Southwest airlines stanford case study solution

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GRADUATE SCHOOL OF BUSINESS STANFORD UNIVERSITY

HR-1A

This case was prepared by Professors Charles O’Reilly and Jeffrey Pfeffer as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Support for this case was provided by the Human Resources Initiative of the Graduate School of Business.

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Southwest Airlines: Using Human Resources for Competitive Advantage (A)

“The work force is dedicated to the company. They’re Moonies basically. That’s the way they operate.”1

Edward J. Starkman Airline Analyst PaineWebber

Ann Rhoades, VP People for Southwest Airlines, was packing her briefcase at the end of a 17 hour day. Tomorrow was an off-site meeting with the top nine executives of Southwest Airlines. The agenda for the meeting was to review Southwest’s competitive position in light of recent actions by United and Continental, both of whom had entered Southwest’s low fare market. That day’s New York Times (September 16, 1994) had an article which characterized the situation as a major showdown in the airline industry:

“‘This is a battle royal that has implications for the industry,’ said Kevin C. Murphy, an airline stock analyst at Morgan Stanley. The battle will, after all, be as much a test of strategy as a contest between two airlines. United and other big carriers like USAir and Continental have decided that they can lower their costs by creating a so-called airline-within-an-airline that offers low fares, few frills, and frequent service. The new operations are unabashedly modeled after Southwest, the pioneer of this strategy and keeper of the healthiest balance sheet in the industry.”2

The reasons for this competition were easy to understand. Over 45 percent of United’s revenues came from passengers who flew through their California hubs. As a market, the California corridor was the most heavily traveled in the U.S., with 80 percent more traffic than the Boston-New York-Washington corridor. Yet, United’s share in this market had fallen from 38 percent in 1991 to 30 percent in 1993.

During the same period, Southwest’s had increased from 26 percent to 45 percent. Other airlines, like Continental, had also been hurt by Southwest’s competition. Southwest’s success spawned a number of imitators, including new airlines like Kiwi and Reno Air as well as major airlines like United and Continental. Concerned with this new competition, the market had driven down Southwest’s stock price and analysts were raising questions about how sustainable Southwest’s advantage really was.

1 Peter Elsworth (1991). “Southwest Air’s new push west.” New York Times, June 16, 1991 2 Adam Bryant (1994). “United’s bid to rule western skies.” New York Times, Sept. 16, 1994

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Rhoades, a former marketing executive with an MBA from the University of New Mexico and a background in banking, had joined Southwest in 1989 to help transform the so-called People Department (Human Resources in most organizations). Southwest had always believed that an important part of their competitive advantage rested with their people and how they were managed. Ann’s job was to help leverage this advantage. At tomorrow’s meeting she would be asked to review Southwest’s current position in light of the new competition. She had prepared a brief overview of what she saw as the major threats and opportunities of the competition and an assessment of Southwest’s strengths and weaknesses in light of these changes. However, she wanted to reflect one last time on these issues to be sure she was not missing anything. Her major concerns were whether Southwest was getting the most in competitive advantage from their own people, and whether the competition could imitate their successful human resource practices.

Background

History

On June 18, 1971 Southwest Airlines, headquartered at Love Field in Dallas, began flying with three Boeing 737 aircraft serving the Texas cities of Dallas, Houston, and San Antonio. Southwest’s competition was Texas International and Braniff, and, to a lesser extent, Continental. Continental used every political and regulatory means to ensure that Southwest would not get off the ground, including keeping Southwest out of the recently built Dallas-Fort Worth airport and waging a four year legal battle that left Southwest almost bankrupt at the time of its first flight. One outcome of the legal battle was the so-called Wright Amendment, named after James Wright, then Speaker of the U.S. House of Representatives. The Wright Amendment prohibited any air carrier from offering direct service into Love Field from any place beyond Texas and the four contiguous states of Oklahoma, Louisiana, Arkansas, and New Mexico. This law meant that passengers flying into Southwest’s central location at Love Field from destinations beyond these four states would have to purchase separate tickets for each leg of the trip and could not check baggage through to their final destination. Furthermore, neither airlines nor travel agents were permitted to advertise connections through Love Field. Ostensibly, this law was intended to encourage traffic through the new Dallas- Fort Worth hub. In fact, it was aimed at stopping Southwest.

Herb Kelleher, CEO and one of the airline’s founders and then Southwest’s corporate counsel, said, “You know, anger can be a great motivator. For me, this became a cause. I was a crusader freeing Jerusalem from the Saracens.”3 More recently, he was quoted as saying, I have told people that I would retaliate if I became very angry, but now I think I would revise that. Let’s just say that if I become peckish, I will attack.”4 This aggressive, underdog spirit still pervades the company, especially among longer serving employees. Many see the goal of keeping this spirit alive as one of the firm’s great challenges. Delise Zachry, an instructor from the People Training Department, noted, “In 1971, 198 people got together and did something that was impossible. Now we need to update the culture to today’s problems.”

In the early days, Southwest gained attention by putting its flight attendants in hot pants and using its location at Love Field to launch an advertising campaign (“Make Love, Not War”), a theme that is still used today when Southwest refers to itself as the “Love” (LUV) airline. This designator is Southwest’s stock ticker symbol. All aircraft have a small heart emblazoned on their sides and hearts are used prominently on corporate communications and advertising. From its inception, Southwest

3 Edward Welles (1992) “Captain Marvel.” Inc., January, 1992 4 Kenneth Labich (1994). “Is Herb Kelleher America’s best CEO?” Fortune, May 2, 1994

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has encouraged its employees to identify with others at the company, deliver great customer service and have fun. They have also pursued a low fare strategy.

In the mid-80s USAir and American, attempting to increase their share of the valuable California market, purchased Air California and Pacific Southwest Airlines (PSA), two successful regional carriers. However, American soon withdrew from some cities and routes when they could not be served profitably. USAir made a number of marketing and service mistakes and also cut back service in the region. Southwest seized the opportunity to expand in California. From basically a zero market share in California in 1989, Southwest moved to the leading airline in passenger boardings in 1993 and now serve 10 cities in the state with more than a 70 percent average market share for city- pairs served.

The Current Situation

From the beginning, Southwest has maintained the same strategy and operating style that it maintains to the present. It concentrates on flying to airports that are underutilized and close-in to a metropolitan area—e.g., Love Field in Dallas, Hobby in Houston, San Jose and Oakland in the Bay Area, Midway in Chicago—although it does fly to major airports like LAX and SFO. The company also began flying fuel-efficient 737s, and now has over 200 of them, the only type of aircraft it flies. Southwest service involves frequent on-time departures as well as low cost fares. They emphasize point-to-point routes, with no central hub and an average flight time of 65 minutes. According to its 1993 annual report, 80 percent of their customers fly non-stop to their final destination. By avoiding a hub and spoke system, they are able to avoid the delays often associated with connecting flights. This makes short-haul trips more attractive to travellers who might otherwise consider driving. It also pays off in shorter turnaround times (70% of their flights had a 15 minute ground time in 1991) and higher equipment utilization. For example, Southwest aircraft spent an average of 11 hours in the air daily compared to an industry average of 8, and they averaged 10.5 flights per gate versus 4.5 for the industry.

Following this strategy, Southwest has always seen themselves as competing not so much with other airlines as with surface transportation. For instance, in 1993 the average passenger fare was roughly $60 for a trip of 500 miles. In 1984 the comparable numbers were $49 and 436 miles. For example, in August of 1994 the roundtrip fare from Oakland to San Diego, a distance of over 1,000 miles, was $135. Southwest uses these low fares and frequent flights to increase passenger volume two to three times. For example, somewhere around 8,000 people used to fly between Louisville and Chicago weekly; after Southwest entered the market that number climbed to 26,000. They dramatically lower the fares and increase the frequency of flights. For instance, in August of 1994 they flew 39 times roundtrip daily between Dallas and Houston, 25 times between Phoenix and Los Angeles, and 20 times between Sacramento and Los Angeles. When American moved out their San Jose hub because they were losing money, Southwest moved in and were profitable from the first day of service. In 1992, they were the leading carrier in passenger boardings in 27 of the 34 airports served. They dominate most of their major markets with almost 70 percent of the intra-Texas and over 50 percent of the intra-California markets in 1994.

Consistent with their strategy of low costs, low fares and frequent flights, Southwest also keeps their fares simple. Unlike other airlines that rely heavily on computers and artificial intelligence programs to maximize flight revenue, Southwest typically offers only two fares on a route, a regular coach fare (there is no first- or business-class) and an off-peak fare. It also tries to price all fares the same within a state (for instance, currently $69 to fly anywhere within California). Southwest has never sold interline connections to other carriers and has been unwilling to pay to be part of other airlines’ reservations systems. As a result, only 55 percent of Southwest’s seats were booked by travel agents compared to 90 percent of tickets for major airlines. In 1994, United announced that their Apollo System would no longer carry Southwest’s schedules or issue its tickets. This makes issuing tickets more difficult for travel agents who often have to call the airline rather

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than working through a computer as they do with other airlines—a clear incentive to travel agents not to book Southwest flights.

To further simplify their operations, Southwest has never offered meal service on its flights. Meals can add $40 per passenger to the cost of a flight. Instead, passengers on Southwest are served beverages, peanuts (referred to as “frills”), and on longer flights, crackers or other light snacks such as cookies. There is no assigned seating. Upon arrival at a Southwest gate, each passenger holding a reservation is given a reusable plastic boarding pass with numbers from 1 to 137, the maximum load of their 737 aircraft. Passengers are loaded in groups of 30 and the boarding passes are collected for use on the next flight. Standby passengers are boarded if seats are available in the order in which they sign up at the departure gate.

Although they are not connected to other airlines’ reservation systems or affiliated with other frequent flyer programs, Southwest does have its own frequent flyer club (“The Company Club”), also a model of simplicity. It is based on the number of trips flown, not the mileage. Members keep a card that is stamped every time a plane is boarded. After accumulating 16 segments, a free ticket is awarded and a Company Club card is issued. The card is then read into the computer system for each trip. This approach economizes on operating costs since it requires no effort to keep track of mileage. Based on some negative advertising by United about Southwest’s frequent flyer program, Herb Kelleher recently sent a letter to all Company Club members detailing how awards from Southwest took less mileage to obtain and were more widely available than other airlines. Kelleher argues that their program “...is the greatest value because it gives you free travel faster, for much less money, without giving up great service.” For instance, after 50 roundtrips within a 12-month period, a companion flies free with a Company Club member, even if you’re travelling on an award ticket.

Overall, Southwest Airlines has been profitable in every one of the last 21 years, a record achieved by no other major U.S. airline. It was consistently profitable even during the 1991–1992 period, during which some 40 percent of the total capacity of the U.S. airline industry was seeking bankruptcy protection or ceased operation completely. Exhibit 1 presents selected financial and operating data for last ten years. According to Money magazine, for the twenty-year period 1972– 1992, Southwest’s stock earned the highest returns of any publicly traded U.S. stock—a compounded return of over 21,000%. Only Wal-Mart comes close to being as good as an investment over this period.

Competitive Advantage

Although the reasons for Southwest’s success were many, one highly visible advantage could be seen in their cost structure. Kelleher recognized that short-haul flying was inherently more costly than longer flights (the plane is taking off and landing more often and has to be handled at every gate). He understood that the lowest-cost provider could leverage that cost advantage most where costs are highest. Exhibit 2 shows the costs per available seat mile for two comparable quarters in 1993 and 1994. Southwest’s costs averaged roughly 7.1 cents while the larger airlines had costs up to 10 cents or more per mile, 20–30 percent higher. This achievement is even more striking when noting that Southwest’s costs in 1984 were 5.86 cents. So, over a decade its costs had increased by only about 20 percent.

Part of this cost advantage derives from the remarkable productivity Southwest gets from their work force. For example, they routinely turnaround an aircraft in 15 minutes from the time it arrives at the gate until it leaves (see Exhibit 3 for the anatomy of a 15 minute turnaround). United and Continental average 35 minutes. Southwest’s gates are typically manned by a single agent and with a ground crew of six or fewer, rather than the three agents and twelve ground crew common at other airlines.

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These low costs also come from other sources. Southwest pilots, for example, spend more time in the air than pilots at other airlines. While pilots at United, American, and Delta earn up to $200,000 a year for flying an average of 50 hours a month, Southwest’s pilots average $100,000 a year flying 70 hours a month. Flight attendants and pilots help clean the aircraft or check passengers in at the gate. Harold Sirkin, an airline specialist with BCG said, “Southwest works because people pull together to do what they need to get a plane turned around. That is a part of the Southwest culture. And if it means the pilots need to load bags, they’ll do it.”5

Southwest’s employees also routinely volunteer to help customers in need. Once a customer arrived at the airport for a vacation trip with his dog in tow, only to learn that he couldn’t bring the dog with him. Rather than have him cancel the trip, the gate agent took care of the dog for two weeks so the fellow could enjoy his holiday. Another employee accompanied an elderly passenger to the next stop to insure that she was able to change planes. Stories of this sort abound.

These efforts pay off in employee productivity. In 1993, for example, Southwest had an average of 81 employees per aircraft while United and American had 157 and 152, respectively. The industry average was in excess of 130. Southwest served an average of 2,443 passengers per employee while United and American served 795 and 840, about the industry average. This means that Southwest needs a smaller load factor to break even than the other carriers (usually around 55 percent). Second, the point-to-point strategy and the use of less congested airports improves the efficiency of flight operations and helps insure high levels of aircraft utilization. Finally, by using a single type of aircraft, Southwest was able to save on maintenance and training costs.

But Southwest is not just a low fare/low cost carrier. It also emphasizes customer service. In fact, the word “Customer” is always capitalized in all Southwest corporate communications, whether it is the Annual Report or an internal newsletter. Colleen Barrett, Executive Vice President - Customers and highest ranking woman executive in the airline industry, insists on this. She is also adamant about treating employees as internal customers and tries to make sure that Southwest is a comfortable and fun place to work. “If you’re comfortable, you’re smiling more and you give better service,” Barrett says. “It doesn’t take a rocket scientist to figure that out.”6 The results are undeniable. In the airline industry service is measured by on-time performance, having the fewest lost bags, and having the fewest number of customer complaints. If an airline is the best in all three categories in a single month, it wins the so-called “Triple Crown.” Southwest has won the monthly Triple Crown 24 times. In 1992, the Department of Transportation began giving an annual Triple Crown. Southwest won the award in 1992, 1993, and 1994.

Leadership at Southwest

While a number of industry experts attribute Southwest’s accomplishments to its unwavering adherence to its low cost niche strategy, others disagreed and argued that its real competitive advantage lay its leadership. A recent Fortune article, for instance, was entitled “Is Herb Kelleher America’s Best CEO?”7 The piece cites a U.S. Department of Transportation report as noting that Southwest was the “principal driving force for changes occurring in the airline industry,” and credits Kelleher with much of this. The author quotes Michael Derchin, a veteran airline analyst who has been monitoring Southwest almost from its beginning, says, “I think Herb is brilliant, charming, cunning, and tough. He is the sort of manager who will stay out with a mechanic in some bar until four o’clock in the morning to find out what is going on. And then he will fix whatever is wrong.” In his view, the difference between Southwest and other carriers is “...in the effort Herb gets out of the

5 E. Scott Reckard (1994). “Shuttle dogfight good news for air travelers.” San Francisco Chronicle, October 2, 1994 6 Jeff Pelline (1993). “Southwest Air’s driving force.” San Francisco Chronicle, June 10, 1993 7 Kenneth Labich (1994). Ibid

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people who work for him.” The Fortune writer, Ken Labich, concluded his article by noting that, “The greatest obstacle to long-term prosperity at Southwest may be Kelleher’s mortality.”

Although Southwest is headquartered in Dallas, Herb Kelleher isn’t a native Texan. He is not a pilot either. He’s a lawyer who grew up on the East Coast, majored in philosophy and literature, graduated from NYU Law School, clerked for a New Jersey Supreme Court justice, and practiced law in Newark, New Jersey. After visiting his wife’s parents in San Antonio, he announced that he wanted to move to Texas. By the mid-1960s he was happily practicing law in San Antonio. One day in 1966 a client named Rollin King described his experience in California on PSA, a short-haul commuter airline, and suggested that Texas could benefit from a similar operation. The two sketched out some plans, borrowed money, and started Southwest.

From the beginning, Herb has adopted a visible, hands on, slightly over-the-top style— always ready to promote a party and have fun. He appeared one Halloween at a Southwest maintenance hanger dressed in drag with a feathered boa imitating Corporal Klinger from the television program, M*A*S*H. He’s also appeared in print advertisements and at company parties dressed as Elvis Presley. (Ann Rhoades suggested that this was fine, but they try not to encourage him to dress like Ethel Merman.) He’s renowned for his love of Wild Turkey bourbon. When Herb met the president of the company that produces it, he told him that he may be just a man to most people, “...but to me he is a god.”8 While recovering from minor surgery, he received over 3,000 cards and gifts from employees, including an intravenous drip set-up—but with Wild Turkey rather than saline solution. He also smokes five packs of cigarettes a day. He says, “I’ve always felt that there’s no reason that work has to be suffused with seriousness, that professionalism can’t be worn lightly. Fun is a stimulant to people. They enjoy their work more and work more productively.” He believes that, “You don’t have to surrender your individuality to work for Southwest Airlines.” This is seen in the phrase sometimes heard at Southwest, “work is important ... don’t spoil it with seriousness.”9

And Kelleher does have fun. He constantly interacts with customers and Southwest employees. He routinely visits maintenance facilities in the early morning hours. Tom Burnett, the Teamster leader who represents Southwest mechanics and cleaners, says, “Let me put it this way. How many CEOs do you know who come into a cleaners’ break room at 3 a.m. on a Sunday passing out doughnuts or putting on a pair of overalls to clean a plane?”10 Once while rushing to catch a flight at Love Field he stopped his car in the loading zone and began talking with a Southwest employee. After an animated few minutes, he realized he was late and rushed off to make his plane. When he arrived in Houston, a Southwest employee asked him if he knew where his car was? He’d left it idling at curbside. Kelleher has also appeared in television ads for American Express—not because he’s such a big user, but because he has lost more cards during a year than any other AMEX customer. Colleen Barrett, an EVP of the company, is always sticking money in his pockets since he routinely forgets his wallet. Reflecting on Herb’s propensity to engage people in conversation, she says, “I could add four hours to Herb’s day if I could get him to walk and talk at the same time.” One friend says, “There is an unwritten rule that, if you don’t want to stay up all night drinking and talking, then you stay the hell away from Herb.”11

This philosophy pervades the entire company. Serious attention is paid to parties and celebrations. Every year, for instance, each station (city) is given a budget for parties for the employees and their families. Most stations supplement this by doing their own fund raising. Up until several years ago, all Southwest employees used to fly to Dallas for the annual company party.

8 Kenneth Labich (1994). Ibid 9 Evan Ramstad (1991). “Cattle call carrier lassos riders, profits.” San Francisco Chronicle, April 7, 1991 10 Bridget O’Brian (1992). “Southwest Airlines is a rare carrier: It still makes money.” Wall Street Journal, October 26, 1992 11 Kenneth Labich (1994). Ibid

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Now that the company has grown too large for that, they hold a rolling party in several cities with Herb and the senior managers moving from one location to another. Celebrations and contests occur continually, including chili cookoffs and Christmas parties. The Love Field corporate headquarters in Dallas is filled with pictures of Southwest employees at parties, awards, trips, celebrations, and banners. In fact, there is no corporate art in the headquarters. All paintings and sculptures, and there are many, are those donated by employees.

Colleen Barrett also reflects the relaxed management style. Officially, she is responsible for communication, marketing, public relations, people (human resources), governmental affairs, and scheduling (see Exhibit 4 for an organization chart). She is also heading the merger efforts with Southwest’s recent acquisition of Morris Air. Unofficially, she has been described as a combination of den mother, management guru, and customer ombudsman. She is a stickler for detail and provides the organizational counterweight to Kelleher’s sometimes chaotic style. “She’s the backbone of the airline,” said one employee. Colleen claims that “The company is only as good as its people,” and constantly reinforces that theme. “We’ll never jump on an employee for leaning too far toward the customer, but we come down on them hard for not using common sense.”

For instance, about four years ago she became concerned with the size and geographic dispersion of the company and set up a culture committee consisting of 65 people from all levels and regions of the company. This committee meets with Colleen four times a year for a full day to preserve and enhance the Southwest spirit. After determining that some distant locations were operating functionally but without the teamwork that Southwest values, they decided to try to reduce this tendency. One outcome was a systematic effort for groups of employees to express their appreciation to others for their contributions. So, for instance, the pilots held a barbecue for the mechanics on the flight line at 3:00 a.m. Other groups, including pilots, decided to thank the reservations agents by coming in and spending a shift with them. Even the officers and directors of the company have a program, called “Day in the Field,” that requires them to spend one day per quarter working in a front line job. Colleen is adamant that this means really work, not stand around and drink coffee.

The People Department

About five years ago the human resources function at Southwest was renamed “The People Department.” This reflected a concern that the old human resources group was, in the words of John Turnipseed, manager of People Services, “a police department.” To counteract this, Ann Rhoades first threw away the 300 page corporate handbook and brought in new people with marketing backgrounds. Currently, to join the department an employee must first have line experience. She sees the role of the People Department as saying “yes” rather than “no” and wants them to “Do what it takes to make the Customer happy.” Employees are the customers of her group. Although they deal with approximately 18,000 employees, the People Department has a staff of about 100. All members of the department sign the department’s mission statement, which is prominently displayed in a very large poster on the wall of their headquarters’ office. It reads:

“Recognizing that our people are the competitive advantage, we deliver the resources and services to prepare our people to be winners, to support the growth and profitability of the company, while preserving the values and special culture of Southwest Airlines.”

Ann takes this charge seriously and believes in what she calls the two Cs; compassion and common sense. She worries about maintaining the culture and tells people to break the rules if they

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need to. While in many companies human resources is considered a backwater, the People Department at Southwest is “like the keeper of the flame,” says Treasurer John Owen.12 Ann notes that, “Most HR people have no courage. They never take a chance. No guts. No capability of making a decision. They’re so afraid of being fired... We need to have confidence in people doing the right thing.” To do this, she believes that it is imperative that you get the right people into HR to begin with. This also underlies the Southwest policy of hiring and firing for attitude. Her department is also continually feeding back information to employees such as on-time performance, turnaround times, number of customers boarded or the cost of a day’s health care for the airline in terms of the number of bags of peanuts served on their flights. The intent is to keep people focused and make them aware of how their actions affect costs.