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SWA CASE STUDYProfessor WilliamsGroup 2 Bernard, Colon, Earl, WalkerSouthwest Airlines: LUV Conquers All

Southwest Airlines

• Since 1971 Southwest Airlines has turned heads with their unique strategies. Starting with a mission statement of “The mission of Southwest Airlines is dedication to the highest quality of Customer Service delivered with a sense of warmth, friendliness, individual pride, and Company Spirit. For forty-four years Southwest has delivered. Truly a company that has exceeded all expectations and become a jet setter in the Airline industry.

Strengths

• Financial stability• Iconic Branding• Strong domestic demand • Employee Moral• Organizational Processes and routines

Opportunities

• Population growth• Increased air travel• New technology • Wright Amendment repeal• New international operations

Threats

• Reduced air travel• Increased Competition • Shortcoming on Shareholder

expectations• Cost Rising

Weaknesses

• Lack of revenue opportunities• Limited flights available• Contract obligations with Boeing

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Primary factorsSWA CASE STUDY

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Financial Stability Maintaining a strong balance sheet, the end of 2nd quarter of 2014 they held a leverage of 37% and cash in hand of 4 billion USD. The beginning of 2014 Southwest generated 1.6 billion of free cash flow. In June of 2014 a reduction of debt and capital leases were at 1.5 billion. Southwest has meet and exceed economies of scale a tough goal for this industry.

Iconic BrandingDeemed the top travel brand and fifth overall brand by The Business Journals in the American Brand Excellence Awards it is one of the most recognized brand in the US. Advertising in high profile sporting events and social media is it consistently exploiting its heritage. A important differentiation in a commodities industry, not going along with the crowd and forgoing revenue is perhaps albeit and not easily accountable.

Strong domestic demand The US market is in strong demand with an 8% passenger unit revenue growth for the 2nd quarter of 2014. This is another record SWA holds the largest gain by an airline. Data from CAPA and OAG suggests that Southwest is the second largest airline in the domestic market when measured by seat deployment.

Employee MoralAs for human resources, it is considered this to be one of Southwest’ greatest strengths. They consider “the people” to be one of their greatest assets. Southwest has branded themselves with a reputation for creating innovative programs to generate an increase in productivity and create ideas to cut cost for a continual affordable airfare for the customer. They have also formulated a collaboration of experience, knowledge, judgment and skills into their legendary “Southwest Way”, which teaches the art of the “warrior spirit”, “the servant’s heart”, and a “fun-LUVing attitude”.

StrengthsSWA CASE STUDY

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Lack of revenue opportunities Rejecting the standard yet again and not "unbundling" as the competitors have done in recent years. Ancillary revenue remains the greatest opportunity to increase medium and long term revenue.

Limited flights availableSouthwest has few flights offered in the morning and until 2015 offered no service to international destinations.

Contract obligations with BoeingThey are currently dependent on a single maker of aircraft, preventing them from purchasing from other suppliers that may offer larger less expensive aircraft.

WeaknessesSWA CASE STUDY

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Population growthThe rise in the elderly and Hispanic population are potential markets that Southwest is currently in the process of exploiting by the expansion into the international flight, beginning with flight to Mexico and South America in 2015

Increased air travel Despite the regulations and complaints of the newly established TSA air travel is predicted to increase rapidly in the next ten years.

New technology Newly developed technology is making air-travel safer and more pleasurable by offering Wi-Fi, streaming movies and up to date weather reports being broadcast on board. Being able to offer these and maintain a low-cost fare will continue to make SWA number one.

OpportunitiesSWOT ANALYSIS

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Reduced air travel The ever changing political and financial markets can have a huge impact on the cost of fuel which in turn can reduce travel in any form especially air travel. A decline in leisure travel due to terrorism and a depressed economy. The development of high speed rails can reduce the number of short flight commutes. Along with the probability of rising airfares is likely due to the inability to implement more cost cutting measures.

Increased Competition. Competing on the basis of customer service, low cost, frequency and convenience of booking travel along with frequent flyer benefits is a tough gig. Competitors are taking notice and strategically positioning themselves to maintain their current standings. With many competitors having assets such as large fleets and branding this can be a difficult hurdle for Southwest in the coming years

Shortcoming on Shareholder expectationsFailing to meet expectations will decrease the value of the company’s stock causing the company difficulty to raise capital needed in both short term endeavors as well as long term financing such as the purchase or expansion of the number of aircraft.

Cost RisingSouthwest labor negotiations are making it tough to predict its unit cost increases in the medium to long term. For the moment its unit costs are in line with major airlines, rising 2% in 1H2014 as passenger unit revenues grew a healthy 6% during that time. Salaries, wages and benefits represented 31% of the airline’s total top-line expenses.

ThreatsSWOT ANALYSIS

S OFinancial StabilityMaintaining a strong balance sheet, the end of 2nd quarter of 2014 they held a leverage of 37% and cash in hand of 4 billion USD. The beginning of 2014 Southwest generated 1.6 billion of free cash flow. In June of 2014 a reduction of debt and capital leases were at 1.5 billion. Southwest has meet and exceed economies of scale a tough goal for this industry.

Iconic BrandingDeemed the top travel brand and fifth overall brand by The Business Journals in the American Brand Excellence Awards it is one of the most recognized brand in the US. Advertising in high profile sporting events and social media is it consistently exploiting its heritage. A important differentiation in a commodities industry, not going along with the crowd and forgoing revenue is perhaps albeit and not easily accountable.

Strong domestic demand The US market is in strong demand with an 8% passenger unit revenue growth for the 2nd quarter of 2014. This is another record SWA holds the largest gain by an airline. Data from CAPA and OAG suggests that Southwest is the second largest airline in the domestic market when measured by seat deployment.

Population growthThe rise in the elderly and Hispanic population are potential markets that Southwest is currently in the process of exploiting by the expansion into the international flight, beginning with flight to Mexico and South America in 2015

New technology Newly developed technology is making air-travel safer and more pleasurable by offering Wi-Fi, streaming movies and up to date weather reports being broadcast on board. Being able to offer these and maintain a low-cost fare will continue to make SWA number one.

New technology

Newly developed technology is making air-travel safer and more pleasurable by offering Wi-Fi, streaming movies and up to date weather reports being broadcast on board. Being able to offer these and maintain a low-cost fare will continue to make SWA number one.

Positive factorsSWA CASE STUDY

W TLack of revenue opportunitiesRejecting the standard yet again and not "unbundling" as the competitors have done in recent years. Ancillary revenue remains the greatest opportunity to increase medium and long term revenue.

Limited flights availableSouthwest has few flights offered in the morning and until 2015 offered no service to international destinations.

Contract obligations with BoeingThey are currently dependent on a single maker of aircraft, preventing them from purchasing from other suppliers that may offer larger less expensive aircraft.

Increased Competition. Competing on the basis of customer service, low cost, frequency and convenience of booking travel along with frequent flyer benefits is a tough gig. Competitors are taking notice and strategically positioning themselves to maintain their current standings. With many competitors having assets such as large fleets and branding this can be a difficult hurdle for Southwest in the coming years

Reduced air travel The ever changing political and financial markets can have a huge impact on the cost of fuel which in turn can reduce travel in any form especially air travel. A decline in leisure travel due to terrorism and a depressed economy. The development of high speed rails can reduce the number of short flight commutes. Along with the probability of rising airfares is likely due to the inability to implement more cost cutting measures.

Shortcoming on Shareholder expectationsFailing to meet expectations will decrease the value of the company’s stock causing the company difficulty to raise capital needed in both short term endeavors as well as long term financing such as the purchase or expansion of the number of aircraft.

Negative factorsSWA CASE STUDY

Strategic AlternativesThe goal of Southwest Airlines is to make air travel available to people who could not afford it. Their profit-making strategy includes keeping prices at rock bottom prices. The company is more interested in minimizing prices, instead of capitalizing on profits. Their ultimate goal is supported by the following lists of strategic objective, followed with alternative capable of accomplishing the respective objectives.

Recommendations & AlternativesSWA CASE STUDY

Strategic Issues and Recommendations

Southwest strategic issues can be summarized into two

categories. Southwest maintain its low cost advantages in the

airline industry. Second, Southwest will need to be able to

maintain its growth through its current operational strategy.

Maintaining Cost

Most of the discount airlines have attempted to challenge

Southwest’s position for low cost. As CASM increases,

Southwest has become vulnerable and at time, appears to be

losing its market advantage. Southwest needs improvement

with non-fuel cost management. Many of the other

operational costs will be harder to control with its current

market position, Southwest can take steps to guarantee that it

can maintain its low cost advantage.

Southwest Airlines Financial Ratios and Measures

LIQUIDITY 2014

Current assets 4.4 Billion = .743 Current Liabilities 5.92 BillionCurrent ratio indicates that Southwest struggles to meet its’ short term obligations.Current assets minus inventories 4.39 Billion =.75Current Liabilities 5.92 Billion Acid ratio indicate that Southwest cannot pay their current inventories and should be looked at with extreme caution.LEVERAGE 2014

Total debt 13.43 Billion= .66 Total assets 20.2 BillionDebt ratio indicates that 66 percent of Southwest assets are financed by debt. This percentage of debt can be a challenge to manage. Even though Southwest has more assets than debt it can be considered a high risk level company.Total Debt 13.43 Billion= 2Total Equity 6.78Billion Considering that in 2014 Southwest has a high debt/equity ratio it indicates that they have been aggressively financing their growth debt, which can result in volatile earnings as a result of the additional interest expense.Profits before interest and taxes 355 Million= 2.6Total interest charges 139 MillionSouthwest’ (times interest earned) is 2 ½ times higher than its interest expense for the year which indicates that creditors can trust that they are able to pay their interest payments when they come due.ACTIVITY

Sales 13.111 Million= .38Inventory 342 MillionInventory turnover for Southwest is .38 which means they sold over a third of their inventory.

Fiscal year is Jan - Dec. 2014 2013 2012 2011 2010

Cash 1.28B 1.36B 1.11B 829M 1.26B

Marketable Securities 1.71B 1.8B 1.86B 2.32B 2.28B

Receivables 365M 419M 332M 299M 195M

Inventory 342M 467M 469M 401M 243M

Raw Materials - - - - -

Work In Progress - - - - -

Finished Goods - - - - -

Notes Receivable - - - - -

Other Current Assets 709M 418M 702M 764M 517M

Southwest Airlines Total Current Assets 4.4B 4.46B 4.23B 4.35B 4.28B

Property Plant & Equipment 22.51B 20.82B 19.5B 18.42B 16.34B

Accumulated Depreciation 8.22B 7.43B 6.73B 6.29B 5.77B

Southwest Airlines Net Property Plant & Equipment 14.29B 13.39B 12.77B 12.13B 10.58B

Investment & Advances - - - - -

Other Non-Current Assets - - - - -

Deferred Charges - - - - -

Intangibles 970M 970M 970M 970M -

Deposits & Other Assets 534M 530M 633M 626M 606M

Southwest Airlines Total Assets 20.2B 19.35B 18.6B 18.07B 15.46B

Notes Payable - - - - -

Accounts Payable 1.2B 1.25B 1.11B 1.06B 739M

Current Portion Long-Term Debt 258M 629M 271M 644M 505M

Current Portion Capital Leases - - - - -

Accrued Expenses 1.57B 1.23B 1.1B 996M 863M

Income Taxes Payable - - - - -

Other Current Liabilities 2.9B 2.57B 2.17B 1.84B 1.2B

Southwest Airlines Total Current Liabilities 5.92B 5.68B 4.65B 4.53B 3.31B

Mortgages - - - - -

Deferred Taxes/Income 3.26B 2.93B 2.95B 2.64B 2.58B

Convertible Debt - - - - -

Long-Term Debt 2.99B 2.63B 2.88B 3.11B 2.88B

Non-Current Capital Leases - - - - -

Other Long-Term Liabilities 1.26B 771M 1.12B 910M 465M

Southwest Airlines Total Liabilities 13.43B 12.01B 11.6B 11.19B 9.23B

Minority Interest - - - - -

Preferred Stock - - - - -

Common Stock Net 808M 808M 808M 808M 808M

Capital Surplus 1.32B 1.23B 1.21B 1.22B 1.18B

Retained Earnings 7.42B 6.43B 5.77B 5.4B 5.4B

Treasury Stock 2.03B 1.13B 675M 324M 891M

Other Liabilities -738M -3M -119M -224M -262M

Southwest Airlines Shareholders Equity 6.78B 7.34B 6.99B 6.88B 6.24B

Southwest Airlines Total Liabilities & Shareholders’ Equity 20.2B 19.35B 18.6B 18.07B 15.46B

Southwest Airlines Annual Balance Sheet Financial Ratios

Strategic Alternatives

The goal of Southwest Airlines is to make air travel available to people who could not afford it. Their profit-making strategy includes keeping prices at

rock bottom prices. The company is more interested in minimizing prices, instead of capitalizing on profits.

The success of Southwest Airlines is determined by hosting the strongest balance sheet and highest credit rating in the industry. Southwest’s pricing

strategy involves the application of price resistance to perfect a system-wide peak and off-peak pricing system. Their strategy involves dividing the short-

haul market into executives and pleasure travelers. This results in cheaper flights in the evening. In the event of full aircraft, the fare-determination

strategy does not call for an increase in the fare. Instead, they increase the number of flights. Their hiring strategy involves a panel interview, complete

with a presentation by the prospective employee.

Diversification is the best way to ensure a steady revenue stream, although Southwest is not known for servicing, shipping or reservations. The best way

for Southwest to diversify is simply by expanding their market. Saving and investing a portion of retained earnings could also smooth the peaks and

valleys of travel fluctuations. A shakeout strategy must be developed to overcome intense pricing competition and cyclical effects of the industry.

Investors selected to work for Southwest Airlines must have a proven track record. Professional financiers only quote the textbook and seldom have any

common sense or profit to back their knowledge.

In observation to the history of Southwest Airlines, they have accomplished over 39 years of profitability. Some of the core attributes contributing to

their accomplishment consist of: legendary customer service, functional strategies and low cost advantage for (operations, maintenance and training).

Highlighting a few of their strategic strengths, Southwest Airlines strategically focuses primarily on point-to-point travel for more direct trip flights,

shortening the passenger trip length. Also, the decision to use a specific type of aircraft “Boeing 737” for simple scheduling, operations, maintenance

and training. Southwest also benefited from fuel hedging in which they pay up front for the right to buy fuel at certain, lower prices (Strategic

Management in Action 250).

As of 2014, Southwest hit 42 years of profitability. According to the shareholders 2014 annual report their net income of $1.1 billion easily surpassed the previous annual record in 2013. Excluding special items, Southwest’s record earnings surged over 73 percent, compared with 2013. Other strategic initiatives launched since 2010 also helped propel our earnings performance, including the Rapid Rewards, frequent flyer program, the addition of the Boeing 737-800 model, and the fleet modernization program. To commemorate the historic year, record results, and transformation, Southwest Airlines unveiled a bold new look for their aircraft and nual report to shareholders 1). branding. They believe the completion of their strategy to transform, along with the record results, positions Southwest exceptionally well for the future (2014 annul report to shareholders).