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Southwest Airlines

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Southwest Airlines. Founded in 1971 by Rollin King and Herb Kelleher ... Southwest Airlines created legal barriers to prohibit the consortium from moving ... – PowerPoint PPT presentation

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Title: Southwest Airlines


1
Southwest Airlines
  • Capturing surplus
  • Han Yi Kim

2
Southwest 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

3
Corporate 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

4
Basis 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

5
The 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

6
Fight 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

7
Conditions 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

8
Third-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)

9
The 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.

10
Price 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

11
Examples
  • 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)

12
Advertising 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

13
Livery
  • 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

14
2005 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

15
Southwest Airlines Top 10 Airports (as of
February 22, 2006)

16
Incidents 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

17
Conclusion
  • 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

18
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