Reference no: EM131607106

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Southwest Airlines began with flights within the state of Texas as a regional airline operating four aircraft. When airline deregulation occurred nationally in 1979 Southwest Airlines expanded their coverage to include New Orleans, Louisiana. (Swamedia.com). Today Southwest Airlines is the third largest airline company in the world and since June 2011 carries the most domestic passengers of any airline in the United States. (International Air Transport Association) Southwest Airlines is currently ranked number 161 on Fortune Magazine's list of top 500 companies worldwide. (Fortune)

Southwest Airlines utilizes a business strategy of providing passenger service to regular routes and providing airfare rates, in many instances, as low as one-third that of their competitors in the same markets. Through this initiative Southwest has recorded 40+ straight years of profits. (Southwest.com)

The market opportunities that are most relevant to Southwest Airlines are those that offer distinct areas for growth, and most potential for advantage over competitors. Southwest Airlines chose to land in smaller airports closer to big cities making it more convenient for the customer. The travel time is greatly reduced in a smaller airport with fewer planes, and Southwest can get more air passenger from city to city. Only recently, as of 2012, has Southwest Airlines increased their flight schedules to major cities, such as New York, Atlanta, and Chicago. (Wall Street Journal)

Southwest Airlines utilizes price discrimination in setting ticket prices within its serviced markets. Price discrimination is a pricing strategy where identical goods or services are transacted at different prices by the same provider in different markets. Price discrimination relies on the variation in the customer's willingness to pay. (Robert Phillips)

The purpose of price discrimination is generally to capture the market's consumer surplus. This surplus arises because, in a market with a single clearing price, some customers, representing the very low-price elasticity segment, would have been prepared to pay more than the single market price. Price discrimination transfers some of this surplus from the consumer to the producer/marketer. Strictly, a consumer surplus need not exist, for example where some below-cost selling is beneficial due to fixed costs or economies of scale. (Robert Phillips)

Southwest Airlines identifies different consumer groups within the market, each with a different demand curve. Southwest recognizes that any given flight will have different types of travelers, either those travelling on business or those on vacation. To provide the greatest possible profit, Southwest establishes a price for each of these types of travelers by equating marginal revenue and marginal cost by using the Inverse Elasticity Pricing Rule (IEPR).

The IEPR states that the difference between the profit maximization price and marginal cost, expressed as a percentage of price, is equal to minus the inverse of the price elasticity of demand.

Thus, Southwest Airlines will maximize profit by charging 2.63 times as much for a business travel ticket as it charges for vacation travel ticket. The exact prices of the tickets will depend on the marginal cost. (T.H.Oum and J.S.Yong)

A contributing factor in profit margins and shares is Southwest's emphasis on cost reduction and cost control. One area that sets Southwest Airlines apart from their competitors is the fact that they operate the world's largest single source fleet of Boeing planes. As of December 2014 Southwest operated approximately 650 Boeing 737s and 75 Boeing 717s.

Because Southwest does not provide direct flights to far-reaching overseas destinations, which would require longer flight ranges and more fuel storage, the Boeing 737 has proven to be the perfect plane to operate.

As other airlines operate up to ten different models and types of aircraft, Southwest's singular operation of the Boeing 737 creates cost saving measures such as only having to train mechanics on one type of aircraft; supply parts inventory is limited to the requirements of one plane type; the ability to swap planes or crews at a moment's notice don't create problems as the flight crews and ground crews are already familiar with the plane.

Southwest utilizes a point-to-point service method versus a hub-and-spoke method used by a majority of its competitors. This allows Southwest Airlines to provide more flights to more people at a lower cost within specific regions of the United States. How Southwest's method works is they fly from point A to point B, discharge their passengers, then fly from point B back to point A. The plane and crew fly these same routes, as many as six times a day. In this method, flight times are relatively similar (taking weather into account), and because of the aforementioned plane-to-ground crew familiarity with using Boeing 737s, ground time is minimized, so efficiencies in fuel savings and departure times are maximized. Southwest Airlines has proven that a point-to-point system results in higher utilization of aircraft and terminal facilities and is more cost efficient for their purposes than a hub-and-spoke method of service delivery.

In a hub-and-spoke method, a hub is a central airport that flights are routed through, and spokes are the routes that planes take out of the hub airport. Most major airlines have multiple hubs. They claim that hubs allow them to offer more flights for passengers. (Howstuffworks.com)

The cost effectiveness strategy of Southwest Airline is carried out with the intention of giving quality service to customers at a low-rate, compared with its competitors. The strategy of cost leadership has been adopted by Southwest Airlines since the organization's beginnings. At the beginning the move to gain market footings, senior management opted to offer flights at low prices. This strategy has stuck with Southwest, where today it is considered as the most cost effective flight carrier, with a large number of customers who fly with the airline. (Forbes)

Southwest Airlines, United Airlines, Delta Air Lines and American Airlines are the top ranked airlines based on 2014 domestic market share. Between January and December 2014 Southwest Airlines reached a total market share of around 17 percent. (Statista.com)

The cost effectiveness adopted by the organization is one that aims to maintain standard service delivery, with lean profit generation as a way of breaking into new markets. Thus, quality service is not sacrificed due to the delivery low-cost flights.

Another way Southwest Airlines ensures that the cost of operating stays low is their approach to purchasing fuel. Southwest has a longtime program to secure fuel prices. Southwest has purchased fuel buyout options for many years in advance. This is done to smooth out fluctuations in fuel costs based on government interference, potential price gouging by oil companies, and potential political unrest in the middle-east. Both in 2001 and 2008 Southwest Airlines substantially increased its bulk fuel buy practice in response to projections of increased crude oil prices.  (Southwest.com).

Southwest Airlines was at one time generally dismissed as an airline for not operating the business in a usual practice for the industry. However, its differentiated mode of operation paid off, as now it is known as a model that many other airlines try to copy in building their own strategic plans. Barriers to entry in the airline industry are relatively low, with capital requirements for aircraft procurement being the most restrictive element for new airlines to manage at startup. This hurdle is sometimes overcome through aircraft leasing options as well as external financing options from banks, investors and aircraft manufacturers. (Market Realist) Loyalty programs, such as frequent flyer miles programs, are used to keep customers across associations, but as switching costs are low for customers they are not very useful in keeping customer within an alliance between airlines.

Early on, Southwest Airlines was dismissed by economists and airline industry pundits as not having a robust business model or a traditional hub-and-spoke strategy like everyone else was using. It has been wildly successful since its inception by serving the need for low-cost, reliable air travel, and has achieved success in such a way as to not engender a competitive response until it was too late to matter from their competitors. . The low-cost strategy and the ability to innovate different patterns of operation in the airline industry, Southwest Airlines is now a model which many low-cost airlines look up to, and attempt to copy its creative strategies. The 'Southwest Effect' is the term given to Southwest Airlines strategy. (Ankli, 2006).