Southwest Airlines Business Model free essay sample

The airlines industry has historically been one of the most unprofitable industries. The reason can be explained when incorporating Michael Porter’s famous Five Forces Model. The threat of competition is Southwest Airlines Co. (NYSE: LUV) is an American low-cost airline based in Dallas, Texas, with its largest focus city at Las Vegas McCarran International Airport. It is the largest airline in the United States by number of passengers carried domestically per year and (as of December 31, 2007) also the largest airline in the world by number of passengers carried. It is also the 6th largest U.S. airline by revenue. [8] It also maintains the third-largest fleet of aircraft among all of the worlds commercial airlines. As of July 12, 2008, Southwest operates approximately 3,500 flights daily. Southwest Airlines has carried more customers than any other U. S. airline since August 2006 for combined domestic and international passengers according to the U. S. Department of Transportation’s Bureau of Transportation Statistics. [9] Southwest Airlines is one of the worlds most profitable airlines and in January 2008, posted a profit for the 35th consecutive year. Southwest Airlines was originally incorporated to serve three cities in Texas as Air Southwest on March 15, 1967, by Rollin King and Herb Kelleher. According to frequently-cited story, King described the concept to Kelleher over dinner by drawing on a paper napkin a triangle symboliziSouthwest Airlines founder Herb Kelleher studied California-based Pacific Southwest Airlines extensively and used many of the airlines ideas to form the corporate culture at Southwest, and even on early flights used the same Long Legs And Short Nights theme for stewardesses on board typical Southwest Airlines flights. The airline adopted the first profit-sharing plan in the U. S. airline industry in 1973. Through this plan and others, employees own about 10 percent of the company stock. ng the routes. (Dallas, Houston, San Antonio)[11] he rest of 1971 and 1972 saw operating losses. One of the four aircraft was sold to Frontier Airlines and the proceeds used to make payroll and cover other expenses. Southwest continued to operate a schedule predicated on four aircraft but using only three, and in so doing the ten minute turn was born, and was the standard ground time for many years. 16] Southwest turned its first annual profit in 1973, and has done so every year since — a record unmatched by any other commercial airline. Southwest has used financial techniques such as fuel hedging to bolster its profitability and counteract many of the fiscal disadvantages of operating an airline. Fuel cost containment measures Southwest Airlines earned a reputation for being very aggressive and proactive about containing fuel costs as a key to maintaining profit margins. [19] With fuel being an airlines most important variable cost, Southwests measures have become a model for the industry. Hedging fuel Southwest has a longtime program to hedge fuel prices. It has purchased fuel options years in advance to smooth out fluctuations in fuel costs. In 2000, Southwest said it had adjusted its hedging strategy to utilize financial derivative instruments when it appears the Company can take advantage of market conditions. Additionally, the company hoped to take advantage of historically low jet fuel prices. SEC statement Southwests decision proved to be a prescient and, for a time, extremely profitable effort. To lock in the low historical prices Southwest believed were occurring at that time, Southwest used a mixture of swaps and call options to secure fuel in future years while paying prices they believed were low. The company also stated that with this new strategy, it faced substantial risks if the oil prices continued to go down, but they did not. Previously, Southwest had been more interested in reducing volatility of oil prices. Now, they hoped to reap large gains from oil price appreciation. In 2001, Southwest again substantially increased its hedging in response to projections of increased crude oil prices. The use of these hedges helped Southwest maintain its profitability during the oil shocks related to the Iraq War and later Hurricane Katrina. According to an annual report, here is the companys fuel hedge for forward years (approximate per barrel basis, as of mid-January): 2007 is 95% hedged at $50/barrel; 2008 is 65% hedged at $49/barrel; 2009 is over 50% hedged at $51/barrel; 2010 is over 25% hedged at $63/barrel; 2011 is over 15% hedged at $64/barrel; 2012 is 15% hedged at $63/barrel. According to its 2006 Annual Report, Southwest paid low prices for fuel thanks to the benefit of fuel hedges: †¢2004 82. 8 cents/gallon †¢2005 103. 3 cents/gallon †¢2006 153. 0 cents/gallon These are well below market rates, which Southwest factors into its low operating costs. However, this below-market oil cost will not continue forever; executives have said that Southwest faces increased exposure to the raw oil market every year. This is not a good sign for the airline, which is also facing tough competition from US legacy carriers that have lowered costs through bankruptcy. Southwest CEO Gary Kelly has decided to slow the airlines growth as a response to this cost. Some analysts have argued against the style of profit-motivated energy trading Southwest did between 1999 and the early 2000s. They suggested that rather than hedging business risk, (such as a hedge on weather to a farmer), Southwest was simply speculating on energy prices, without a formal rationale for doing so.