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Southwest Airlines You are now free to move about the country.™

Southwest Airlines (Southwest), the once scrappy underdog in the U.S. airline industry, was one of the largest U.S. airlines and, based on number of passengers, one of the largest in the world. The company, unlike all of its major competitors, had been consistently profitable for decades and had weathered energy crises, the September 11 terrorist attacks, and the 2008-09 recession. An insight into Southwest’s operating philosophy can be found in the company’s 2001 annual report:

Southwest was well poised, financially, to withstand the potentially devastating hammer blow of September 11. Why? Because for several decades our leadership philosophy has been: we manage in good times so that our Company and our People can be job secure and prosper through bad times.… Once again, after September 11, our philosophy of managing in good times so as to do well in bad times proved a marvelous prophylactic for our Employees and our Shareholders.

Now in its 45th year of service, Southwest was facing some major challenges. Legacy carriers in the United States had become more efficient, and the mega-mergers involving Delta/Northwest, Continental/United, and American/US Airways were shaking up the industry. Smaller companies like JetBlue, Alaska, and Spirit were pressuring Southwest’s cost advantage and low-fare focus. Southwest had the highest labor cost per employee in the U.S. airline industry. With more than 50,000 employees, the company was a long way from the small scrappy upstart challenging the industry with its innovative strategy.

The U.S. Airline Industry The U.S. commercial airline industry was permanently altered in October 1978 when President Jimmy Carter signed the Airline Deregulation Act. Before deregulation, the Civil Aeronautics Board regulated airline route entry and exit, passenger fares, mergers and acquisitions, and airline rates of return. Typically, two or three carriers provided service in a given market, although there were routes covered by only one carrier. Cost increases were passed along to customers, and price competition was almost nonexistent. The airlines operated as if there were only two market segments: those who could afford to fly, and those who couldn’t.

Deregulation sent airline fares tumbling and allowed many new firms to enter the market. The financial impact on both established and new airlines was enormous. The fuel crisis of 1979 and the air traffic controllers’ strike in 1981 contributed to the industry’s difficulties, as did the severe recession that hit the United States during the early 1980s. During the first decade of deregulation, more than 150 carriers, many of them start-up airlines, collapsed into bankruptcy. Eight of the 11 major airlines dominating the industry in 1978 ended up filing for bankruptcy, merging with other carriers, or simply disappearing from the radar screen. Collectively, the industry made enough money during this period to buy two Boeing 747s.1 The three major carriers that survived intact—Delta, United, and American—ended up with 80% of all domestic U.S. air traffic and 67% of trans-Atlantic business.2 The rapid growth of Southwest was in stark contrast to the much slower growth of its major competitors.

Competition and lower fares led to greatly expanded demand for airline travel. Controlling for inflation, the average price to fly one domestic mile dropped by more than 50% after deregulation. By the mid-1990s, the airlines were having trouble meeting this demand. Travel increased from 200 million travelers in 1974 to

Copyright © 2017 Thunderbird School of Global Management, a unit of the Arizona State University Knowledge Enterprise. This case was written by Professor Andrew Inkpen with research assistance from Chee Wee Tan, Andrew Cohen, Valerie Degroot, Wes Edens, Prita John, Jairaj Mashru, Sandip Patil, and Arturo Wagner for the sole purpose of providing material for class discussion. It is not intended to illustrate either effective or ineffective handling of a managerial situation. Any reproduction, in any form, of the material in this case is prohibited unless permission is obtained from the copyright holder.