Competitive Strategy Southwest Airlines

Topics: Southwest Airlines, Airline, Aircraft Pages: 16 (2051 words) Published: November 27, 2004
The domestic US airline industry has been intensely competitive since it was

deregulated in 1978. In a regulated environment, most of the cost increases were

passed along to consumers under a fixed rate-of-return based pricing scheme. This

allowed labor unions to acquire a lot of power and workers at the major incumbent

carriers were overpaid.

After deregulation, the incumbent carriers felt the most pain, and the floodgates had

opened for newer more nimble carriers with lower cost structures to compete head-on

with the established airlines. There were several bankruptcies followed by a wave of

consolidation with the fittest carriers surviving and the rest being acquired or going out of

business.

Analysis of the airline industry

To determine the profitability of the airline industry, we will do an industry analysis using

Porter's five-forces framework. This industry analysis will help us in understanding the

size of the Potential Industry Earnings (PIE), and how much of this the different

participants can extract.

Rivalry among competitors

There is intense rivalry among different airlines. In the pre-deregulation days, airlines

competed mostly on things like service, meals and in-flight movies etc., since prices

were mandated by the Civil Aeronautics Board. In the post-de-regulation era, this rivalry

has taken on the form of severe price competition, with airlines ruthlessly undercutting

each other with fare promotions.

There are a number of airlines making the airline industry fairly crowded. Even though

the 3-firm concentration in 1992 was 50%, and the 8-firm concentration was 92%, the

fact that the airlines competed on price made the industry much more competitive than

the numbers might suggest.

The service the airlines sell (air transport) is pretty homogenous, and there is not much

product (in this case, service) differentiation. The major differences between the services

offered by different airlines include the total time spent on an airplane and the number of

connections. While time-sensitive business travelers may prefer shorter, direct flights,

most leisure travelers don't see this as a big differentiator when the price is factored in.

Buyers (both business as well as leisure travelers) have low switching costs and there is

very little relationship-specific investment that travelers make. Although the airlines

made an effort to create customer loyalty by offering frequent flyer programs, most of the

competitive advantage this provided was quickly eroded by almost all airlines offering

such programs. Moreover, leisure travelers are motivated to shop around for the best

price.

The airline industry is also characterized by very high fixed costs. The majority of the

operational costs (labor, landing fees, cost of aircraft etc.) are fixed regardless of how full

the planes are, and the marginal cost of adding an extra passenger is almost negligible

(just the cost of food plus an insignificant amount of extra fuel). Thus, on the margin,

every extra seat sold contributes directly to the bottom line. This motivates airlines to

undercut each other till price approaches marginal cost.

Intense competition also lead to excess seat capacity in several markets. This,

combined with periods of declining demand because of macro-economic factors, and the

high fixed costs and low marginal costs make the airline industry very price competitive.

Things like access to Computer Reservation Systems and innovative pricing coupled

with yield management were competitive advantages for a little while before they

become a staple of being in business as an airline.

Entry

Entry into the domestic airline industry is relatively easy since there are no significant

barriers to entry. Inputs such as aircraft maintenance, food service, ground services,

reservations etc., could be outsourced. Airplanes...
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