Airline industry

Introduction & Rationale for the Issues

The airline industry is one of the most analyzed and researched areas in industrial and business economics. This focus on the industry is due to the noted opportunities that exist and define competitive advantages. Southwest is an important player in the overall market and faces many opportunities, due to the necessary industry and competitive advantages available to the firm. Although the overall industry seems to have many areas or processes that are important, it is clear that Southwest has tremendous opportunities to expand and increase profits. More specifically, there has been tremendous growth in the sector, and this presents an opportunity for Southwest to develop strategically and take advantage of the necessary economies of scale. Also, code sharing deals with ATA, makes it possible for Southwest to continually gain a competitive advantage as it directly meets the needs of the consumers. It is also clear that the relationship air travel has with its substitutes allows Southwest to explore how price changes can be advantageous for profit growth.

Strategy Direction and Action

Strategic Vision

Southwest has established clear objectives that include:

  • Grow the value of our existing brands and expand their product portfolio
  • Confront ongoing market challenges that have limited the growth. These challenges - created by changing consumer tastes and an evolving traveling environment
  • Seize share of this growth by achieving our goal and creating better balance in our portfolio.
  • Work with affiliates and other services to seek opportunities for new brands and products.

The mission of the Southwest can be summarized within the strategic principles outlined by the company below:-

To guide this effort, Southwest's leadership team has identified three strategic priorities:

  • Strengthen brand portfolio by growing the value of existing brands and significantly expanding product portfolio;
  • Transforming the market model and improve efficiency and effectiveness;
  • Establish a winning, inclusive culture as Southwest attracts, develops, and retains a talented and diverse workforce.

Internal Analysis

Financial Analysis

        Southwest faces almost one-to-one current ratio; with 0.90 and 0.88 in 2006 and 2005 respectively. This is not surprising in a sector that has a lot of its assets in capital equipment and machinery however when compared to the industry average, it seems that SOUTHWEST will have problems with their short-term obligations.

The accounts receivable ratio fell slightly between 2005 and 2006, even though the overall sales/revenues increased. By maintaining accounts receivable, Southwest is indirectly extending interest-free loans to their clients. This high ratio implies either that Southwest operates on a cash basis or that its extension of credit and collection of accounts receivable is efficient.

The average collection period for Southwest is favorable since it takes customers 43 days in 2006 to pay their bills (up from 41 days in 2005), indicating the effectiveness of credit and collection policies of Southwest.

Inventory turnover is favorable. However the increase in inventory level from 2005 to 2006 may be unhealthy since it represents an investment with a rate of rerun of zero and it opens the Southwest up to trouble should prices begin to fall. However, the turnover statistics implies good sales and some level of effective buying.

Given that Southwest is in a more capital-intensive industry the debt to equity ratio that is approximately 1.5 is healthy for Southwest. If a lot of debt is used to finance increased operations (high debt to equity), Southwest could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing.

Similarly, the long-term debt to total assets implies that the company's reliance on debt for asset formation is not that risky and Southwest is less likely to have a repayment burden. The times interest earned based on the trend from 2005 to 2006 is stable, especially with the increase in earnings before interest and taxes from 2005 to 2006. However in 2005 the times interest earned were 2.2. This might be indicative of the fact that the creditworthiness of Southwest is increasing slightly over time, especially in wake of the fact that are in a highly capitalized industry.

        The total margin comparison is done across industries rather than over time, given the analysis within the industry for Southwest currently operates faces similar percentages.

        Return on assets and return on equity is favorable in 2006 at 0.5% and 0.8% in 2006. However, in 2006 with a net loss for Southwest only (the company had a consolidated profit when Jazz and the Inter-segment elimination was included), then the ratios are negative and this is similar across industries, as companies engage in expansion strategies that will benefit the industry overall but affects the measure of how well the companies used reinvested earnings to generate additional earnings.

        The net profit margin was 0.6% for the consolidated operations in 2006 and was 0.8% in 2005, even though revenue increased in 2006. This decline is attributed to the rise in expenses associated with aircraft maintenance fees and commissions.

        The earnings per share in 2006 were unfavorable when compared to that of its major competitors. The significant drop in the price/earnings ratio has been associated with the new product lines that have attracted.

Organization's Management

        Officers at Southwest are considered the highest-ranking employees/executives. As the highest-ranking executives at Southwest then the roles of officers are identified as 'strategic roles', since they are the core of the organizational structure.

External Analysis

Rising Fuel Prices

        Southwest Airlines prides itself in being able to offer low prices, and this has given the company a competitive edge. However, with rising fuel prices, Southwest will face a higher cost of production, and prices for air travel will increase. This is disadvantageous for Southwest Airlines who is known as the low price carrier. The rise in fuel prices will lead to a rise in air travel on Southwest for consumers. As the price of fuel rises, this leads to a decrease in supply (notice the demand curve shifts to the left). This will cause the price of travel on Southwest Airlines to rise from P0 to P1. This is a major threat to Southwest Airlines, since the airline is known for its low prices. Due to the price increase, the quantity of customers, which travel on the airline, will decrease;it is a movement from Q1 to Q0. What is the recommendation to combat this threat?

To implement this policy it is necessary for Southwest Airlines to engage in expansive capital investment that will lead to overall investment within the company. There is some much technological advancement that utilizes mechanisms that have fuel efficiency as a major facet of the aircrafts; Southwest Airlines needs to be engaged in this type of capital investment. For example, the landing of the Airbus A380 at Los Angeles International airport a couple of weeks ago showed that a major advantage of the new aircraft is that of fuel efficiency.

Technology

Technological advancements have the direct effect that leads to increased opportunities for Southwest Airlines. As changes in technology will affect production and operations at Southwest, it will lead to increased efficiency and expansion. This can be characterized as an increase in supply. However, as supply increases, equilibrium price falls, which then caused demand to increase. Hence the change in technology can also have an indirect increase in demand, which represents an opportunity for expansion.

Competitive advantages within the airline industry have taken a new form, and technology is at the helm of this change. Technological advancements have allowed communication and transportation technology to cost less and be more will result in increased efficiency for companies like Southwest Airlines. Southwest Airlines should take advantage of the necessary economies of scale (lowering average costs) so that they can gain a competitive advantage in the industry and reduce the threat of the rising fuel prices.

In conclusion, Southwest Airlines is within an industry that is now facing a significant amount of threats, some are economic, and some are structural. Fuel prices happens to be an issue that is in both areas, hence it is not easily rectified, however, technological advancements provide the necessary prerequisite to deal with this problem in a rather efficient way, by providing the necessary tools, to increase supply and simultaneous use less fuel, which lowers the input cost. Southwest Airlines has a successful model that uses a low pricing mechanism to retain and attract customers. Increasing fuel costs is a threat to this model, as such there has to be a remedy in place to alleviate the negative externalities associated with this. The use of technology is the optimal recommendation, with added benefits in other areas, which will help Southwest Airlines to regain efficiency.

Porter's 5 Factor Analysis

        Southwest does not have good short-term liquidity however, this is expected, since the company has mostly long-term assets and the associated current liabilities within a heavily capitalized firm like Southwest will not be covered by current assets completely.

        Southwest is within a very competitive industry that requires the company to be innovative and continually develop services that can meet market demand and changing consumer tastes. The financial analysis shows that Southwest is competitive and has a strong financial outlook when compared to the industry.

Similarly, the company faces supply-side challenges such as higher fuel costs, regulations, and strategic competition from other airlines. These activities can cause the price of services to increase and affect the overall revenue of the firm, hence Southwest has to improve marketing activities and maintain clients to face favorable profitability and financial ratios.

The recommendations are based on the analysis that focuses on how the company implements a strategic objective of increasing loyalty and profitability of customers by directly providing services that are useful to the organization.

The bargaining power of buyers is highlighted by the fact that Southwest wants to increase brand loyalty, hence the strategic marketing activities, which reinforces elements of the marketing mix and helps to alleviate the bargaining leverage of the buyer. In the airline sector industry demand is highly elastic since there are many substitutes, Southwest minimizes the threat of the buyer power, by making demand more inelastic since they offer a wide array of services across different categories of travel goods and products that are different from competitors, this is unique and lessens the threat just being a similar product in a vast market and creates a unique product differentiability for Southwest.

Based on the analysis of the buyer power above, it is clear that ideally the threat of substitutes exists, but Southwest minimizes this creating brand loyalty via their strategic business process, which is the idea behind focusing on the investor only and removing the conflict of interest typical within the industry.

There are serious barriers to entry in this market structure, especially as it relates to the high fixed costs and the large start-up cost for an airline. This explains Southwest's integration of a strategic process, so that they can maintain their profitability from and leverage economies of scales. There are very some absolute cost advantages, the inputs needed are difficult to acquire, in the sense that buying an aircraft and dealing with the regulations to make it a passenger aircraft is expensive and requires a lot of investment, capital requirements are high; since the industry is highly capital intensive, and the distribution channel is specialized in travel related industries. Southwest exists in a market that has little freedom of entry, hence they have to continually improve and maintain a competitive advantage to maintain economies of scale and to remain profitable.

  • Thompson, A., and Gable, J., (2008). Southwest Airlines in 2008: Culture, Values, and Operation Practices. Strategic Management

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