Title: Southwest Airlines
1Southwest Airlines
- Capturing surplus
- Han Yi Kim
2Southwest Airlines
- Founded in 1971 by Rollin King and Herb Kelleher
- The third-largest airline in the world
- The United States most successful low-fare, high
frequency, point-to-point carrier. - Known as a discount airline since 1973
- - offers low fares
- - no-frills service
- - basis for Southwest's popularity and rapid
growth
3Corporate Culture
- Tickets must be bought from the airline itself,
the phone or online - Extra Rapid Rewards
- - frequent flier program
- - credits for online booking users only
- Customers are assigned to a boarding group
depending on check-in time - - find their own seats on the plane
- Colorful boarding announcements and crews that
burst out in song instead of no video
entertainment - Meal service is less than on historically full
service airlines
4Basis for profitability
- Fuel hedging
- Purchased fuel options for years in advance to
smooth out fluctuations in fuel costs - substantially increased its hedging in 2001 in
response to projections of increased crude oil
prices - Advantaged after Sep. 11, 2001 attack, the oil
shock from Iraq War, and Hurricane Katrina - Operated only one model of aircraft
- Boeing 737, medium range-narrow body commercial
passenger jet aircraft - easy to replace parts and ground support
equipment
5The Southwest Effect
- A trend that indicated the success and
profitability of Southwests business model - less expensive than driving between two points in
the early 1970s, during the first major energy
cost crisis in the U.S. - Basis of lean operations and high aircraft
utilization - When a low fare carrier enters a market, profit
grows dramatically
6Fight against high speed rail
- In 1991 Texas TGV Corporation planed to connect
the Texas Triangle (Houston Dallas San
Antonio) with a privately financed high speed
train system at a lower fare rate - The same model Southwest Airlines used 20 years
earlier to break in to the Texas market - The original estimated cost was 5.6 billion, but
the task of securing the necessary private funds
proved extremely difficult - Southwest Airlines created legal barriers to
prohibit the consortium from moving forward with
the help of lobbyists. - In 1994, the Texas TGV Corporation has failed and
withdrew high speed rail development - lost 40 million to be invested
7Conditions for price discrimination
- A firm must have some market power to price
discriminate - The demand curve the firm faces must be downward
sloping - Southwest knows that it can attract more
customers at lower fare price - The firm must have some information about the
different amounts people will pay for its
product. - Southwest must know how reservation prices or
elasticities of demand differ across consumers - A firm must be able to prevent resale, or
arbitrage. - Customers need to present an identity card before
boarding
8Third-Degree Price Discrimination
- The firm identifies different consumer groups, in
the market, each with a different demand curve. - Southwest Airlines recognizes that any given
flights has different types of travelers - business travelers vs. vacation travelers
- To maximize profit, the firm sets a price for
each group by equating marginal revenue and
marginal cost. - Equivalently, by using the inverse elasticity
pricing rule (IEPR)
9The Inverse Elasticity Pricing Rule (IEPR)
- The rule stating that the difference between the
profit-maximization price and marginal cost,
expressed as a percentage of price, is equal to
minus the inverse of the price elasticity of
demand.
10Price elasticity of demand
- The percentage change in quantity demanded (Q)
that occurs in response to a percentage change in
price (P) -
- Estimates of the price Elasticity of demand for
Airline - Category
Estimated EQ,P - Airline travel, leisure -
1.52 - Airline travel, business - 1.15
- Source Tea Hoon Oum and Jong-Say Yong,
Concepts of Price Elasticities of Transport
Demand and Recent Empirical Estimates, Jounal of
Transport Economics and Policy (May 1992)139-154
11Examples
- Using the inverse elasticity pricing rule to
determine the ratio of between tickets for
business (PB) and vacation travelers (PV) - The IEPR tells that (PB MC)/PB -(1/e)
- Substitute the estimated price elasticity of
demand for business travelers, e -1.15 - solve for MC MC 0.13 PB
- The IEPR also tells that (PV MC)/ PV -(1/e)
- Substitute the estimated price elasticity of
demand for vacation travelers, e -1.52 - solve for MC MC 0.342 PV
- Equate these two expressions for MC PB /PV
0.342/0.130 2.63 - Thus, Southwest Airlines will maximize profit by
charging 2.63 times as much for a business travel
ticket as it charges for vacation travel ticket - (the exact prices of the tickets will depend on
the marginal cost)
12Advertising campaigns
- Just Plane Smart
- The Somebody Else Up There Who Loves You
- THE Low Fare Airline
- Symbol of Freedom
- Wanna get away?
- ding You are now free to move about the
country
13Livery
- Some southwest planes feature special themes,
rather than the normal livery - Shamu One/Two/Three
- California One
- Arizona One
- Lone Star One
- Triple Crown One
- Sliver One
142005 Financial Statistics
- Net income 548 million
- Total passengers carried 88.4 million
- Total RPMs 60.2 billion
- Passenger load factor 70.7 percent
- Total operating revenue 7.6 billion
15Southwest Airlines Top 10 Airports(as of
February 22, 2006)
Cities Daily Departures Numberof Gates Nonstop CitiesServed Service Established
Las Vegas 216 21 51 1982
Phoenix 200 24 41 1982
Chicago Midway 200 29 43 1985
Baltimore/Washington 165 19 34 1993
Oakland 138 11 20 1989
Houston Hobby 134 17 28 1971
Dallas (Love Field) 120 14 14 1971
Los Angeles (LAX) 118 12 19 1982
San Diego 92 10 16 1982
Orlando 90 9 28 1996
16Incidents and Accidents
- On March 5, 2000, Southwest Airlines Flight 1455
overran a runway at the Burbank airport in
California - Leaving 43 injured but no fatalities
- Resulted in the dismissal of the pilots
- On December 8, 2005, Southwest Airlines Flight
1248 skidded off a runway at Midway Airport in
Chicago, Illinois, in heavy snow conditions - A young boy was killed in a car struck by the
plane after it had skidded into a street - Several minor injuries reported from passengers
onboard the aircraft and on the ground
17Conclusion
- Southwest Airlines uses third-degree price
discrimination to fill the plane with travelers
in the most profitable way - Depending on the price of elasticity of demand
for tickets - Charge a higher price for business travelers who
have relatively inelastic demands - Charge a lower price for vacation travelers who
have relatively elastic demands
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