Southwest Airlines Americas low-cost airlines - Case Study Example

A Study of Low – Cost Airlines: Southwest Airlines Submitted By: XXXX Number: XXXX of XXXXXX Turtor’s XXXX XXXX Date of Submission: 18 November 2008 Total number of words: 2337 (Excluding Bibliography and Appendix) Introduction: This report aims at analysing America’s low cost airlines – Southwest Airlines. Southwest Airlines stand at the 6th position in terms of revenues however is the best airlines as of December 2007 in terms of number of passengers carried every year. The airlines fly to almost 65 different destinations and have carried the highest number of passengers since 2006 when compared to all of its competitors. Southwest has been able to maintain its profitable position for 35 years now that is an unmatched accomplishment within the airline industry. The company’s revenue earning for 2007 has totalled to almost $9.86 billion, which is an enormous increase of almost 8.5% from 2006. Southwest has continuous plans of expansion and continued increase in the Available Seat Miles (ASM) or its capacity, when most of the airlines have started reducing their ASM. Southwest’s competitive edge: Southwest Airline’s business model is focused directly at only one area i.e. Low cost flights for short distances. The main competitive edge that the company has is that it has designed its business model in a manner where the company’s main aim is to keep the price low to increase profitability rather than increase its market share. The company has analysed the market well and it understands the specific market niche. This can be considered as the company’s biggest advantage over other competitors as the business model is well focused and the flight works on point to point rather than hub – and – spoke system. The company has also been the first to take up the initiative to start a website which is now the number one airline website in the industry and more than 69% of the passengers check in using the website (Henkle, et al, 2008). Also, the company is the pioneer in the ground keeping time of the aircrafts and the company is the only one with the least amount of ground time for the flights – an average of maximum 20 minutes to maximise profits. Also the company believes in providing its personnel with all the critical information of the company and the decision - making rights to solve issues at a faster and more effective rate. All these apart from its well - built brand name and image over the years can be considered as the company’s main competitive edge in the market. Current Position of Southwest Airlines: Currently the business stands well above the industry standards. It is the sixth largest in terms of revenues. Southwest Airlines has created an image for it that has led the customer perspective of the company to be efficient and effective. The company as mentioned above has continuous plans of increasing its ASM when most of its competitors are reducing the ASMs. Southwest Airlines competes against many low cost carriers and low cost subsidiaries of larger carriers. The main competition faced by Southwest Airlines is from AirTran Holdings (AAI) and JetBlue Airways (JBLU). The other competitors are American Airlines, Continental, United and US Air. Looking at Table 1 below, it is quite evident that Southwest Airlines is among the top Airline companies in the US. Southwest Airlines with its strategic planning has been able to cut down its costs. With the rising costs and the dropping demand, many of the competitors have had to implement newer strategies where they have been required to cut down on the food and beverages services offered on board. Also the inclusion of new charges for customers to check in the baggage has been implemented to increase profitability in 2008. However in the case of Southwest Airlines these measures have not been implemented since the operating costs of the company have always been relatively lower than the competitors. Airline Fleet Size Annual Departures (000) Available Seat Miles (Millions) 2007 Revenue Operating Margin Net Income (Millions) Southwest Airlines (LUV) 520 1,162 99,636 $9,861 8% $645 AirTran Holdings (AAI) 137 262 22,680 $2,309 5.90% $52 American Airlines (AMR) 655 769 169,856 $22,833 3.10% $356 Continental Airlines (CAL) 365 411 99,061 $14,105 4.40% $460 JetBlue Airways (JBLU) 134 196 32,148 $2,843 5.80% $18 Table 1: Comparison of Southwest Airlines with some of its competitors ( Major Issues: As already mentioned earlier the company’s biggest strength is the fact that the turn around time between each flight is a maximum of 20 minutes. On an average Southwest Airlines operates a total of 3,500 flights in a day. For a company that operates such high numbers of flights on a daily basis it is essential that extra precautions be taken to ensure the safety of the customers. Post the accidents in 2000, and the major accident in 2005, where the flight skidded off a runway due to heavy snow conditions, and resulting in killing a six year old boy after the flight had skidded onto a street, the company has taken a number of measures to ensure the safety of its passengers. Southwest had then implemented the Aviation Safety Action Program (ASAP) to enable the company capture all the incidents that were flight – related. The flight crew is required to fill out a form for any incident that occurs on board, which is then stored into the ASAP database. This report would include a detailed narrative report where the crew requires describing the incident and a structured data, which includes data like the weather flight no. etc. This was implemented to assist the company store all the data for every incident to ensure better productivity and efficiency of the flight safety staff. It also helped the teams analyse the root cause of the incidents and ensure that it does not occur again (TDWI, 2005). Solution to the issue: As a solution for this problem where the company had to correctly record all the data and analyze the data to ensure better results, the company required to implement an easy – to – use system which was effective as well. The company thus implemented a system called Polyvista that was used to analyse all the data and provide solutions to the company. To ensure all the main personnel were aware of the working of the system, the implementation team consisted of a flight safety expert, a data expert and a Polyvista consultant. This system met up to all the requirements of the company keeping in mind that the company did not employee statisticians and required to have a system that was simple, clear, fast, able to handle complex data, help provide actionable information, provide early warnings for factors that cause incidents and most of all discover unknown relationships, and correlations. This system has helped the company improve the flight safety in a short – term basis and avoid accidents for the long term (TDWI, 2005). Financial Analysis: Southwest Airlines: As already mentioned this report aims at analyzing one of the biggest airlines of US: Southwest Airlines. The company analysis has been made based on a questionnaire (See Appendix 1). ABC Analysis: After analyzing the financial reports of the company and based on the publically available information it is noted that activity based costing method is used within the organization. The company uses the ABC system which helps the company offer the cheapest possible fares to its customers. Also as already mentioned earlier the company is the first to start a website of its own and is the one of the first which allows it customers to purchase and book tickets online, thus eliminate the cost’s of commissions to agents and even the printing of the airline tickets (LaGrange, 2001). Each activity has a cost driver attached to it and the ABC system utilizes this cost driver to distribute the costs among the products (12 Manage, 2008). Budgeting Needs: The company has already been following excellent budgeting systems which are very evident from the results that the company has been showing. However, there are a few other budgets that the company can incorporate into is systems to help improve the current systems. Sales Budget: A sales budget is one which estimates the anticipated sales and is normally based on the product, territory, or person. These reports can be prepared on a weekly, monthly or annual basis. A sales budget is essential for a company with such large operations like Southwest Airlines. These budgets will alow the company to record the number of products (tickets) sold and the selling price per unit (per ticket). This will allow the company to forecast the sales for the coming periods and will provide as an evidence for the reports. Manufacturing costs: These costs refer to the expenditures by the company on material, labor, electricity, supplies and overheads. These costs are generally reported under GAAP, and provide information about the number of units that have been produced along with the cost per unit produced. Administrative expenses: Being an Airline company the expenses (fixed as well as variable), for each of the departments will be different. Administrative expenses normally include all the expenses incurred by the company like the cost of writing and filing, stationary costs, etc. These costs total to a large sum for Southwest Airways and it is essential to be recorded. ABC Analysis: Budgeting needs: On the basis of the activity based costing method, there are three main costs that need to be included for the company. These costs are mentioned below along with valid reasons for their inclusion into the ABC analysis: Labor: Since the nature of business is one which involves a number of labors, this is a very important expense which should be considered. The pay to the employees in the company is quite a big part of the total expenses. Hence it is essential to correctly allocate these expenses to ensure that the overhead costs are not added on to all the different flights equally however are based on the ABC analysis, to do justice to each of the travels. Utilities: The usage of utilities as already mentioned earlier are very important based on the nature of the business. The utilities of the company again need to correctly be allocated among the various flights that are operated within the company. Equipments / Planes: Since the business depends completely on the planes/ equipments, it is essential that this is taken into consideration. There are a number of different expenses that are involved, like renting of the planes, or even repairing of the planes. These are normally very expensive and can eat into the profits of the company at time. Hence it sis essential to record these expenses as well. Cost Drivers: Every company has a few cost drivers. Cost drivers are aspects of business which the company does not have control over. These cost drivers generally cause a cost to be incurred. The two main cost drivers of airline business are normally: Labor: This is estimated to be the highest cost driver within the airline industry. It is essential to understand that the cost of labor is calculated in the airline industry based on collective bargaining. Thus any changes to this can be very tedious and a long procedure. In the case of Southwest Airlines, the company in 2006 has employed 68 employees per plane when compared to an average of 75 people. Also the company has been able to cut down further the prices of labor by further reducing the number of employees per plane to 66. These steps adopted by the company have helped the company save on compensation to employees and the wages. These changes have resulted in the company’s operating costs to be increased (almost $10.04 per passenger when compared to the average of $6.56). Fuel: The second huge expense for airline companies is the fuel costs. These costs account to almost 15% of the total costs. Most companies pass these costs to the customers by increasing the prices of the tickets. However in the case of Southwest Airlines, which has planned its strategies well in advance and have concentrated a lot on the hedging on the fuel prices (Wall St., 2007). The company has contracts that have been fixed, so as to allow the company to pay a fixed price for the fuel irrespective of the current selling price in the market. For instance, the company has had to pay $1.98 per gallon irrespective of the fact that the current selling price of the jet fuel is $ 2.60 to $2.65 per gallon. The company has been able to save a lot of money by entering into these contracts and is the safest while being protected from the fuel volatility. On an overall basis the company has saved close to almost $686 million in fuel expeses in 2007. The company has already hedged the fuel costs until 2012. The table below shows the hedging summary. Table 2: Hedging Summary: Southwest Airlines (Wall St, 2007) The above mentioned factors i.e. Labor and fuel, are two factors which do not fall under the control of Southwest airline. It is not possible for the company to change the prices neither is it possible for the company to reuce the consumption of these factors. It is essential to even note the indirect costs of the company. The main reasons for the indirect costs can be delays, fuel inefficiencies, and maintance (Vause, 2004). Conclusions: From the above discussion it is seen that Southwest airlkines the pioneers of the low – cost model, have seen immense growth over the years and now stand at the sixth position in terms of revenues. Also the company has had the most number of customers since 2006. The company has kept up its high performace throughout and has ensured all the steps taken to ensure complete safety of the passengers. The recommendations to Southwest Airlines would be just one, the company can concentrate of business customers. This would prove to be reletavely easier since the business travelers are normally less demanding and less price sensitive. This would be one of the most profitable implementations that the company could include over the already well developed business. References 12 Manage, 2008, ‘Activity Based Costing (ABC)’, 2008, Accessed on 09 November 2008, Retrieved from http://www.12manage.com/methods_abc.html Henkle, A., Lindsey, C., Bernson, M., ‘Southwest Airlines’, Accessed on 12 November 2008, Retrieved from ocw.mit.edu/NR/rdonlyres/Sloan-School-of-Management/15-761Operations-ManagementSummer2002/7370C22B.../lec25swa.pdf LaGrange, G. L., 2001, ‘Armys Directorate of Logistics Saves $6 Million with Activity Based Costing’, Accessed on 17 November 2008, retrieved from http://findarticles.com/p/articles/mi_hb6527/is_/ai_n28827935 TDWI, 2005, ‘Keeping Southwest Airlines One of the World’s Safest Carriers Is No “Accident”’, 20 November 2005, Accessed on 17 November 2008, Retrieved from http://www.tdwi.org/Publications/WhatWorks/display.aspx?id=7713 Vause, C., ‘Fueling Historical Losses - How Rising Fuel Costs Have Exposed Strategic Flaws in the Airline Industry’, Issue 6, Summer 2004, Accessed on 17 November 2008, Retrieved from http://virtualstrategist.net/Issue6/6-2-1.HTM Wall St., 2007, ‘Southwest Airlines: Losing Its Fuel Hedge Competitive Advantages’, 19 April 2007, Accessed on 18 November 2008, Retrieved from http://www.247wallst.com/2007/04/southwest_airli.html Axia College Material Appendix C Week Three Cost Accounting Journal Questions Respond to the following questions (25 points): 1. Which publicly traded company will you use for the final project? I choose Southwest Airlines. 2. Based on publicly available information for your company, can you tell if the company uses an activity-based costing system? What advantages do you think an activity based costing system provides or would provide (if any) for this company? Explain your answer based on the characteristics of activity-based costing systems and what you have learned about your company. Yes, Southwest Airlines uses an ABM/ABC system. The use of this system helps SWA to offer the cheapest air fares possible. In addition, SWA offers their customers the option to purchase their tickets online which eliminates the need for travel agent’s commission and this reduces the cost of printing airline tickets. 3. Identify any ethical issues that might arise in this organization. I could only find good comments regarding ethical issues for this organization. It appears SWA really lives up to its reputation. 4. Consider the budgeting needs of the organization you’ve chosen. Though the company’s budget may not be publicly available, answer the following questions based on available information and your knowledge of budgets. List three kinds of budgets you would prepare as part of an operating budget for the organization. Explain why you think each of the budgets would be included in the company’s operating budget. a.) Sales budget – this will include the number of products sold and the sales price per unit. b.) Manufacturing costs (materials, labor, and overhead) – provides the number of units that were produced. c.) Administrative expenses – entails the variable or fixed operating expenses for each department of the organization. List three activities that would be included in an activity based budget for the organization. Explain why you think these activities would be part of the company’s activity based budget. a.) Equipments – costs of rental or repair b.) Labor – pay for labor employees c.) Utilities – are used as part of the production process Cost Accounting Journal Questions Respond to the following questions (25 points): 1.) Based on publicly available information for your company, can you discern what the cost drivers are for your company? If you can, what are they? If not, what cost drivers do you believe are relevant for your company? The potential cost drivers for Southwest Airlines appear to be fuel and labor. Fuel is especially the most volatile driver because fuel makes up for 25 percent of the total costs for airline operation. 2.) Why do you consider them cost drivers? I considered them cost drivers because SWA is unable to control the cost of fuel. In addition, they do not want to pass the additional costs of fuel onto their customers so this hurts them financially as well. Unless, SWA can control their fuel usage they will not be able to gain a competitive advantage. 3.) Based on your company’s publicly available financial information and other publicly available information about your company’s operations, determine what sort of indirect costs your organization has and why. I believe SWA’s indirect costs can include delays, fuel inefficiencies, and maintenance. All these factors affect the company’s indirect costs because the total cost differs between how the airline can reduce its cost. Read More