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Southwest Airlines

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Southwest Airlines Capturing surplus Han Yi Kim Southwest Airlines Founded in 1971 by Rollin King and Herb Kelleher The third-largest airline in the world The United ... – 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)
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

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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