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Southwest Airlines is the name of the airline chosen for this paper's research topic. The purpose of the research is to examine Southwest Airlines' recent economic impact, growth, and production figures. The study also addresses the company's options for maintaining market dominance. By analyzing the company's price and benchmarking it against other companies, the report will also address the economic market for Southwest Airlines and its rivals. Being an economical airline in the sector is something the company takes great pride in, while still maintaining devoted and happy workers and clients. With these said, I will analyze and compare information based on the facts from annual reports and other relevant internet sources to find the best feasible way of improving the profitability of the company.
History of the Company
Southwest Airlines is a Dallas based airline started way back in 1967 by Rollin Kind and Herb Kelleher employing the simplest idea that if one gets passengers to the place they intend to be on time when they want and at the lowest fares. People will fly your airline if the provider of the services makes darn sure that the customers have a good time while taking a flight (About Southwest, n.d.). With 45 years of experience and success, Southwest Airlines has opened the door to a customer service based travel at an affordable rate making it one of the largest carriers in the nation in domestic passengers boarded as well as the largest fleet of Boeing aircraft (About Southwest, n.d).
The company operates Southwest Airlines which is the leading passenger airline that offers scheduled air transport in the U.S. and global markets that nears the United States. For forty-three consecutive years, the business was profitable with a net income of $2.2 billion. The success of Southwest has a rocky beginning with Kind and Kelleher fighting competing for airlines as they pushed back on the threatening ideas Southwest stood for. These fights landed the company in the United States Supreme Court. This encounter lasted well over a year, but Southwest Airlines stood their ground to be airline they set out to be. January 1971 brought a fresh start as Lamar Muse joined as the President and began to build Southwest to what we know today raising millions of dollars and cutting deals with bigwigs such as Boeing. Southwest Airlines provides the best in aviation transportation all over the world and is expanding every year with more routes, more aircraft, and extensive customer oriented staff ("Revenue, EPS, & Dividend - Southwest Airlines Company (LUV) - NASDAQ.com," n.d.).
Supply and Demand Conditions
First, the price of related services and products for Southwest Airlines will be looked at. Southwest is known to have some of the most affordable prices in airline travel across the board when compared to other national airlines. “In addition to motivated employees and great customer service, Southwest Airlines also offers one of the lowest-priced solutions for air travel. Its pricing strategy offers meager prices compared to other airlines, such as Delta (DAL) and American Airlines (AAL). To be able to offer low prices, Southwest had to build its business model around low operating costs” (How Is Southwest Different From Other Airlines?). Maintaining and keeping low operating cost gives a chance for Southwest Airlines to provide relatively less and fair fare prices even in a fluctuating demand or rise in oil prices.
Southwest may still have many unopened destinations, but they are slowly opening up too much more and will eventually take on the affordable airline with all destinations you could think to travel to. This brings us to the setting trend for Southwest for the coming years as the company continues to expand to new destinations. As the expansion continues, Southwest will become more demanded because the affordable pricing will allow more consumers to travel via flight and arrive at the location they desire. This demand will force Southwest Airlines not only to increase its fleet, employees, and travel times, but it will also increase training and hiring of said staff in compliance with their customer satisfaction goals.
Secondly, the future pricing and the trend of income and revenue for Southwest Airlines over the last five years will be evaluated and discussed. We will look at five years because in that time frame Southwest Airlines has expanded its destinations with the expiration of the Wright Amendment. A little history on the Wright Act for those who may not know is provided here forth. The Wright Amendment limited flights are going out of Dallas Love Field to destinations within Texas State. This constrained Southwest Airlines in the state of Texas from being able to travel very far or get many consumers who were looking for regional destinations. On October 13, 2014, we note that the Wright Amendment was lifted and thus increasing the demand for flights Southwest Airlines needed to produce to keep up with the new customer line they were open to. Over the five years, we will be looking at that is 2010-2015; we will see a relatively steady increase in total revenue in the business. The graph below shows the total revenue for the years stated above ("Revenue, EPS, & Dividend - Southwest Airlines Company (LUV) - NASDAQ.com," n.d.).
As we can see the revenue for Southwest Airlines is increasing every year as more and more destination ports open, and consumers choose the affordable airline over other higher priced options. As for Southwest and their future pricing, Southwest Airlines has a statement that if you can get a customer to their destination, makes them happy, and makes it affordable they will come back over and over again. This statement has been the basis of Southwest Airlines from the beginning and will continue to be the basis for the future. While raising prices is ultimately inevitable due to inflation, Southwest Airlines will continue to be the most affordable amongst other airlines.
Next, we will look at the supply side by examining the price of substitutes and the number of firms in the current market. When looking at substitutes driving, bus and train travel are the other options available for travel. Bus and train travel is long and can usually take several days, as well as the destinations and ports of these modes are smaller than they use to be in the past.
Driving would be the next best substitute compared to airline travel. While this is an affordable option, but also takes a more extended period, places wear and tear on the customer's vehicle, involves the consumer having to make the effort of driving themselves, and if the destination is overseas, you may not be able to drive there at all. So depending on where your ultimate destination is your choice in substitutes could be limited. Lastly, we will look at some airlines currently in the firm. Major current carriers include Delta, American, American Eagle, Continental, Virgin, Spirit, United, and other several international carriers. Of course, the number of airlines to choose from is a vast pool, but that doesn’t mean every airline goes to every destination. While the supply of carriers is not short, the consumer must research their particular destination and price point to determine the specific quantity required for their travel requirements.
Price Elasticity of Demand
According to Rassenfosse & Potterie (2011), the price elasticity of demand is a word in economics often utilized when discussing sensitivity in the price of goods and services. For this, we will use a particular example to compare Southwest Airlines and a destination to another airline and the same destination. We will use the case Dallas to Chicago leaving around noon. For this example, a random future date selected. When looking at the Southwest Airlines options, they only depart out of Dallas Love Field and arrive at Chicago Midway Airport. Results are as shown in the table below:
Next, we will look at American Airlines which only departs from Dallas/Fort Worth Airport and arrives in Chicago O’Hare. Results are shown below:
When we look at these outcomes we see two things straight away, first Southwest Airlines offers more options on flights within an hour timeframe, and they are the cheaper airline. When looking at price elasticity, we must first know the difference between elastic and inelastic. When a product is viewed as a necessity such the quantity demanded would not change in response to price changes. But when a product is seen as a luxury, such as an airline travel, the price change would influence the quantity demanded as consumers with less disposable income would do away with the purchase altogether. While American Airlines is a great airline, those who need flights are more likely to choose the flights with a lower price because this is a “luxury” and selecting the cheaper flights gives a chance to those with less disposable income to have the option to travel.
Lastly, we will look at consumer’s responsiveness to price change. As stated above airline travel is usually considered a luxury and while many wish they could just fly everywhere, it is not always an option. Many consumers have to take into consideration the number of people traveling, the time frame they are going to use when flying and staying in their destinations as well as how much they will be taking with them. Many airlines charge more to travel on the weekends and charge for extra baggage that isn’t just carried on. All of these additional costs can add up quickly and make the option to fly inaccessible.
For example, if a family is traveling, they may choose to drive to their destination due to the amount of luggage and people flying. On the other hand, a person traveling just for the day for business may decide airline travel is the best option because they have no luggage and driving would not get them to their destination in time. In this instance, customer responsiveness is significantly determined the situation they are currently in and if they can afford a luxury such as an airline travel.
Last but not least, a company such as Southwest Airlines must carefully look at price changing due to the fact that the products and services they produce are elastic. If Southwest Airlines were to just up their price by double their customers would respond negatively and that would decrease revenue for the company and decrease demand. If a consumer cannot afford the service they are looking for they will find another way to get where they need to go. Southwest must ensure that when fluctuating prices they are careful and only move the cost to obtain their goal to maintain revenue and profit while still giving their customers an affordable way to travel ("Price Elasticity Of Demand," n.d.).
Cost of Production
There are various costs that Southwest Airlines faces, their current trends and how they have impacted the profitability of the company. The company faces several costs of production which are divided into fixed and variable costs. Fixed costs are costs that remain constant or remain the same for all output while variable costs are that change with each project. Fixed costs for the company include things like research and development costs, insurances, production plant, and machinery. On the other hand, variable costs include the price of fuel and oil, raw materials, labor costs and administration costs. In the production process in the business, all the costs are needed to ensure the profitability of the company. The costs of production are components that depend on one another, and therefore they are necessary so that the company can be able to transport people from one place to another.
In fourth quarter 2015, the total operating expenses reduced by 1.4 percent as compared with the 2014 fourth quarter. In 2015, the business expensed $139 million to union indenture bonuses which is a unique thing in the production. When the unique items are excluded in both periods, we note that the operating costs in fourth quarter 2015 were $4 billion as compared to $3.9 billion in 2014.
The economic fuel cost in 2015 was $2.03 per gallon as compared to $2.62 per gallon in the previous year. The fuel derivative market and contracts derivatives are expected to decrease soon further. From the fourth quarter in 2014, the expense of oil, fuel, and unique items increased by 8.1 percent.
This section discusses the market share of Southwest Airlines and the top competitors of the company by offering the present percentages for each organization and the trend over a period. With these said there are various techniques for measuring the market share of a company. One method can be looking at RPM (Revenue per Passenger Mile) which is a measure of demand that the in 2014 approximately $108 billion. This was eighteen percent when compared to the four competitors such as JetBlue Airways, Delta Air, Alaska Air and United Continental Holdings. The percentage has risen from sixteen percent in the year 2016. United Continental and Delta are the only larger competitors that have a significant market share regarding revenue per passenger mile at 30 percent and 40 percent respectively.
According to Řasa and Plos (2015), Southwest Airlines had a market share of 18.8 percent in January 2015 based on ASM (Available seat miles) as a gauge of capacity. Over the past five years, this value has almost been constant regardless of the industry going through a time of extreme consolidation.
Basing on the four competitors discussed above, Southwest Airlines had approximately 15.4 percent share of the market in the year 2014. This is a definite position acknowledging the other firms have more significant and have an extensive worldwide presence. With these said, the other larger companies had a market share that ranges from 21 to 23 percent.
The figure above shows the Southwest Airlines market share in percentage for the years 2012, 2013, 2014 and 2015.
In the United States, there are barriers to entry into the airline industry. The most challenging obstacle to entry is the high capital needed to purchase the raw materials and hire labor. New airlines can face difficult moments in establishing or gaining entry into the market. Besides, there are high costs like research and technology required maintaining and keeping up with new competitors and innovations. The market structure of Southwest is not homogeneous. They tend to differentiate their products from the competitor's products and services. The company endeavors as much as possible to find the equilibrium price that satisfies both the company and the customers.
From an economic viewpoint, I would like to offer recommendations to Southwest Airlines. First, I will recommend that the company improves its flight scheduling and arrangement algorithms to match the airplane flight management arrangement better. Second, the company has to compete with other airline industries on virtually all of its scheduled routes. The competitive factors that Southwest should consider are customer comfort service and amenities, frequent flyer schedules and programs and cost and pricing structure.
Furthermore, the company should consider opening up other destinations. This will bring us to set the trend for Southwest in the coming years as the business expands to new destinations continually. As the expansion continues, Southwest will become more demanded because the affordable pricing will allow more consumers to travel via flight and arrive at the location they desire. This demand will force Southwest Airlines not only to increase its fleet, employees, and travel times, but it will also increase training and hiring of said staff in compliance with their customer satisfaction goals. With these recommendations, Southwest Airlines will have a better stand against their competitors like JetBlue Airways, Delta Air, Alaska Air and United Continental Holdings.
About Southwest - Southwest Airlines. (n.d.). Retrieved from https://www.southwest.com/html/about-southwest/index.html?clk=GFOOTER-ABOUT-ABOUT
How Is Southwest Different From Other Airlines? | Investopedia. (n.d.). Retrieved from http://www.investopedia.com/articles/investing/061015/how-southwest-different-other-airlines.asp
Price Elasticity Of Demand. (n.d.). Retrieved from http://www.investopedia.com/terms/p/priceelasticity.asp?layout=orig
Rassenfosse, G. D., & Potterie, B. V. (2011). On the Price Elasticity of Demand for Patents*. Oxford Bulletin of Economics and Statistics, 74(1), 58-77. doi:10.1111/j.1468-0084.2011.00638.x
Revenue, EPS, & Dividend - Southwest Airlines Company (LUV) - NASDAQ.com. (n.d.). Retrieved from http://www.nasdaq.com/symbol/luv/revenue-eps
Řasa, L., & Plos, V. (2015). Enhancing Safety at Airline Operations Control Centre. MAD - Magazine of Aviation Development, 3(14), 5. doi:10.14311/mad.2015.14.01
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