The Southwest Airlines - Research Paper Example

Introduction Southwest Airlines entered the interstate airline market in 1978, beginning as a small intrastate airline in Texas before 1978, then entering the interstate market after the Deregulation Act of 1978 (Dresner et al., 1996, p. 311). Its expansion took it to the California and Midwest markets in 1991, the East Coast markets in 1993, the Northwest in 1994 and Florida in 1996 (Dresner et al., 1996, p. 311). Its strategy from the beginning was to differentiate itself from other airlines, who use the hub and spoke method, by focusing on “dense, short-haul markets, on a point-to-point basis with frequent service” (Dresner et al., 1996, p. 311). Along the way, it refined its low price strategy by cutting down on food and beverage offerings, mandating open seating which increases capacity, flying only one type of plane, locking in low fuel prices when the fuel prices spiked in 2008, and favoring secondary markets such as Chicago Midway over congested markets, such as Chicago O’Hare. These strategies helped Southwest cut prices, and the result of Southwest’s ability to slash prices has been nothing short of astounding on the entire airline industry, resulting in fare cuts across the board, and substantially increasing airport traffic for the airports that serve Southwest in relation to airports that do not. The result of the impact of Southwest Airlines on the airline industry has been so significant that it was given a name – the “Southwest Effect”. Analysis Different studies have done different analyses on the Southwest Effect. Morrison (2001) performed a study on the aggregate effect of Southwest on Southwest’s competition, then compared the aggregate estimate with fare reductions that were the result of deregulation, as a way to quantify Southwest’s effect on the success of deregulation (Morrison, 2001, p. 241). Morrison stated that the airfares on a given route are influenced by another airline in three ways. First, is when the other airline serve a given route; second, when the other airline serves an adjacent route that is seen by consumers to be a reasonable alternative to the first route; and third, the other airline affects fares if the existing airlines on a route lower their fares in order to keep out potential competitors (Morrison, 2001, p. 241). Morrison quantified Southwest’s impact on each of these categories, stating that there was a potential for Southwest to impact 94% of domestic passenger miles (Morrison, 2001, p. 243). His unit of measurement for this impact was an equation regarding fare regression, which quantifies how an average fare regresses due to actual and potential competition, along with control variables that would also have an impact on the fares. His data came from the 1,000 most travelled routes (Morrison, 2001, p. 244). Morrison found that the savings that consumers realized because of Southwest competition was $12.9 billion, of which Southwest’s actual low fares accounted for $3.4 billion. The rest of the $12.9 billion was due to the other airlines lowering their fares in response to competition. This accounted for 20% of the domestic passenger revenue for that year. It also accounted for half of the fare reductions that were attributed to deregulation. This was a sizeable impact for Southwest, as it only accounted for 7% of passenger miles (Morrison, 2001, pp. 254). Morrison found Southwest’s disproportionate impact troubling and encouraging – troubling because one carrier could have such an impact, and encouraging because of the large impact on passenger welfare (Morrison, 2001, p. 254). That same year, Vowles conducted a study on the “Southwest Effect”, seeking to ascertain the impact that Southwest Airlines had on not only the airports it chooses to serve, but on airports within close proximity to the airports where Southwest had either an origin or destination (Vowles, 2001, p. 251). ). Vowles also sought a comparison to the “Wal-Mart effect”, as the “Wal-Mart effect”, with Wal-Mart’s emphasis on low prices, devastates the downtown areas of the cities and towns within which it locates, in both competing and non-competing retail types, because the presence of Wal-Marts attract other big box retailers to the areas where Wal-Mart is located. In this case, the “Wal-Mart effect” refers to the ability of Southwest to alter the prices of airfares at not only the routes and airports that Southwest serves, but also the surrounding airports and routes (Vowles, 2001, p. 251). The expectation is that, like Wal-Mart, Southwest will bleed traffic from surrounding airports, as consumers will drive to the airports servicing Southwest instead of going to the airport closest to them, which will lead to increased fares in the surrounding airports, which will lead to a further spiral at these airports (Vowles, 2001, p. 251). The study focused on regions that had multiple airports. Vowles found that in the Baltimore, Washington DC pairings, that the Baltimore to Chicago O’Hare, where Southwest did not serve, increased after Southwest entered the market by 74%, but the Baltimore to Chicago Midway route, which did have Southwest service, increased by 1855%, from 552 passengers in the quarter before Southwest entered the market to 10,790 passengers after (Vowles, 2001, p. 252). Meanwhile, Washington DC, the closest airport, which did not have Southwest service saw it services to both Chicago O’Hare and Chicago Midway decrease by over 50% (Vowles, 2001, p. 252). In the study of the Cleveland area, in the year before Southwest came in, service from Cleveland to Baltimore had an average fare of $172.65. After Southwest entered the market, the average fare for this route plummeted to $30.45 (Vowles, 2001, p. 253). The other routes studied were Cleveland to Washington Reagan national, whose fares dropped from an average of $150.94 to $82.33 in this span of time; and Cleveland to Washington Dulles, where the average fare went down from $150.94 to $100.74 (Vowles, 2001, p. 253). Only the route that was served by Southwest, Cleveland to Baltimore, increased passengers during this time, increasing 869% from 1624 to 15,730 during this time, while passengers in the other two routes dropped 15% (Vowles, 2001, p. 253). In the Cleveland to Chicago route, the passenger increase from Cleveland to Chicago Midway increased from 1031 passengers prior to the entrance of Southwest to 7046 passengers after, with average fares decreasing from $119.81 to $39.15 (Vowles, 2001, p. 253). Other markets studied by Vowles include Columbus, which saw the passengers from Columbus to Chicago Midway increase from 1166 passengers paying an average of $113.21 in fares before the entrance of Southwest, to 8642 passengers paying an average of $37.10 in fares afterwards, while the route from Columbus to Chicago O’Hare decreased from 5370 passengers to 4252 passengers during this same period, with these fares decreasing from $116 to $89.44; Jackson, Mississippi, whose three multi-airport regions – Chicago, Houston and Washington DC/Baltimore - all saw am increase in passengers after Southwest and a decrease in fares, while airports in the region that did not have a Southwest route dropped considerably during this same time period, the most drastic of these being the Washington DC/Baltimore routes, where the two routes not serviced by Southwest – Washington Dulles and Washington Reagan - both saw a substantial decrease in passengers and increase in fares due to Southwest, and the Southwest airport route to Baltimore increased passengers by 328% and decreased fares by 33%; Orlando, which also saw a substantial increase in passengers for its Southwest airport routes and a corresponding decrease in fare, with corresponding decreases in passengers and decrease in fares in the surrounding airports without a Southwest route; Manchester, where passengers increased in both Chicago O’Hare and Chicago Midway, and fares decreased in both, showing that the Chicago O’Hare flights were forced to cut prices to compete with Southwest; Manchester to Baltimore and Washington, where, before the entrance of Southwest, Baltimore lagged far behind the two Washington DC airports in numbers of passengers, at 245, then increased by 5,379% to 13,245 after Southwest, to take the lead over the other two Washington DC airports, while average fares dropped by 74%, while the traffic at the two DC airports either stayed stagnant or decreased; and Omaha, Providence, Louisville and Tampa, who all saw similar results (Vowles, 2001, pp. 254-256). Pitfield (2008) conducted a time series analysis on Southwest’s impact on individual routes and a market share comparison (Pitfield, 2008, p. 1). This study is helpful, as it provides updated data from Morrison’s and Vowles’ studies, thus enabling a comparison of Southwest’s affect over time. The routes studied by Pitfield included Washington-Chicago; Boston-Chicago; Bay Area-Chicago (Pitfield, 2008, pp. 8-14). The reason why Chicago was so represented in this study is because Southwest often uses this airport instead of larger airports (Pitfield, 2008, p. 4). Pitfield found that on the Washington to Chicago route, that the influence of Southwest has fluctuated over the years. United and American airlines dominated that route in the early 1990s, with a 90% market share. Then Southwest came into that route in 1993, and, in its first full year of operation, it garnered an 11% share and reduced United and American’s share to 80%, a 10% drop (Pitfield, 2008, p. 8). Southwest then increased its market share to around 15.5% for the years 1995-1997, before falling a bit in 1998 to around 14%. Southwest’s share hovered around 14% until 2003, before dipping to around 11% in 2005-2005, then coming back up to 13.5% in 2006 (Pitfield, 2008, p. 22). Pitfield states that the fluctuations appear to be because of the main carriers competing, and the impact of Independence Air, a short-lived airline (Pitfield, 2008, p. 8). On the Boston-Chicago route, United and American were again the dominant carriers, accounting for 90% of the flights between the years 1990 and 1995 (Pitfield, 2008, p. 27). In Southwest’s first full year, 1997, it garnered a 6.02% market share, then 7.85% market share, then started hovering between 10-12% market share between the years 1999 and 2004, before jumping to 17.22 % in 2006. During that time, the market share of the two big carriers, United and American, decreased steadily, ending up with a market share of 73% in 2006 (Pitfield, 2008, p 27). In the Bay Area-Chicago route, it was also initially dominated by United and American airlines, as they made up 98% of the routes in 1990. This dominance continued, even when Southwest entered the market in 2002, as the impact of Southwest in its first three years, 2002-2004 only equaled to around 8.5% of the market share. Then it jumped to around 16% in 2005 and 18.5% in 2006 (Pitfield, 2008, p. 29). Pitfield speculated that the market jump in 2005 could have been the result of a code share that Southwest made with ATA Airlines in that year (Pitfield, 2008, p. 13). Conclusion All these studies taken together show the immense impact that Southwest Airlines has had on the airline industry. Morrison’s study shows that the overall fares decreased substantially when Southwest entered the market. Vowles’ study went more into detail about the impact that Southwest had on individual markets, showing an exponential increase in markets where Southwest entered and a corresponding decrease in adjacent markets that did not feature a Southwest flight, and a general trend of a substantial decrease in average fares for all the markets studied – both the markets that featured a Southwest flight and the adjacent markets. Pitfield’s study showed the impact of Southwest markets over time. What is striking is that the Vowles and Morrison studies were conducted in 2001, and the Pitfield study showed that, generally, Southwest was a force to be reckoned with during the early 2000s, yet seemed to have a substantial jump in 2006 from the earlier days. Therefore, all of these studies taken together show that, if Southwest had an enormous impact in the early 2000s, before it experienced its 2006 bump, the impact is that much more enormous today. It is evident that Southwest’s model in keeping prices lower by focusing on secondary airports, such as Chicago Midway instead of Chicago O’Hare, flying a single type of aircraft, offering a single class of service and no pre-assigned seats, flying into smaller cities, the avoidance of hub and spoke systems used by traditional airlines, and focusing on quantity has had a significant impact on other airlines who were slow to adapt to the threat that Southwest posed. Other ways that Southwest is able to offer low fares is by keeping its food and beverage services no-frills, and avoiding aggregator services, like Expedia.com, only selling tickets on their website (Caucutt, 2010, p. 2). These strategies have helped Southwest keep its fares low, and has forced other airlines to do the same. While other airlines do have some advantages over Southwest – for instance, Southwest is only a domestic airline, and does not fly internationally – Southwest has repeatedly shown that it has the smartest business plan of any of the major carriers. For instance, in 2008, when the other airlines were floundering in the face of high oil prices, Southwest famously stayed profitable due to the fact that it hedged on fuel prices, locking them in at $51 a barrel that year, while the other airlines were paying $100 a barrel (Caucutt, 2010, p. 2). Another enormous advantage that Southwest supplies is their bags fly free (Caucutt, 2010, p. 2). At an era where other carriers are charging $50 or more to fly bags, this service is not only an incredible public relations gambit, but is a real value that is concrete for consumers. It also creates the impression that other airlines are money- hungry and somehow cheats because they charge for bags while Southwest does not. As a result, although not charging for bags costs Southwest around $300 million annually in lost fees, Southwest has more than made up that difference, as it estimates that the free bag feature has helped it grab an additional 1% of the marketplace, which is the equivalent to $800-$900 million, so it definitely has seen a return on investment in this particular gamble (Caucutt, 2010, p. 3). The recommendations to other carriers would be to obviously try to copy Southwest’s model as much as possible, including offering open seating, few refreshments and bags fly free. There is also some wisdom to not participating in aggregation services that compare flight prices, as these services make comparison shopping a bit too easy, which leads to ever more undercutting between competitors on the site. Of course, it is not entirely feasible for carriers to copy Southwest, since they need to fly bigger planes for international flights, and have corresponding costs on these flights, costs that Southwest, a strictly domestic carrier, does not have. Some carriers have attempted to address this problem by making alliances with other airlines, where the major carrier focuses on long-haul flights, with the alliance partner focusing on short-haul flights, such as the case with American Airlines and American Eagle (Shumsky, 2006, pp. 84-85). Perhaps the best recommendation would be for all major airlines who travel internationally to adopt the same type of model that American Airlines has, and make alliances with smaller carriers for short haul flights, while the major carrier focuses on international flights. Then the short haul flight carriers can copy Southwest’s business plan, while the major carrier can maintain its one advantage over Southwest, which is its ability to fly internationally. That way, the alliance should be profitable on both ends, which could help all the major carriers to become profitable once more. Sources Used Dresner, Martin, Jiun-Sheng Chris Lin, Robert Windle. “The Impact of Low-Cost Carriers on Airport and Route Competition.” Journal of Transport Economics and Policy 30(3)(1996): 309-328. Morrison, Steven. “Actual, Adjacent and Potential Competition: Estimating the Full Effect of Southwest Airlines.” Journal of Transport Economics and Policy 35(2)(2001): 239-256. Pitfield, D.E. “The Southwest Effect: A Time-Series Analysis on Passengers Carried by Selected Routes and a Market Comparison.” Journal of Air Transport Management 14(3)(2008): 113-122. Shumsky, Robert. “The Southwest Effect, Airline Alliances and Revenue Management.” Journal of Revenue and Pricing Management 5 (2006): 83-89. Vowles, Timothy. “The ‘Southwest Effect’ in Multi-Airport Regions.” Journal of Air Transport Management 7(2001): 251-258. Read More