Discuss about the Report on Fundamentals Of strategic Management for Southwest Airlines?
Southwest wants to connect the world through low cost and high quality service to all its customers. “Southwest’s purpose is to connect people to what’s important in their lives through friendly, reliable and low-cost air travel” (southwest.com)
Southwest yearns to be the most flown, loved and profitable airline in history (portions from southwest.com). Southwest is dedicated to provide their customers with the highest quality of customer service while offering low cost flights. Their service is delivered with “warmth, friendliness, and individual pride” that sets them apart from any other airlines.
Southwest is a culture that promotes the “Southwest way.” This is categorized into three segments. The first is having a “Warrior Spirit” meaning to be fearless in delivering their product. The second is a “Servant Heart” meaning follow the golden rule and put others first. The last segment is “a fun loving attitude” which means to be proud and passionate about your work and have fun doing it every day. Many companies have tried to emulate and study Southwest’s culture, but Gary Kelly (CEO) believes their success is just the simple formula above. Having a purpose and being passionate about what you are doing is the award winning culture Southwest promotes each day.
Figure – 01: ROCE of Southwest Airlines for the Years 2010-2014
Interpretation of ROCE (Return on Capital Employed)
During its long and sustained stay as a mature corporation in the USA aviation field, Southwest has been successful in maintaining its leadership role by consistently showing a growth pattern amidst competition, economic slow-downs and global financial difficulties. Southwest was able to retain its profitability and stability even during the financial turmoil of 2008-2009 which forced many established companies to shut down their operations. The EBITDA figures for the period 2010-2014 of Southwest Airlines aptly illustrate its growing strength and amply speak about the management capabilities of the directors of the company[1].
In this regard, ample testimony about the robust strength of Southwest Airlines is established by the Return on Capital Employed (ROCE) ratio of the company, the results of which are presented here. We have arrived at the conclusion after taking into consideration some of the essential financial factors of Southwest Airlines. It is not significant to make a comparison of Southwest with any other airline operating in the same regions as Southwest does not have a competitor having matching financial factors and economic strength as that of the leader.
Calculation
Interpretation of EVA (Economic Value Added)
To determine a company’s EVA, we use the following formula: NOPAT- (WACC*Capital Invested) Southwest is showing a negative EVA prior to 2014 mostly due because it was in a growth phase, if we look at the ROA for the past 5 years, we can see that the numbers have been steadily increasing: 3.09, 1.06; 2.3; 3.97; 5.75; & 8.8, this suggest that early expenses in capital investment started to produce returns on latter years. It’s not surprising to see a negative EVA in this case. In the aviation sector, especially for companies such as Southwest Airlines, which are operating on a thin profit margin and are not charging exorbitant fares from the flyers, a change towards negativity on its EVA figure can also be possible because of sudden decline in the tourist inflow. Another reason for decline can be because of the company’s need to upgrade its aging fleet of aircrafts[2].
Calculation
*Notes on WACC:
Cost of equity is determined using capital asset pricing model assuming 6% equity market premium, 10-year risk free rate, and the historical adjusted beta for Southwest. Cost of debt is determined using historical cost of adjusted debt, which includes net present value for aircraft leases.
Figure – 03: FCF Values of Southwest Airlines for the Years 2010-2014
Interpretation of Free Cash Flows (FCF)
Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Southwest have been generating on average $2,077M operating cash flow for the past 5 years, a grow rate of 29% YoY, with the exception on 2011, were its operating cash flow was -11% YoY, (mostly due to a 96% increase on capital expenditure YoY). Capital expenditures amount an average of 63% of the operating cash flow. Southwest Airlines has experienced negative cash flow during the economic slowdown in 2008 but that was exceptional time. The company has never seen such times after that and has been consistently keeping a healthy Free Cash Flow for its day to day operations as well as for its capital resources[3].
Calculation
Figure – 04: Turnover Ratio of Southwest Airlines for the Years 2010-2014
Figure – 05: Inventory, Receivable & PPE Ratio of Southwest Airlines for the Years 2010-2014
Figure – 06: COGS, SG&A, GM Ratio of Southwest Airlines for the Years 2010-2014
Interpretation
The purpose of this factor is demonstrating the financial efficiency of an organisation. Under normal working conditions, a stable economic atmosphere and a dynamic management policy of the organisation’s Board can make it possible for the organisation to demonstrate positive trends in efficient management of its financial results. In the first nomenclature, analysis of Turnover Ratio is determined by comparing the sales revenue with the capital employed to attain this targeted revenue. In the second nomenclature, the analysis of sales revenue with receivables for service oriented organisations and between sales revenue and inventory for organisations in the manufacturing sector. We shall be conducting both these analyses for Southwest Airlines and make an assessment of the company for the period 2010-2014 from the results obtained[4]. We can also see that the GM ratio have been increasing steadily the last 4 years, while COGS & SG&A expenses have been flat or declining, the turnover ratio shows an upward trend, but somewhat slower than the GM. This indicates that early capital investments are generating more revenue year over year.
Interpretation
Sales Revenue Growth
Revenue growth of Southwest Airlines has been consistent and strong during this period of 2010-2014. Steadily rising every year, this growth shows that the management had good and effective control over its market penetration, over implementation of its policies and over its management capabilities[5].
Operating Profit Margins
Except for 2011 and 2012 when Southwest Airlines demonstrated a downward trend in its operating profit margins, the company has been showing a regular trend of increasing operating profit margins. This can be attributed to the company’s concentration on expansion, takeover attempts for the growth of its market share and modernisation of its infrastructure for the future operational efficiency[6].
Net Working Capital to Sales
This ratio is used for determining how well the organisation’s working capital has been utilised by the management towards better revenue collection and its improvement amidst market’s adverse forces, competitive adversaries and adverse economics of the sector. It is established by the available results that Southwest Airlines has been a successful enterprise in this field also[7].
Fixed Assets to Sales Revenue
This ration is used by analysts to determine how well the management has been doing in managing its fixed asset resources for improvising its sales revenue[8].
Long Term Assets to Sales Revenue
A constant change in this ratio is indicative of the organisation’s consistent growth in sales revenue as well as the management’s capability of utilising this revenue for building up the capital equipment structure of the organisation. This has been a positive trend in Southwest Airlines in the given period from 2010 to 2014[9].
Graphs
Sales Revenue Growth
Figure – 07: Sales Growth of Southwest Airlines for the Years 2010-2014
Operating Profit Margin
Figure – 08: Operating Profit of Southwest Airlines for the Years 2010-2014
Net Working Capital to Sales Revenue
Figure – 09: Working Capital of Southwest Airlines for the Years 2010-2014
Fixed Assets to Sales Revenue
Figure – 10: Fixed Assets of Southwest Airlines for the Years 2010-2014
Industry ROCE. In order to perform the industry ROCE analysis, here the major players in the US airline industry have been taken into consideration. The calculation considered the time frame from 2010 to 2014. Subsequently the average value was taken into account, which represents the industry average. There were two different tables employed in which one includes the ROCE of Southwest airlines and in other one Southwest Airlines was not considered. During the calculation, American airlines, Alaska Airlines, and Delta airlines were taken into account.
While considering the industry average without Southwest Airlines, it can be said that from 2011 onward, the industry ROCE gradually increases. When the ROCE subsequent to 2010 significantly fall down, it again shows an incremental trend till 2014.
Figure 11: Industry ROCE [without Southwest Airlines]
On the other hand, while considering the industry ROCE with Southwest airlines, then also the same results were evidenced. Hence, it can be argued that the value of the organization operate in this industry gradually increases.
Figure 12: Industry ROCE [with Southwest Airlines]
|
2010 |
2,011 |
2012 |
2013 |
2014 |
||
|
Southwest Airlines |
EBIT |
$ 988.00 |
$ 693.00 |
$ 623.00 |
$ 1,278.00 |
$ 2,225.00 |
|
Capital Employed |
$ 12,158.00 |
$ 13,535.00 |
$ 13,946.00 |
$ 13,669.00 |
$ 14,277.00 |
|
|
ROCE |
0.08126337 |
0.05120059 |
0.04467231 |
0.093496232 |
0.15584507 |
|
|
American Airlines |
EBIT |
$ 4,304.00 |
$ (1,054.00) |
$ 107.00 |
$ 1,399.00 |
$ 4,249.00 |
|
Capital Employed |
$ 16,308.00 |
$ 15,218.00 |
$ 14,206.00 |
$ 28,472.00 |
$ 30,336.00 |
|
|
ROCE |
0.26391955 |
-0.06926009 |
0.00753203 |
0.049135993 |
0.14006461 |
|
|
Alaska Airline |
EBIT |
$ 1,215.00 |
$ 449.00 |
$ 532.00 |
$ 838.00 |
$ 962.00 |
|
Capital Employed |
$ 3,592.00 |
$ 3,685.00 |
$ 4,004.00 |
$ 4,258.00 |
$ 4,510.00 |
|
|
ROCE |
0.33825167 |
0.12184532 |
0.13286713 |
0.196806012 |
0.21330377 |
|
|
Delta Airlines |
EBIT |
$ 2,217.00 |
$ 1,975.00 |
$ 2,175.00 |
$ 3,400.00 |
$ 2,206.00 |
|
Capital Employed |
$ 31,803.00 |
$ 30,798.00 |
$ 31,280.00 |
$ 38,100.00 |
$ 37,242.00 |
|
|
ROCE |
0.0697104 |
0.06412754 |
0.06953325 |
0.089238845 |
0.0592342 |
|
|
Industry average [without southwest] |
ROCE |
0.22396054 |
0.03890426 |
0.06997747 |
0.11172695 |
0.13753419 |
|
Industry average |
ROCE |
0.18828625 |
0.04197834 |
0.06365118 |
0.107169271 |
0.14211191 |
Table: Industry ROCE
Industry ROCE using six forces. The attractiveness of the airlines industry belongs to the determined by the all the available possibilities of generating returns of the total capital amount employed by the organization to cope up the competitiveness in the market place. This industry is more intentionally facing the competition in the market, but able to generate normal returns and long term market sustainability (www.columbia.edu). From the evaluation perspectives of an investor’s investment, southwest airline company is generating return on capital employed during the operating period of 2010 to 2014 are a reflection of all six market force factors of the company.
This six force model is showing a different force which influences the industry competition within a specified period of time.
Bargaining power of buyers
There are different group of buyers segmented in the airline industry are following like individual buyers and also those buyers who buy tickets for some other people for personal and professional reasons. These airlines customer groups are highly diversified in different countries. The airlines company southwest company is providing most of the discounts and offers to their customers and clients with the premium class facilities and limited differentiation.
Threats of new entrants
There are huge amount numbers of new airlines companies are entering in the airline industry with huge offers and different attractive travelling packages to attract the existing and potential customers (www.columbia.edu). The company southwest is providing the least fare package airline services to all the passengers but due to new entrants of competition company required to make future contingency plans.
Competitive rivalry
There is huge competition in the market for southwest airlines with seven other competitors company which is providing similar kind of services to the passengers during time of operation. Delta and united continentals holdings are one of those companies who are highly competitive with southwest airlines in the market to taken over the business activities.
Threat of substitute products
There are also threats of some another alterative convenience facilities which can be replace the passengers of southwest airline’s taste and preferences at the time of journey. The car, train, water way and other bus facilities but when it’s come to the time saving facilities airlines facilities is not compare with any other facilities at that specified period of time.
Supplier’s power
The software and hardware vendor are required different types of dependency to provide better supplier power towards the southwest airlines. To manage the supplier’s power by the southwest airlines to maintained the cost of the operations in the organization.
Complementary products
There are several complementary products nowadays invented in the market for example like helicopter facilities and private jet which is also providing huge competitive scenarios for the airlines company like Southwest airlines. These complementary products are also motivated the companies to enhance their competitive strategies to make them stable in the airline industry.
Potential profits for Southwest Airlines. As per the profit margin analysis of the company Southwest Airlines, it can be said that the budgeting scenarios and financial analysis of the company highly efficient to manage the different financial obligations, and also forecasting about generating overall operating profit margin of the company within mentioned financial period of time. Southwest Airlines has been efficiently reported that they are much efficient enough to manage their cost of goods sold, depreciation and taxes to develop as well as attain desired profit margin in every financial year. The primary aim of the company to manage the profit margin of the company to manage competitiveness with their peer groups in the market.
In this context, it is also that the growth phases in the revenue generating activities and profit margin are generated from their operating activities. The firm is tried to initiate some better business strategies like discounts on prior purchase of tickets strategies, which will assure the company attains significant profit margin. This is the one of the most successful strategy which is used by the organization to positive earning abilities during the financial year 2012 to 2015. Southwest Airlines always expanding strategies to enhanced 14% to 28% gross margin in the financial year 2014 and become a one of premium automobile manufacturing company in the market if United States.
Every airline career required established position in the market through target and segmenting activities. The companies are frequently introducing new strategies for its target customers. They also applying these strategies to segment the target group of customers based on the given five aspects (Lorente and Lorente). Southwest airlines are basically positioned both in the low cost and luxury career category as per the consumer’s desire and preferences. This specific segmentation is creating its own unique identity in the airline industry over this selected timeframe.
The airline organization is highly benefited because of proper market segmentation as it helps to avoid the other carriers’ competition in the market. The organization is one of the most exclusive brands which are providing qualitative segmenting for both type market segments of luxury as well as low cost carriers.
Figure 13: Market segments
The top managerial authorities of the Southwest Airlines are efficient enough to manage the customer’s value proposition in the organization. The company is exclusively offering the luxury prices for selection of their exquisite products. In airline industry, there are plenty numbers of the market players offering mix amount of propositions to evaluate the customers of the organization. The market competitor companies like American airlines, Alaska Airlines, and Delta airlines are also facilitating mass market segment to provide efficient service not in the market of the United States, but also throughout the globe (Financials.morningstar.com). The value propositions by Southwest airlines largely focused on catchy wordings like “Love”. It has been noted that the organization employed an advertisement with title “HOW DO WE LOVE YOU?” Here, the ad mainly reflects its flight schedules. At the same time another ad titled “WE ARE SPREADING LOVE” reflects its customer dedication aspects.
The idea behind the differences and uniqueness of this airline organization’s customer value propositions are following in nature:
The service provided towards the customers should be affordable;
Specific packages related to long fleet should be as per the modern taste and preferences of the customers;
The service provided should fulfill the perception of the customer as much as possible;
Create long –term brand awareness among the customers to maintain the corporate reputation and goodwill in the market.
Manage loyalty and references of the existing customers to manage the brand value of the organization.
Always required to considered customers feedback to generate product development processes of the organization.
In addition to these above mentioned value propositions, the organization also has been started several loyalty programs which is promoting the company effectively in the global market (Financials.morningstar.com). They always concerns about their customer and providing all the safety and comfort demos in front of their potential and existing customers of the organization.
In the above section, the market segmentation strategy followed by Southwest Airlines has been demonstrated. However, if all the segments are considered together, then it can be said that the operation of Southwest airlines can be broadly classified under three segments, passengers, frights and other revenue segments. Over the period, revenue from passengers segments provides major contribution towards overall revenue (Financials.morningstar.com). If the last year’s performance has been taken into consideration, then it can be said that almost 88.68 % of the total revenue were generated from passengers segments. At the same time, the study has also revealed that the contribution from freight segment was 0.83 % of the total revenue and 10.49 % of the total revenue were from other segment.
Figure 14: Market segments analysis
The organization has adopted various attractive strategies in order to maintain its exiting position. In order to choose this specific market segment, the organization thinks differently from the other carriers operates in this marketplace. While adopting any strategies, they have focused on more load factors than the average level. At the same time, their low price strategy also supports them to expand the market quickly (Financials.morningstar.com). Further the demand outpaces supply strategy also supports them to consider such specific market segments.
It has become clear that the airline industry evidenced significant downfall like other industries subsequent to the global financial crisis 2008 (Csimarket.com). However, over the timeframe, the airline industry has evidenced an incremental trend in terms of overall performance. While considering what are the factors that enables airline industry to attain such success, it was found that work culture, competitive environment, successful leadership, trust, open sharing of information and creativity spirit are the major aspects.
Figure 15: Key Success factors of the Airline Industry
It has been noted that Delta Airlines and United Continental Holdings are the major competitor of Southwest Airlines. While measuring the competitiveness, among these three players, it has been found that Southwest Airlines evidenced poor performance in against other too (Brigham and Houston). However, this has argued based on the revenue generation aspects as shown in the below mentioned table:
|
Amount in million |
COMPANY NAME |
REVENUE |
|
Passengers |
SOUTHWEST AIRLINES CO. |
$ 4,716.00 |
|
DELTA AIR LINES, INC. |
$ 9,595.00 |
|
|
United Continental Holdings, Inc. |
$ 8,960.00 |
|
|
APROX. MARKET |
$ 23,271.00 |
|
|
COMPANY NAME |
REVENUE |
|
|
Freights |
SOUTHWEST AIRLINES CO. |
$ 44.00 |
|
DELTA AIR LINES, INC. |
$ 196.00 |
|
|
United Continental Holdings, Inc. |
$ 235.00 |
|
|
APROX. MARKET |
$ 475.00 |
|
|
COMPANY NAME |
REVENUE |
|
|
Other revenue |
SOUTHWEST AIRLINES CO. |
$ 558.00 |
|
DELTA AIR LINES, INC. |
$ 565.00 |
|
|
United Continental Holdings, Inc. |
$ 1,111.00 |
|
|
APROX. MARKET |
$ 2,234.00 |
|
|
COMPANY NAME |
REVENUE |
|
|
Total |
SOUTHWEST AIRLINES CO. |
$ 5,318.00 |
|
DELTA AIR LINES, INC. |
$ 10,356.00 |
|
|
United Continental Holdings, Inc. |
$ 10,306.00 |
|
|
APROX. MARKET |
$ 25,980.00 |
Table: Revenue generation
However, if the segment wise growth rate is taken into account here, then it can be seen that the organization has shown better performance than its competitor.
References
Brigham, Eugene F, and Joel F Houston. 2013. Fundamentals Of strategic Management. Mason, Ohio: South-Western.
Csimarket.com,. 2016. “Southwest Airlines Co. Competition Revenue Growth By Company’s Segment – Csimarket”. https://csimarket.com/stocks/competitionSEG3.php?code=LUV.
Financials.morningstar.com,. 2016. “Balance Sheet For Southwest Airlines Co (LUV) From Morningstar.Com”. https://financials.morningstar.com/balance-sheet/bs.html?t=LUV®ion=usa&culture=en-US.
Financials.morningstar.com,. 2016. “Balance Sheet For American Airlines Group Inc (AAL) From Morningstar.Com”. https://financials.morningstar.com/balance-sheet/bs.html?t=AAL®ion=usa&culture=en-US.
Financials.morningstar.com,. 2016. “Balance Sheet For Alaska Air Group Inc (ALK) From Morningstar.Com”. https://financials.morningstar.com/balance-sheet/bs.html?t=ALK®ion=usa&culture=en-US.
Financials.morningstar.com,. 2016. “Balance Sheet For Delta Air Lines Inc (DAL) From Morningstar.Com”. https://financials.morningstar.com/balance-sheet/bs.html?t=DAL®ion=usa&culture=en-US.
Lorente, Cristina Nicolàs, and Laura Nicolàs Lorente. 2013. Microsoft Dynamics strategic Management. Birmingham, UK: Packt Pub.
www.columbia.edu,. 2016. “Www.Columbia.Edu”. https://www.columbia.edu/cu/consultingclub/Resources/Airlines_Eric_Henckels.pdf.
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[2] tayloor, M.P. Purchasing Power Parity and Real Exchange Rates. (Oxon: Routledge, 2013), 81.
[3] Yona, L. International Finance for Developing Countries. (Keynes: AuthorHouse, 2011), 171.
[4] Cichosz, P. Data Mining Algorithms: Explained Using R. (West Sussex: John Wiley & Sons, 2014), 216.
[5] Taylor, M.P. Purchasing Power Parity and Real Exchange Rates. (Oxon: Routledge, 2013), 108.
[6] Keown, A.J., Martin, J.D., Petty, J.W. and Scott, D.F. Financial Management: Principles and Applications (10th ed). (New Delhi: Pearson Education India, 2012), 252.
[7] Cichosz, P. Data Mining Algorithms: Explained Using R. (West Sussex: John Wiley & Sons, 2014), 261.
[8] Mudra, J. International Financial Management (12th ed). (Stamford, CT: Cengage Learning, 2014), 135.
[9] Yona, L. International Finance for Developing Countries. (Keynes: AuthorHouse, 2011), 180.
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