faces s few problems despite being a large industry player. The recent leadership crisis in the Middle East has greatly influenced the Crude oil industry. This industry is at the core of the operations of the Aviation industry.

These price increases have directly affected petrol and gas prices, which are a great proportion of operating costs in the industry. Needless to say. This has resulted in rising operating costs for Southwest airlines.

There have been drastic climate changes in the recent past. The western hemisphere has experienced very cold winters with snowstorms and avalanches. These have forced Southwest airlines to delay or postpone some of its flights. This translates to revenue loss for tickets that are cancelled.

The cost of housing travellers who are stranded also increases operating expenses. The Eastern hemisphere on the other hand has experienced very high temperatures. This leads to dust storms which reduce visibility while flying. These too have caused a few flights to be cancelled.

Natural disasters such as the tsunami in Japan prevent airlines from flying to the worst affected areas. Southwest airlines has had to cancel flights and change routes that required a stopover in these places. These changes in schedules are costly in terms of planning. Some airplanes are stranded in these disaster hit areas while others are actually damaged by the effects of the natural disasters.

Inflation rates continue to soar at an alarming rate. This rapid increase in prices affects Southwest Airlines by increasing operating costs. The result is reduced profit margins. Inflation also deals a blow to Southwest’s low cost strategy.

It is difficult for Southwest to pass on these increased costs to consumers since it has cut out a niche in the low cost criteria. The principal reason why most people fly with Southwest is its affordable cost. Any increase in prices comes with reduced customers. This is quite undesirable since Southwest Airlines is a profit making organization.

US Airline Industry and Porter’s Five Forces

Porter’s Five Forces assess an industry’s attractiveness based on certain forces within the industry and some without. The first factor is the degree of rivalry between the industry players. The American aviation industry has many players who exercise fierce rivalry. This is evident in the advertising campaigns and new offers that are unveiled daily. The aim of all the companies is to gain the largest market share and create customer loyalty.

The second factor is the barriers to entry. Entry into the aviation industry is relatively easy since it is not a government monopoly. The largest constraint is the amount of capital required. Airplanes and runways are expensive to buy. However, this is not a hindrance to most large investors.

The existing players have also created brand names that are not easy to erode. They also experience cost advantages due to their scales of operation. A new entrant may not be able to compete with the prices they offer.

The threat of substitutes is not strongly felt in the airline industry. This is because travel by air still remains the fastest among all available options. It is also quite convenient. International flights in particular cannot be substituted. However, the subway system provides competition for internal flights. This is because they offer the same services at a lower cost and are unaffected by most weather changes.

The fourth and fifth forces are buyer and supplier powers. Suppliers wiled a lot of power in this industry since the industry depends on well services airplanes for its prosperity. The airline manufacturers and maintenance engineers are quite crucial to this industry.

Buyers also have a lot of power since they have many options available to them and can switch anytime they wish. Southwest therefore has to take into close consideration the consumer demands.

This industry still has huge profit potential. This is evident from the existing players’ financial statements. However, a new entrant should ensure they have enough financial resources and be prepared to face fierce competition during the initial years. New entrants can find a suitable niche and focus on it. This way, they will be guaranteed success.

Culture and Success Strategies

Southwest has maintained an open door office culture that is very popular with employees. This has improved morale and led to good performance over the years. The company’s response to change is also relatively fast due to the willingness of employees to participate.

In 2008, during the financial crisis, when most companies were downsizing via compulsory retrenchment, Southwest chose to go the voluntary retirement way. Employees were given a choice to go for early retirement at will. This enabled the company to reduce labour costs without tampering with employee morale.

The strategy southwest has chosen to pursue is a no frills one. The company avoids providing services it considers unnecessary. This enables it to charge lower fares than most airline companies do. Southwest chooses to concentrate on its core business, which is flying its customers to their destinations of choice.

EasyJet has also adopted this strategy. It is not a difficult strategy to copy but efficiency is the advantage that Southwest has. The brand name is also hard to erode.

Financial Analysis

This paper employs financial ratios in comparing the performance of AirTran Airlines, Southwest Airlines and American Airlines. Most key financial ratios are computed using Microsoft Excel while a few are taken direct from the companies’ annual reports for 2009. The liquidity ratios computed include gross and net profit margins and return on assets.

The companies have similar gross profit margins, ranging from 1.73 for AirTran, 1.71 for Southwest Airlines and 1.66 for American Airways. The difference between the highest and lowest is a bare 0.07, meaning that all companies are earning almost equal GPM. The net- profit margin however, tells a different story.

South West Airlines is doing the best at 0.096, followed by AirTran with 0.057 and finally American Airways with -0.073. The net profit margin indicates the percentage of revenue that remains after adjustment for operating costs and other unusual items. In the case of American Airways, the operating costs exceeded the sales thus the negative figure.

This is not a good sign, as it will eventually translate to losses. Southwest Airlines is doing the best in cost control since it has the highest figure of 0.096. This could be attributed to the low cost strategy that the company pursues. This strategy has given the company great competitive advantage over its rivals.

AirTran posted the best return on assets at 1.06, followed by American Airlines with 0.755 and finally Southwest Airlines with 0.72. This is an indicator of AirTran’s ability to manage its assets better than its competitors.

The return on shareholder’s equity follows a similar trend, with AitTran posting the highest figure of 4.66. Southwest Airlines posted a figure of 1.88 while American Airways posted the lowest figure of -5.7. This shows inefficient use of shareholder’s funds in earning sales on the part of American Airways.

Southwest Airlines posted the highest current ratio, 1.41, indicating its superior ability to pay its current liabilities as they arise. AirTran followed with a figure of 1.05 and American Airways trailed with 0.85. The quick ratio also shows a similar trend, with Southwest airlines posting the highest figure of 1.31. American Airways posted the lowest figure at 0.786, just below AirTran’s 1.019.

The working capital ratio computed was inventory days. This shows on average how long inventory stays in stock before being used. AirTran holds its inventory for the shortest period. The company could be employing a JIT system in managing its inventory.

American Airlines posted the longest inventory period of 16 days. Southwest airlines held its inventory for an average of 13 days. Southwest airlines are doing better than its competitors in terms of liquidity ratios. However, in one category, inventory days, AirTran is doing better than Southwest.

Leverage ratios deal with the level of debt a company has in its capital structure. American Airways has the best debt to asset ratio. It posted a figure of 0.83, almost double, what the other two airlines had. This could indicate either low asset base or good use of the existing assets.

AirTran and Southwest had 0.46 and 0.42 respectively. There was a huge disparity in the debt to equity ratio where American Airways had -6.0. This was because the airline had exhausted all its reserves in an effort to survive the 2008 financial crisis.

The only element of equity in its balance sheet was ordinary shares. Therefore, the debt outweighed this by far. AirTran did better than Southwest posting a figure of 2.11 while the latter had 1.12. The airline under study seems to be doing average in terms of leverage.

The P/E ratio of Southwest is higher than its competitors. The figure was 92.38 while American Airways and AirTran posted figures of 66.6 and 57.1 respectively. This indicates that investors think that Southwest has high prospects of success.

The market to book value ratios range between 1.4 for Southwest and 0.92 for American Airways. This ratio compares the market value of the company and its book value. AirTran had a ratio of 1.03. Southwest airlines are still the best in this category.

Operating Performance

American Airways had a Passenger Revenue Yield per Mile of 20.7B. This was the highest among the three. Southwest followed closely with 10.5B while AirTran trailed with 2.41B. The first two airlines did exceedingly well in this category while AirTran posted very poor results.

AirTran had a load factor of 76.6% while Southwest had one of 80.6%. These are average figures in the aviation industry. However, American Airways did poorly with a load factor of 71.20%.

Acquisition of AirTran

Acquisition of AirTran will increase Southwest Airline’s market share and make it a larger industry player than before. This move is well timed with the entry of new players into the aviation industry. The leverage ratios of Southwest Airlines are also likely to improve with this recent acquisition. This is because AirTran has better leverage ratios than Southwest.

The gross profit margin will also improve since AirTran has high sales in relation to cost of goods sold. The return on Shareholder’s equity is also likely to improve, given the fact that AirTran posted the best figure in this category for the year 2009.

Southwest airlines are likely to be pursuing a synergy management strategy in acquiring AirTran. This is a good strategy since both companies operate in the same industry. This is likely to result in a huge increase in the customer base. There might be a slight problem during rebranding, as customers may get confused. However, this can be easily curbed using good advertising.

The core competences of both companies can be combined for better performance. Synergy management usually results in better results if the companies’ competencies can be combined effectively. Therefore, I agree with management that this decision will help increase shareholder value.

Southwest Airlines should focus on exploiting the synergy that will be created by owning another airline. There will be lessons to be learnt from AirTran, especially about operations and financial management.

Southwest’s management should be open to cultural change and accommodate employees from AirTran. When these companies have been merged successfully, and Southwest has sufficient capital base, then another merger or acquisition can be effected.

References

New York Times. (2011, February 3). Times Topics. Web.

Ratliff, R. L., & Reding, K. F. (2002). Introduction to Auditing: Logic, Principles, and Techniques. New York: The Institute of Internal Auditors.

Russo, M. V. (2008). Environmental Management: Readings and Cases. New York: Sage Publications.

United States General Accounting Office. (2003, September 17). United States General Accounting Office. Web.

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