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Southwest
AirlinesCompany
John J. Vitton, University of North Dakota
Charles A. Rarick, Transylvania University
Ronald P. Garrett, United States Air Force
Illtenzet siteof interest: www.iflyswa.com
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W quarter earnings for 1994 that \\:ere far below analysts' expectations!
Financially, the 1990s had been devastating for the domestic passen-
ger airline industry. Southwest was the sole exception among the major air car-
riers, having rung up 22 years of consistent profitability, while other carriers
hemorrhaged red ink. It was the only major carrier to achieve net and operat-
ing profits in 1990, 1991, and 1992. Yet here in black and white, Southwest
stated in its 1994 annual report that it experienced a 47 percent decline in earn-
ings in 1994's fourth quarter as compared to fourth quarter 1993. Also, as com-
pared to 1993 levels, load factors and passenger revenue yields were
depressed. Load factors, which measure an airline's percentage of seats occu-
pied by paying passengers, fell to 57.8 percent in January 1995, down from 63.1
percent for January 1994.
Harassed by low fares offered by ne\\.:ly aggressive carriers such as United's
"U2" and Continental's Lite, Southwest responded by slashing its already
ultra-cheap fares. Southwest was particularly provoked by United's apparent
targeting of the California market with "U-2," a Southwestern style, low-cost,
lw-frills operation. Gary Kelly, Southw~st's Chief Financial Officer, "noted that
intra-California traffic accounts for 11.1-15%of Southwest's total business." He
also stated that "Since we're already on a competitive stance with United, we'll
simply confine our efforts, particularly our long-haul service to markets where
United dominates."I These fare wars came at a rather inopportune time, when
Southwest was digesting the acquisition of Salt Lake City-based Morris Air.
While the acquisition gave Southwest a presence in the Pacific Northwest, t~e
one-time acquisition cost of 510 million and the conversion of the Morns
TI/is caseis illtmdl'd/or classroom disClIssioll ollly. IIOt to depict e((ectipe or illl'ffectil'l' halld/illg of adminiS-
tratil'l' sitllations. All rights rl'ser<'edto tI,e alltllOr(s).
Whell orderillg tlli.- ca,ej;"OI'1 thl' Pmlticl' Hall CII,tom Case Program, plea,e IIse ISB:--J0-13-799370-6.
- .- ....---.
operation into that of the parent company hurt Southwest's bottom line. South-
west's 13% increase in capacity in 1994 was also provoking a competitive
response.
Herb Kelleher, Southwest's ebullient CEG, was identified as "Commander-in-
Chief" in the aircarrier's first-ever national TV ad campaign. Speaking from a
mocked-up war room, with "Wild Blue Yonder" playing in the background, Herb
said: "It's not a gimmick, it's not a promotion with us. It's something we believe
in with all of our fiber. It's every seat, every flight, everywhere we fly. Other air-
lines try to copy Southwest, but they're just facsimiles of the real thing. Southwest
is THE low-fare airline. If there's a fare war, they're gonna get nuked."z
COMPANY HISTORY
The Southwest Airline operation is truly a Horatio Alger story! During a 1967
luncheon meeting, Herbert D. Kelleher, a young San Antonio lawyer, was dis-
cussing with his client Rollin King, a Texas entrepreneur and pilot, the bank-
ruptcy of a small air carrier, which had served small Texas towns. Later in the
meeting, King broached the concept of a low-fare, no-frills, short haul airline
with frequent flights between major Texas cities. Three points of a napkin were
labeled-Dallas, Houston, and San Antonio.
Initially skeptical and later intrigued by King's plan, Kel1eher raised
$560,000 to back the venture. An application was filed with the Texas Aeronau-
tics Commission in November 1967; however, starting up an airline was very
difficult as the airl~ndustry was heavily regulated. The burden of proof was
on King and Kelleher to convince the Texas regulators that a new airline was
needed. In February 1968, the Commission approved and issued a certificate to
Air Southwest Company to fly from Love Field, Dallas, to Houston and San
Antonio. Braniff, Continental, and Trans Texas obtained a restraining order to
block Southwest's certificate from taking effect, claiming that the Texas market
could not possibly support another air carrier. IlIvestors urged Kelleher to give
up the fight after losing the first two of three courtroom battles. Kelleher perse-
vered and won the third battle when the Texas Supreme Court ruled in Air
Southwest's favor. This allowed the airline to begin service with a fleet of three
aircraft. Lamar Muse was hired to run the airline, which was renamed South-
west Airlines. Muse, as the former president of several airlines, brought exten-
sive airline knowledge to the new company. His initial actions included buying
four 737-200 aircraft and hiring veterans from Braniff, American Airlines, and
Trans Texas to help mold and create an innovative approach to operations
which is still prevalent today.3 On June 18, 1971, the first Southwest flight took
off from Love Field in Dallas headed for Houston.
In 1971, one-way Southwest fares were $20 for the flights from Dallas to San
Antonio and from Dallas to Houston. The company lost $3.7 million in its first
eleven months in operation. Southwest added a fourth plane to its fleet in Sep-
tember 1971, and two months later opened service on the third leg of the trian-
gle, Houston to San Antonio. On February 1,1973, Braniff initiated price wars
on the flights between Dallas and Houstonand Southwest countered by offer-
ing half-fare tickets. Despite fare wars, Southwest proudly proclaimed 1973 as
its first profitable year.4 The airline also announced that it was expanding its
routes into the Rio Grande Valley (Harlingen), Texas.
C-196 SOUTHWEST AIRLINES COMPANY
There were more battles to be fought, however. A hearing was held in U.s\. ~" ,-
District Court on whether Southwest would be allowed to remain at D~'~
Love Field, or be forced to move with other airlines to the new Dallas-FoifH
Worth Regional Airport. Judge W.M. Taylor Jr. ruled in April 1973 that South:,'
west could operate out of Love Field as long as it remained open as an airport.S
Southwest gained a virtual monopoly position at Love Field, which was much
closer to downtown Dallas than the Dallas-Forth Worth airport. This monopoly
proved to be limiting, however, when the Wright Amendment became law in
1979. This law, championed by Texas V.S. representative James Wright, who
later was forced out of office for misuse of funds, prevented airlines operating'
out of Love Field from providing direct service to states other than those neigh-
boring Texas. Southwest's customers could fly from Love Field to Arkansas,
Louisiana, New Mexico, and Oklahoma, but had to buy new tickets and board
different Southwest flights to points beyond. .
Braniff was fined the maximum of $100,000 on December 27, 1978, for using
illegal tactics designed to force Southwest Ai~s out of business. As a result
of this settlement, Southwest was able to add to its Boeing fleet.
The Airline Deregulation Act of 1978 allowed Southwest to enter markets'
outside the state of Texas. This expansion will be described in the Operations
Section. I.
In the 1980s, Southwest's annual passenger traffic count tripled. Nearly'
bankrupt Muse Air Corporation, founded by one-timer Southwest Executive,
Lamar Muse, was sold to Southwest in 1985, which operated that Houston-.
based airline as TranStar. TranStar was liquidated in 1987 when profits fell,-
due to competition from Houston-based Continental Airlines.
Air Transport World magazine named Southwest the 1992 "Airline of the..
Year," stating that "Southwest has demonstrated excellence over the years~.
disciplines required for safe, reliable, and fairly priced air transportation.',() The.. .Cl
airline also won the first annual Triple Crown for the best on-time perfor-. .
mances, best baggage handling record, and best customer satisfaction in 1992~
and repeated again in 1993.
In 1994, Southwest expanded its service into the Northwest and California,
by acquiring Salt Lake City-based Morris Air on December 31,1993.
between the V.s. Post Office and private carriers and made the postmaster gen=-.
era I "the czar of the industry without competitive bidding."S Air mail contracts ~.
SOUTHWEST AIRLINES COMPANY C-197
of labor, landing fees, and interest charges. The CAB approved of severa!i
small increases but in 1970, the airline industry recorded the largest loss initS~
previous history. Fuel costs soared during the 1970s, rising from 13 percenf6~.
airline operating expenses to 31% by 1980, due to OPEC cartel pricing polici~:'
in 1974 and again in 1979.,,11 '}
The deregulation movement began in 1974. Many economists and consumeri\
advocates, such as Ralph Nader, cited the lower fares of the unregulated intra~;:A
state air carriers in California and Texas (22-26% lower than interstate carriers);;
and called for the abolishment of the CAB. In 1974, the airline industry could::;
be described as an oligopoly with the "Big Four" being American, Eastern~
Trans World, and United. In earlier years, the airlines established fares at' ,5
approximately the level of standard railroad passenger fares plus Pullman cat :~
charges. Under the CAB, airline management did not have to manage financ~:
carefully, as the CAB would allow a 10-12% return on assets (ROA) to b~ "
tacked on to labor, fuel, and other costs. This was then passed on to customerS~
in the form of higher prices. Many also felt that the economies of jet aircraft:
were not reflected in lower prices to the customer.
The Airline Deregulation Act was passed by Congress on October 24, 1978.
The CAB was phased out in a "twilight zone" with domestic routing decisions'
coming under the jurisdiction of the airlines. The CAB lost authority over
domestic rates and fares on January I, 1983, and the CAB was out of existence
on December 31,1984. On January I, 1985, the CAB's authority over foreign air"
transportation matters was transferred to the Department of Transportation in
consultation with the Department of State. The CAB's authority over mergers,
intercarrier agreements, and antitrust immunities for foreign transport was
turned over to the Department of Justice. However, in the twilight years, DOT;
was given approval over mergers. Safety responsibilities remained with DOT's
Federal Aviation Administration.
Immediately after the Deregulation Act of 1978, the second OPEC oil shock
hit the aviation industry with hurricane force. This was followed by the illegal.
strike by the Professional Air Traffic Controllers Organization (PATCO).
Eleven thousand FAA controllers, who had signed an employment oath not to
strike against their government, went out on strike and were subsequently
fired after a warning by President Reagan to return to work within 48 hours.
Despite soaring interest rates, the 1979-1982 recession, and escalating oil prices,
more than 120 new airlines appeared, with most being small commuter lines.12.
As of 1988, over 200. airlines went bankrupt or had been acquired in mergers
since deregulatIon; only 74 carriers remained.13 Among the casualties since
1978 were Braniff, Eastern, Pan American, Peoples Express, Air Florida, Mid-'
west, Frontier, and a host of smaller carriers.
Major airlines, unshackled from the North-South or East-West air routes
required by CAB edicts, have gone to a hub-and-spoke flight structure which
uses feeder aircraft operating on the spokes to consolidate passengers at the
hubs. In 1988, "450 million passengers boarded commercial airlines, compared
to 275 million in 1978. However, with nine of ten airline passengers traveling
on some sort of discounted fare, the average cost of travel on an airliner has
dropped 13 percent over the last decade if inflation is taken into account,
according to the Transportation Department."14
The airline industry recently chalked up its greatest growth: 56% more pas-
sengers crammed aboard its planes in 1990 than a decade before. The 1980s was
a time of heady expansion, of billion-dollar aircraft orders, and rapid addition of
SOUTHWEST AIRLINES COMPANY C-199
international routes. Horizontal mergers were allowed and eight carriers swal-
lowed 11 others. Economists viewed the industry as a highflier across a business
landscape marred by the declining auto, steel, and energy industries.IS
"In the ten years (1978-1988) since deregulation, the Department of Trans-
portation presided over 21 mergers. During that era, the ten largest airlines
controlled 93 percent of the domestic market, compared with 89 percent in
1977, in part as a result of major airlines gobbling up regional and other smaller
carriers.,,16 Two of the Department of Transportation mergers, Northwest/
Republic and USAir /Piedmont, were challenged by the antitrust division of
the Department of Justice to no avail.
In 1988, at last count, the eight largest airlines had gained effective control
over 48 of the 50 largest regionals. The Department of Transportation allowed
the major airlines to acquire numerous commuter airlines. Alfred Kahn, now a
Cornell University professor and formerly the chairman of the Civil Aeronau-
tics Board, was the principal architect of airline deregulation. Noting the flurry
of mergers and acquisitions, Kahn stated that "consumers are more likely to be
exploited."l?
In the early 1990s, the airline industry was confronted with a bath of red ink,
excessive leverage often twice what is considered prudent, and a business turn-
down that reduced revenue. More than 100,000 airline employees have been
laid off since 1989. Many others have taken pay cuts. In addition, the U.S. Jus-
tice Department has been investigating airline price fixing. The concern
involves anticompetitive price signaling using the computerized reservation
systems. Also, computer bias-giving an advantage to the computer owner's
by listing their flights prior to leasee flights-and other "dirty tricks," such as
computer screens showing competitor's flights filled when they were not, were
other concerns.
Deep discount for the discretionary (leisure) traveler, while the business
traveler pays higher fares, created another problem area. In 1993, 92% of airline
passengers bought their tickets at a discount, paying on average just 35% of full
fare. Frequent flyer programs are extensively used to promote customer
loyalty.
High concentration, resulting in a few airlines controlling landing slots and
gates, is a major concern at many hub airports. Some studies have shown the
routing through hubs has increased air fares rather than reducing them.
Major airlines are concerned that weak competitors in Chapter 11 bank-
,., ruptcy are permitted to disregard creditor short-term claims and their subse-
quent low prices make competition destructive. Between 1989 and 1993, the
industry lost $12 billion and Southwest alone showed a profit.18 Air safety is at
an all-time high. The industry is heavily unionized but has been cutting costs
through layoffs, reduction in food items offered, and two-tier pay schemes.
Delta, United, American, US Air, and Northwest were the leading firms in an
industry confronted with huge losses.
By 1995, the airlines recovered from their financial swoon, with Northwest
and others registering significant profits. "Low cost airlines generated about
$1.4 billion in revenue in 1994, up from $450 million in 1992 and next to noth-
ing in 1989," according to Paul Karos, an airline analyst at CS First Boston. John
Dasburg, Northwest Airlines CEO, says that the new low cost, short haul carri-
ers "are viable products, they will endure, for the same reason Motel 6 endures.
This product will be defined. It will be located in the top hundred markets that
are 750 nautical miles or less from each other."19
--_.- - --- ---
HUMAN RESOURCES
. Management
Herbert D. Kelleher is Chairman of the Board, President, and Chief Execu-
tive Officer and the driving force behind Southwest's success. Son of a
Campbell Soup Company manager, Herb Kelleher's formative years were
spent in Haddon Heights, New Jersey. Herb was star athlete and student
body president at Haddon Heights High School. He graduated from Wes-
leyan University in Connecticut where he studied English literature. Later,
he attended New York University Law school. Herb and his wife moved in
1961 to San Antonio, Texas, where he entered his father-in-Iaw's law firm.
During Southwest's early years, Kelleher served as gerieral counselor and
director of the firm. When Lamar Muse, Southwest's president, resigned in
1978 because of differences with Rollin King, Kelleher became president.
Three years later Kelleher took over as CEO and president of Southwest Air-
lines Company.
Herb is a 62-year-old Irishman, a workaholic, who smokes five packs of
cigarettes a day and is considered to be one of the zaniest CEOs in America.
He loves to party and drink and has been known to sing "Tea for Two"
while wearing bloomers and a bonnet at a company picnic. One Easter, he
walked a plane's aisle clad in an Easter bunny suit and on St. Patrick's day,
he dressed as a leprechaun.20 Behind all of this is a leader who works 14-hour
days, seven days a week, and leads by example. His management style-
referred to as "management by insanity"-is far from any textbook style and
it has worked extremely well. He has made work at Southwest fun for its ....,
employees and customers. He encourages flight attendants to organize trivia
contests, delivering instructions to customers in rap fashion and awarding
prizes to customers with the biggest holes in their socks.21 Kelleher uses the ..
"Management By Walking Around" (MBWA) concept. He regularly helps
flight attendants serve drinks and peanuts when he flies. Every quarter,
Kelleher and other top managers work a different job within the company
for a day.22 They have been observed doing tasks ranging from serving as
counter agents, to loading baggage, to serving drinks. Southwest has fos-
tered the practice of trying to breed leaders, not managers or administrators.
Kelleher's span of control was reduced from 13 executives earlier to only
four or five to free him up to monitor long-term developments, promote
growth, and also to maintain good employee and customer relations. Some
critics claim Kelleher holds power very tightly and he is the only one who
makes major decisions. Some of the decisions were not so good, such as the
acquisition of Muse Air. Others say Herb is the type of manager who will
drink at a bar in the early hours of the morning with a mechanic just to find
out what is wrong. Then he will fix the problem.
Until 1991, Southwest was the only major airline without an incentive
stock-option plan for management personnel. There are no other manage-
ment perks and executives receive the same percentage of pay increases as
other employees. Southwest officers, with the exception of Kelleher, are in
the 35- to 48-year-old bracket. On March 23, 1993, Herb Kelleher was
appointed to a highly visible congressional commission entitled the National
Commission to Ensure a Strong Competitive Airline Industry.
SOUTHWEST AIRLINES COMPANY C-201
. EMPLOYEES
Herb Kelleher proudly proclaimed that "The people who work here don't think
of Southwest as a business. They think of it as a crusade."23
Southwest's personnel department is called the "University of People," to
reflect top management's attitude toward its employees. Southwest generally
recruits only in cities into which it flies in order to obtain employees who are
familiar with Southwest. Recruiters are looking for that "Southwest Personal-
ity" of friendliness, warmth, and kindness. They search for people who are
extroverts with a sense of humor. Recruiters ask prospective employees ques-
tions such as: "Tell me how you recently used your sense of humor in a work
environment" and "Tell me how you used humor to defuse a difficult situa-
tion." Job candidates who can't answer these questions satisfactorily are auto-
matically disqualified. Only one in ten applicants fits the company's image and
is hired. Southwest looks for extroverts with a team attitude. One flight atten-
dant played "The Eyes of Texas" on his harmonica over the loudspeaker after
.. touchdown and sang cautions about remaining seated until coming to a full
stop at the terminal. A customer reported the attendant received "three ova-
tions from the passengers and would have had a standing ovation except that
the seat-belt sign was on." Southwest does not hire anyone from other airlines
as it does not want to inherit their problems.24 The motto at Southwest is: "Do
it right, but keep it light."
Levering and Moskowitz also found that "Southwest also put a lot of
money into training. Its University for People, located in a terminal building
at Dallas's Love Field, not far from the corporate headquarters, runs quarterly
leadership training programs that are required for all supervisors and manag-
ers. Customer-care programs are run by line-level employees. For example,
flight attendants teach other flight attendants. Pilots get customer-care train-
ing, a very rare practice in the airline industry. This is in keeping with Herb
Kelleher's answer to the question why his low-fare carrier had been posting
profits: 'We dignify the customer.'"
Training is emphasized in part because Southwest promotes from within. The
airline fills roughly 80 percent of higher-level jobs through internal promotion.
While almost 90% of Southwest's employees are unionized, they do not
exhibit the adversarial roles found in many major corporations. Contract agree-
ments allow very flexible work rules. Pilots and flight attendants are often seen
cleaning the aircraft between flights.25 New contracts have been signed
recently with the Southwest Airlines Pilot Association; the Teamsters, which
represents mechanics, aircraft cleaners, and stock clerks; the lAM, which repre-
sents customer-service and reservations employees; the Ramp, Operations, and
Provisioning Association and Southwest Airlines Professional Instructors
Association. In January 1995, Standard & Poor's noted that Southwest Airlines
took a major step to reinforce its market share when it reached an innovative,
ten-year agreement with its pilots. The contract maintains current pay rates for
five years, with 37% raises in three of the final five years. Stock options are
offered in lieu of pay increases.
With an average salary of $47,000, Southwest's work force is among the air-
line industry's best paid and its productivity is also higher than the industry's
average.26 Southwest was the first carrier to offer a profit-sharing plan to
employees (1973) and some early participants have become millionaires.
Employees can collect only when they leave. Other benefits include unlimited
- ... -. - -
space-available travel for employees and their families and fully transferable
passes for accomplishments such as perfect attendance. Southwest also offers a
flexible health-benefit program under which employees can choose coverage
suitable to their individual circumstances, and a stock-purchase plan under
which employees can acquire stock at 90% of market value via payroll deduc-
tions.27 Employees own about 10% of the company's outstanding shares.
Kelleher has delegated to the lowest level the authority to make decisions on
the spot without having to wade through layers of management and waste
valuable time. Says Kelleher: "The bigger we get, the smaller I want our
employees to think and act." The 1993edition of The 100 BestCompanies to Work
For In America chose Southwest as one of the ten best. "Last year, Southwest's
turnover was about 7% including retirements-half the industry average.,,28 In
1990, when fuel prices skyrocketed, one-third of the Southwest employees con-
tributed $130,000, unbeknownst to upper management, to offset some of the
increased operating costs.
Herb Kelleher, in the company's 1991 annual report, attributed the airline's
success to its business strategy and "because our people have the hearts of
lions, the strength of elephants, and the determination of water buffaloes."
OPERATIONS
Southwest runs one of the most impressive operations in the airline industry.
Its 203 aircraft make over 1,900 flights a day. In 1994, Southwest generated
624,476 flights, carrying 42,742,602 customers in perfect safety to their destina-
tions. (SWA, 1994 Annual Report)
Southwest's gates average 10.5 departures a day, whereas the industry aver-
age is only 4.5 departures. Southwest's aircraft are airborne for an average of
eleven hours and ten minutes per day, compared to the industry average of only
eight hours. The airline's philosophy is that it can make money only when the
aircraft are in the air. Seventy percent of the time, Southwest is able to off-load a
group of passengers, service the aircraft, and board a new group of passengers
in 15 minutes (see Exhibit 1).29Ten percent of the turnarounds are under ten
minutes. Most airlines require an hour's ground time to turnaround a flight.
This feat is made possible by "guaranteeing seats" but not reserving them with
only one class of seat. Groups of thirty are given plastic chips at the gate and
board in a first come, first on board operation. Not having to load meals
onboard also speeds up the turnaround as does aircrew help in cleaning the air-
craft (See Exhibit 1). In 1994, only 0.86 percent of the airline's flights were can-
celed or delayed due to mechanical incidents. (SWA, 1994 Annual Report, p. 8)
Operating only Boeing 737 series jet aircraft, Southwest simplifies its train-
ing, maintenance, and inventory costs. The company's fleet of aircraft averaged
only 7.7 years of age at the end of 1994. "At year's end 1994, Southwest owned
97 of the 199 aircraft in the fleet. Of the remaining 102 aircraft, 72 were oper-
ated pursuant to long-term leases with various renewal and purchase options
at the end of the lease periods and 30 of the older 737s were under short-term
leases expiring over the next several years.,,30 Southwest contracts out all
heavy engine maintenance plus most component work to firms that can do the
work for less than doing it in-house. Almost 75 percent of Southwest's fleet
have Stage 3 engines which are quieter and more fuel efficient. Twenty-five
SOUTHWEST A TRY Y1\TJ;<::rn~"" ..- .
Exhibit 1 Anatomy of a 15-Minute Turnaround
Source: "Hit'em Hardest with the Mostest," Forbes, September 16, 1991.
--- -- - - - -- --- --
C-204 SOUTHWEST AIRLINES COMPANY
-
Exhibit 2 Airline Efficiency Measures
Source: Commercial Aviation Report, 1993 Data, "Southwest's New Deal," Fortune, January 16,
1995, p. 94.
1993. Labor and fuel costs are the most significant, with each ranging as high as
35% of costs. Travel agent fees range between 8% and 14%, with an average of
approximately 10%.
As of 1994, Southwest Airlines operated eight reservation centers located in
Albuquerque, Chicago, Dallas, Houston, Little Rock, Oklahoma City, Phoenix,
and Salt Lake City. "Southwest in recent months (July 1994), was dropped by
the major computer reservation systems owned by competitors such as United,
US Air, and Continental, which have been hurt by Southwest's expansion into
East Coast markets. The reservation system owners maintained that since
Southwest refused to pay fees for having its flights listed in their systems, it
should not enjoy the same benefits as paying carriers. Southwest has refused to
pay these fees, and is listed now only on American Airline's Sabre system."
Travel agents currently sell 80% of U.s. airline tickets. Their commissions
ranged from 12.96% (1990), 14.08% (1991), 14.31% (1992), to 14.36% (1993). To
counter these escalating fees, Southwest is using ticketless systems. Passengers
are given confirmation numbers over the telephone for their flights and present
identification to airline personnel at airport gates. Also, the growth of on-line
systems, which provide access to travel-related information, is causing a
growth spurt in personal computer sales. Southwest has added more agents
and new reservations centers to iron out the problems that still exist in its over-
loaded reservation system.
MARKETING
FINANCE
tion of Muse Air. By 1987, Muse was draining $2 million a month from South-
west, so Kelleher shut down the operation. Its $4.6 million, 1990 fourth-quarter
net loss was only the second in 71 quarters.36
In 1989, Southwest's annual operating revenues exceeded $1 billion. This
made Southwest a major airline, according to Department of Transportation
definitions. Only ten domestic carriers presently earn revenues of over $1 bil-
lion annually. Southwest Airlines has one of the strongest financial statements
in the airline industry. It continues to have the highest profit margins, the low-
est operating costs, and a high credit rating. The absence of a huge debt load
sets it apart from other major airlines. At a time when other airlines have up to
275% of their assets financed, Southwest has approximately 54%.
In 1990, Salomon Brothers ranked Southwest second among the major air-
lines in financial strength. Only two US. major carriers posted 1990 operating
profits, with Southwest racking up $81.9 million and American $68 million.
Net profits were generated by only two airlines. United's net income was $95.8
million and Southwest's $47.1 million in 1990. Gary Kelly, the Vice President of
finance for Southwest, stated, "We emphasize cost controls, sound marketing,
f and growth at a reasonable rate. That makes the finance official's job easy."
Southwest has never missed a dividend payment since dividends were initi-
ated in 1976.
Between 1991 and 1992, Southwest's passenger revenues increased 28.3%,
its freight revenues jumped 25.5%, and other revenues rose 46.6%. Even more
impressive, Southwest's net income increased from $27 million in 1991 to $91
million in 1992, and its cash position was $303.1 million. On the other side of
the coin, operating expenses increased 20.1% from 1991 to 1992. The primary
factors contributing to the increases were the addition of seventeen 737 airJ
craft, higher travel agency commissions, increased contributions to profit shar-
ing, higher aircraft leasing charges, and increased maintenance costs. (SWA
Annual Reports) According to Kelleher, "Hard times come on a regular basis.
Our secret is that we manage in good times as if it were hard times, and then
we are ready for hard times.,,37
Because of the company's astute leadership, conservative expansion, and
sound financial condition, it is able to access the capital markets to acquire new
aircraft, expand operations, and continue the patient development of new short
haul city pairs. Southwest has an impressive unrestricted, revolving credit of
$250 million from a number of domestic banks. For further financial informa-
tion see the Consolidated Balance Sheet (Exhibit 3) and the Consolidated State-
ment of Income (Exhibit 4).
THE FUTURE
'So
~ ~
Wall Street analysts, institutional investors, and financial reporters are stand-
ing by to hear "the rest of the story!" Will Southwest reverse the 1994 plunge in
earnings of 47%? Will load factors improve? Has Southwest expanded too rap-
idly and will it enter bankruptcy as did Braniff, in the years following enact-
ment of the Airline Deregulation Act? Can Southwest maintain its distinctive
culture as it grows? With the delivery of the new Boeing 737-x aircraft set for
1997, will Southwest make good on its threats to offer transcontinental flights?
---- -----
Exhibit 3 Southwest Consolidated Balance Sheet
(in thousands except/share and per share amounts)
Current Liabilities:
Accounts payable $ 117,473 $ 117,599 $ 94,040 $ 82,023
Accrued liabilities 348,476 288,979 265,333 208,357
Air traffic liability 131,156 106,139 96,146 65,934
Income taxes payable - - 7,025 6,744
Current maturities of long-term debt 13,516 9,553 16,068 16,234
Total current liabilities 610,621 522,270 478,612 379,292
Long-term debt less current maturities 661,010 583,071 639,136 735,754
Deferred income taxe? 281,650 232,850 183,616 136,462
Deferred gains from sale and leaseback of aircraft 245,154 217,677 199,362 224,645
Other deferred liabilities 30,369 28,497 21,292 13,161'
Commitments and contingencies
Stockholders' equity
Common stock, $1.00 par value: 500,000,000 shares authored;
143,255,795 shares issued and outstanding in 1994 and
142,756,308 shares in 1993 144,033 143,256 142,756 96,047
Capital in excess of par value 162,704 151,746 141,168 177,647
Retained earnings 1,120,581 943,704 770,095 605,928
Less treasury stock, at cost (2,904 shares in 1992) - - - 879,586
Total stockholders' equity 1,427,318 1,238,706 1,054,019 879,622
$ 3,256,122 $ 2,823,071 $ 2,576,037 $ 2,368,856
Exhibit 4 Southwest Consolidated Statement of Income
(in thousands except for share amounts)
Operating Revenues:
Passenger $ 2,760,756 $ 2.497,765 $ 2,216,342 $ 1,623,828
Freight 65,825 54.419 42,897 33,088
Charter and other 46,170 39,749 37,434 146,063
Total operating revenues 2,872,731 2,591,933 2,296,673 1,802,979
Operating Expenses:
Salaries, wages, and
benefits 867,984 756,023 641,747 512,983
Fuel and oil 365,670 319,552 304,424 257,481
Maintenance materials
and repairs 217,259 190,308 163,395 122,561
Agency commissions 123,380 151,247 144,941 113,504
Aircraft rentals 169.461 132,992 107,885 77,472
Landing fees and
other rentals 160,322 148,107 129,222 105,929
Depreciation 156,771 139,045 119,338 101,976
Other operating expenses 498,373 437,950 382,945
Merger expenses - - 10,803 317,269"\
Total operating expenses 2,559,220 2,275,224 2,004,700 1,609,175
Operating Income 313,531 316,709 291,973 193,804
Other Expenses (Income):
Interest expertise 58,810 53,368 58,460 59,084
Capitalized interest (31,371) (26,323) (17,770) (15,350)
Interest income (20,095) (9,166) (11,093) (10,672)
Nonoperating (gains) losses, net 1,047 (963) 2,739 3,299
Total other expenses 8,391 17,186 32,336 36,361
Income Before Taxes and Cumulative
Effect of Accounting Changes 305,140 299,523 259,637 157,443
Provision For Income
Taxes 122,514 1120,192 105,353 55,816
Income Before Cumulative Effect
of Accounting Changes 182,826 179,331 154,284 101,627
Cumulative Effect of
Accounting Changes - - 15,259 12,538
Net Income $ 182,626 $ 179,331 $ 169,543 $ 114,165
Per Share Amounts:
Income before cumulative
effect of accounting changes $1.23 $1.22 $1.05 $ .71
Cumulative effect of
accounting changes - - .10 .09
Net Income $1.23 $1.22 $ 1.15 $.80
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C-210 SOUTHWEST AIRLINES CaMP ANY
Gary Kelly, Southwest's Chief Financial Officer, expects that "Some of South-
west's difficulties will take the first half of '95 to get fully sorted out.,,38
"Long-range planning is a thing of the past at Southwest Airlines, where
Kelleher approvingly quotes Klausewitz: 'No battle plans survive contact with
the enemy.' Southwest sets its basic construct, niche, and adopts new tactics
everyday.,,39
Michael Boyd, an aviation systems research analyst, believes United, sad-
dled with higher costs, is likely to lose any head-to-head battle with Southwest.
Aaron Gellman, director of the Transportation Center at Northwestern Univer-
sity, admires how Kelleher manages to stay ahead of his rivals and said:
"Whatever other airlines do, Herb is going to eat them up in ways they haven't
even thought of. The hardest thing for rivals to copy seems to be Kelleher's
secret weapon-the trust and respect of his employees."
REFERENCES
1. McKenna, James T., "Southwest to Raise Ante in United Markets," Avintioll Week& SpaceTech-
lIology,July 18, 1994, p. 22.
2. Garfield, Bob, "Commander Kelleher Eyes Future in New Southwest Ads, "Advt'rtisillg Age,
Vo!. 65, No. 42, October 3,1994, p. 3.
3. "The Southwest Story," Southwest Airlines Company, Dallas, Texas, 1990, p. 2.
4. Southwest Airlines Annual Report, Southwest Airlines Company, Dallas, Texas, 1990, p. 6.
5. "The Southwest Story," Southwest Airlines Company, Dallas, Texas, 1990, p. 6.
6. Southwest Airlines, "Fact Sheet," 1992.
7. Wells, Alexander T., Air Trallsportatioll: A Mallagemellt Perspective, Wadsworth Publishing
Company, Florence, Kentucky, Third Edition, 1994, p. 38.
8. Kane, Robert, and AlIan Vose, Air Trallsportatioll, Kendall & Hunt Publishing Company,
Dubuque, Iowa, 1971, p. 25.
9. Clark, Lindley H., "Airlines and Railroads: A Weird Marriage," The Wall Street Journal,
Wednesday, March 15, 1989, p. A16.
10. Biederman, Paul, "Tile U.S. Airlille Illdustry: Elld of all Era," Prager Publishers, 1982, p. xiii.
11. Hamilton, Martha M., "Airline Mergers to Land on Other Desks," Washillgtoll D.e. Post,
December 22,1988, Section One, p. A23.
12. Wells, p. 302.
13. Ibid, pp. 76-77.
14. Ibid.
15. Ibid.
16. Hamilton, Martha M., p_ A23.
17. Rose, Robert L., "Major U.s. Airlines Rapidly Gain Control Over Regional Lines," The Wall
StreetJournal,Wednesday, February 17,1988,p. A-I.
18. Smith, Timothy K., "Why Air Travel Doesn't Work," Fortulle, April 3, 1995, p. 46.
19. Ibid., pp. 49-50, & 56.
20. Levering, Robert, and Milton Moskowitz, The 100 Best CompalliesTo Work For III America,
Doubleday Press, 1993, p. 413.
21. Woodbury, Richard, "Prillce of Midair," Time, January 25, 1993, p. 55.
22. Jaffe, Charles A., "Moving Fast by Standing Still," Natioll's Busilless, October 1991, p. 59.
23. Teitelbaum, Richard 5., "Where Service Flies Right," Fortulle, August 24,1992, pp. 115.
24. Levering and Moskowsitz, p. 412.
25. Chakravarty,Subrata N., "Hit'em Hardest With The Mostest," Forbes,September 16,1991,p. SO.
SOUTHWEST AIRLINES COMPANY C-211