southwest airlines is an enigma in the airline space because it's an organization that was founded in 1967 on a very simple operating model and has maintained its focus on that model today. Whereas other organizations have gone through major changes, through consolidation, through a change to a point-to-point rather than a hub-and-spoke model, the southwest airline system has remained largely intact, and the culture that Herb Kelleher brought to southwest has been largely the same over time. One of the things that's really powerful about southwest is its culture amongst its community and the culture of people, the very simplified fare structure, and some core rules that have maintained customer loyalty over time. And we'll dive into a couple of those in detail in this case study, but today what we're really here to talk about is will southwest airlines in its low-cost model be at an advantage amidst the coronavirus crisis. Does it have the opportunity to recover faster or recover more than other organizations do? Does it have the ability to more flexibly cut costs based on its business

model and we'll take a look at some of the information under the surface to see what our perspective is on Southwest Airlines. Welcome to this case study on Southwest. Southwest Airlines, established in 1967, was focused on its initial point-to-point service between Dallas, Houston, and San Antonio. The organization grew to a very large size, with about 60,000 employees at its peak in late 2019. In peak travel season, Southwest operates about 4,000 flights a day. They count flights as departures, not take-offs and pickups, so that's every flight that departs is about 4,000 departures a day in the U.S. Southwest actually has the highest passenger volume of any U.S. airline, and because of that, you see some major operating focus areas for them. For example, they focus on having a completely full flight wherever possible. They focus on fare transparency, having certain levels of the fare to incentivize people to purchase early, and the purchasing is set at a very strict timeline. So, if you don't buy your ticket within two

months, then you're gonna be paying a premium. And if you have to buy it within a week, it's gonna be the highest rate, sometimes more expensive, in fact, than its other mainline carriers. In addition, Southwest has a recent expansion with its focus in 2019 on service to Hawaii. As well, Southwest does have some international service in the Caribbean, but most of the flights that Southwest flies are in a limited duration in terms of flights. So, 103 destinations, 40 states, and their point-to-point system has been largely a key for success. Southwest, as a business model, is a very clear business model. Southwest is a fixed-cost business. If they fly with 10 passengers, as they've had to recently with coronavirus, or if they occupy a gate but don't send a flight out of it, they have to pay for that. They have employees, and they pay them not on a per-unit basis or, uh, if we sell seats, you get revenue, but on a contractual basis. So, they have a certain number of flights that they get paid for.

and they pay when they're on the payroll, and they pay to fly. So, Southwest Airlines, as a fixed-cost business, has been in peril like all other airlines during the coronavirus crisis. Why? Well, when your passenger flight volumes drop off 90%, you can just take a quick look at their filings, their common information from their consolidated statement of income, and you can see what that does. So, let's just take a look at it. In 2019, their passenger revenues were 20.8 billion dollars. Great. Their freight revenues, 172 million. So, 20.8 billion versus 172 million. What does this mean? Um, they also have another category, by the way, which is 1.5 billion. That's usually credit card and other affiliated financial services not related to the other programs that they have. So, where is the big part of their revenue? Massively, massively, like over 90 percent of their revenue is in their passenger revenue. And so, because you have such a high amount, if you drop it by 90%, so you remain only 10% of the passenger

volume you're ending up with 20.8 divided by 10 or 2 billion 2.1 billion dollars. Let's take a look at their costs: salaries, wages, and benefits. Almost all of those are fixed, 8.3 billion, not even anywhere close to breaking even. Fuel and oil, okay, you don't have to buy it, but you might have contracts with fuel and oil, so you probably can't just cut it off immediately. And when you need it again, you want to be able to get it again, so that's not just a super easy spigot to turn off. Maintenance, materials, and repairs. Sure, when planes aren't flying, you're probably maintaining them a little bit less, but you also might want to use the time to spend some money to get your planes through routine maintenance if they're parked. Landing fees and airport rentals, again, not super flexible. You can't just be like, Today I'm not going to use my gate, tomorrow I'll use it again. So they often have to maintain those contracts. Depreciation and amortization, fine.

that's a non-cash expense, not a huge worry, and then other operating expenses of 3 billion. So, with the exception of fuel and oil, we have largely fixed costs almost the whole way across the board - 19.5 billion in total. And if you take out fuel and oil, you only end up with about 15 billion. So, 2 billion in revenue versus 15 billion. If that were to protract for an entire year, no way that Southwest could maintain their future as a business. So, what is the number one thing that an organization like Southwest thinks about when they think about managing their business? So, let's look at the margins in the business - 22.4 over, um, we've got 19.5 in cost, so about 3 billion out of the 22.4. So, we're looking at under 15 profits. I mean, it's good but not great, but very, very sensitive to this passenger volume. And so, what does Southwest need to do going forward? Cut all of the costs that they possibly

can which again they're kind of limited and just work as fast as they can to get passenger volumes back. Does southwest being a low-cost airline help them in this situation? In my view, probably not. What is one of the challenges of low-cost airlines? They're usually preferred by a certain segment of travelers. You have two primary segments of travelers: business travelers and leisure travelers. If you believe that leisure travel will recover faster than business travel, southwest might be okay-ish but still in deep trouble. If you believe that business travel will recover faster, that people will need to and want to get back on the road for business and be willing to pay more for that, then southwest is in really deep trouble. So a lot of that depends on your view, and because leisure travel is sometimes considered elective travel more than business travel, that would be one of my primary concerns. In addition, who do you want back first? The passengers that are willing to pay the most. Southwest's pricing model has it so that the capacity is both on a capacity in the time basis.

So, you can get a cheap flight on Southwest if there remains open capacity. Do I want to attract a 79 customer who is coming back onto my plane? Is going to be one of 10 customers? Do I want to fly a plane with in revenue? Probably not. I can't even cover my fuel costs. I can barely cover any of my other costs in the first place, but I definitely don't want to do that. So, they have to rethink the way that they price and shape their capacity restrictions and some of their pricing models in the moment where they're trying to maximize revenue per plane. So, this is how fixed-cost business has to think about managing right now. Number one, get my top line back as fast as possible. Get people buying flights, even if they're not for today. Get them buying for tomorrow or any point in the future. In addition, if you can't get them to buy those flights, then get them to the ones that are buying. Get them to pay more so that you can fill up the planes with higher revenue.

occupants, and if you can't get your leisure travelers back, you might want to think about taking the opportunity to court other business passengers that maybe didn't use to travel on Southwest because they were always full or they were in the back of the line. Maybe those passengers could be a good opportunity to acquire them when there's disruption in the space. But ultimately, right now is a really difficult time to be in a fixed-cost business. When you lose your revenue, it's the same with a business like this and other areas of the travel industry, such as hotels or rental cars. So, we'll take a look at some of those other comparable companies, but at this point, Southwest is not very well positioned to return to success unless they see a major increase back in passenger volumes because they have so much cost that they have to recover. We hope that you enjoyed this case study on Southwest and thinking about how a company in crisis and COVID would need to adjust its operating plan or is limited on how they can adjust.

their operating plan going forward. If you have other ideas that could help Southwest or other companies that you want us to look at, please reach out to us at team@managementconsulted.com or check us out on our YouTube channel or on our podcast, Strategy Simplified. You

Southwest Airlines Case Study

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