This document summarizes a case study about Southwest Airlines facing increased competition from major carriers like United and Continental. Ann Rhoades, VP of People at Southwest, is preparing for a meeting to discuss how Southwest can maintain its competitive advantage in light of these new threats. Southwest has traditionally relied on strong company culture and human resource practices to drive lower costs and better service. However, Rhoades is concerned the competition may be able to imitate these practices. She will review Southwest's strengths and weaknesses and make recommendations. The case provides background on Southwest's history and culture since its founding in 1971.

1. Strategic Analysis and Leadership Interventions 1
Strategic Analysis and Leadership Interventions 3
Strategic Analysis and Leadership Interventions
Kelley Hageman
Capella University
Introduction
Every organization that is offering services to people, must first
implement strategies that will help in determining how to deal
with different issues that tend to arise, more specifically in the
nursing field. It is out of this a cycle is formed with various
models that will facilitate changes, so as to reduce any
boundaries that tend to occur. (Melnyk, & Overholt 2011). In
these cases, we are focusing on the issue of blurring, which has
caused a loss in clear nursing authority. The reason every nurse
is licensed, is to ensure that better methods are applied in
making sure that the patient receives the best, most recent,
evidence based care, from the professional nurse. It has also

2. been said that the character of the nurse is as important as the
knowledge she possess. From the education of the nurse to the
character, different leadership aspects are portrayed, and
determine what professional qualities the nurse will offer to the
patient. Having said that, the nurse needs to continue to acquire
a better understanding, greater knowledge, and more refined
skills that will help them improve their delivery of health care
services to the patient, and what he/she brings to the table. In
addition, the strategies and the working structure that are
brought out, determines the application of the model to be used,
and how each person is restricted to his/her responsibilities.
Choose an analysis model that is appropriate to your selected
issue
Any model is initiated to making sure that certain matters are
addressed which helps increase the ability to come up with
better solutions in dealing with the issues at hand. More
specifically, the boundaries that are created by the medical
nurse administrator and senior nurses have at times been
blurred, which has prompted a loss in apparent nursing
authority. It is out of this that, this problem has caused patients
to suffer, if the people that can best take care of them and their
issues, is not being placed in charge of their care. Initiation of
any Model implies that there are some factors that need to be
addressed and accomplished for the better of the institution. In
addition to models, the introduction of the PDSA cycle helps to
solve particular issues which may arise from having the ability
to use each model, in that it helps identify the primary cause of
the problems and how the issues can be improved.
By introduction of these phases within the PDSA cycle, changes
can be made. Change happens because with this model, planning
is facilitated, acting in accordance to needs, and finally, the
doing phase, which all show a good strategic structure, that the
helps the nurse clearly identify any patient with any problem,
and as a nurse leader, they can delegate accordingly. Apart from
the PDSA cycle, there is focus methodology, which is a process,
that facilities change that is happening. It is out of this model

3. that every possibility of change is being presented, and can then
bring about what is best for patient care, and it also implies that
each person is responsible for his/her duty, since the structure
that is created, shows every detail that should be followed by
people who are offering different services, which makes clear
the line of responsibility, and keeps the patient at the center of
care.
Identify and describe the model you will be using, then use the
model to analyze your work issue. Be sure to address the issue
from a nurse leadership perspective.
PDSA cycle and the FOCUS methodology are both applicable in
this case, and help clarify ways in which to facilitate change in
the health care services, but I will be using the PDSA cycle. I
am choosing this model because it essentially narrows it down
to three questions being, what are we trying to accomplish?
How will we know that a change is an improvement? What
changes can we make that will result in improvement? (Ransom
et al., 2005). With this model, a better strategy is formed in a
quick easy manner. It focuses on what is the most important
issue at hand, and what we do to improve it. Assessment of the
situation will be carried out so as to know the reason the model
is being initiated. For instance, in this case an evaluation of the
patient’s experience of care can be obtained, which will bring to
the forefront the main areas that are experiencing the most
issues in the delivery of their care, and the roles of those
involved in their care. From there, the nurse leader assesses the
information, and delegates accordingly.
The strategies that are developed are to simply help the nurses
have the credibility of enhancing changes so as to improve the
health care sector, the care they are providing, and the safest
way to practice. Hence, the central issue in this scenario is the
gap that exists when nurses are not given clear authority to act
on certain situations because of blurred lines of authority, or
not feeling supported in their role. As a nurse leader, it needs to
be made clear what, apart from the nurses scope of practice,
what other issues they face, or responsibilities that in these

4. particular instances are either theirs to take on, or someone
else’s. Nurses, especially new nurses, need to be made to feel
that they have a place in their workspace in which they belong.
Nursing administrators need to make it clear what they take care
of, what issues need to be brought up to them, and what they
expect of others. Seasoned nurses need to be aware that “eating
their young,” is not an acceptable approach and will not be
tolerated. Lastly, new nurses need to be given appropriate and
thorough training that will set them up to excel in their chosen
field.
Choose one additional model and briefly describe that model.
Another model that might be applicable in this scenario is part
of the strategic planning method. In this method, ssurveys and
questionnaires are used along with focus groups and interviews,
use of advisory boards, review of literature on similar programs,
and review of best practices. Frequently, surveys or
questionnaires are used when there are a large number of
stakeholders in order to get a general idea of the options
available. (Kelly, 2014) In this case there are a lot of
stakeholders; you have nurses, managers, and patients.
Surveying each of these groups, without names, can give a clear
and concise idea as to how you as a team are doing, and areas in
which you are lacking. There’s no real way to go wrong with
this method.
Suggest six interventions that would be useful for the nurse
leader when dealing with a variety of work issues. For each
intervention, you should provide the expected outcome.
The nurse's environment is a fundamental factor in care that is
provided, and one that should be highly considered. There are
many interventions that can be used to ensure that the work
environment and issues that tend to arise are controlled and
addressed. Firstly, there is the aspect of better research that can
be initiated in the health services, such as surveys. This would
help the nurses to be in a position to eye any factor that will
affect the patients’ care, and report on it, or rather suggest
better ideas. This can also help nurse leaders to be informed on

5. issues that may be slipping through the cracks. Secondly, are
the inclusion and extraction criterion that identifies every nurse
with different skill sets and experience. The nurse leader can
look at this information, which can help come up with a better
conclusion on solving different issues regarding patient care
and delegation. Third, is the data extraction. This helps in
obtaining better quality scores from the health sector and data
synthesis, which enlightens on certain changes that tend to
occur, how they are facilitated, and how it is affecting the unit
as a whole. Quality assessment is the fourth, and it is a crucial
intervention that nurse leaders should always portray. It is out
of this that good records are obtained from the analysis of
teammates and patients alike, and it helps with the management
of the environment. Screening is the next intervention and skill
a nurse leader should portray while working. It helps in
improving the workplace since particular measures are taken to
ensure that all issues are addressed. Last, is that the nurse
leader needs to play an active role on the floor. If the nurse
leader is playing an active role, it initiates teamwork, unites,
decreases the feeling of being micro-managed, and promotes an
environment of openness and equal responsibility.

6. References
Kelly, P. (2014). Essentials of nursing leadership and
management. Clifton Park: Cengage Learning.
Melnyk, B. & Overholt, E. (2011). Evidence-based practice in
nursing & healthcare: a guide to best practice. Philadelphia:
Wolters Kluwer/Lippincott Williams & Wilkins.
CASE: HR-1A
DATE: 1995 (REV’D. 04/05/06)
This case was prepared by Professors Charles O'Reilly and
Jeffrey Pfeffer as the basis for class discussion rather than to
illustrate
either effective or ineffective handling of an administrative
situation.
Copyright 1995 by the Board of Trustees of the Leland Stanford
Junior University. All rights reserved. To order copies or
request permission to reproduce materials, e-mail the Case
Writing Office at: [email protected] or write: Case Writing
Office, Stanford Graduate School of Business, 518 Memorial
Way, Stanford University, Stanford, CA 94305-5015. No part of
this publication may be reproduced, stored in a retrieval system,
used in a spreadsheet, or transmitted in any form or by any

7. means - electronic, mechanical, photocopying, recording, or
otherwise - without the permission of the Stanford Graduate
School
of Business.
SOUTHWEST AIRLINES (A)
“The workforce is dedicated to the company. They’re Moonies
basically. That’s the way they
operate.”1
—Edward J. Starkman, Airline Analyst, PaineWebber
Ann Rhoades, vice president of people for Southwest Airlines,
was packing her briefcase at the
end of a 17-hour day. Tomorrow was an off-site meeting with
the top nine executives of
Southwest Airlines. The agenda for the meeting was to review
Southwest’s competitive position
in light of recent actions by United and Continental, both of
whom had entered Southwest’s low
fare market. That day’s New York Times (September 16, 1994)
had an article that characterized
the situation as a major showdown in airline industry:
This is a battle royal that has implications for the industry, said
Kevin C. Murphy,
an airline stock analyst at Morgan Stanley. The battle will, after
all, be as much a
test of strategy as a contest between two airlines. United and
other big carriers
like USAir and Continental have decided that they can lower
their costs by
creating a so-called airline-within-an-airline that offers low
fares, few flights, and

8. frequent service. The new operations are unabashedly modeled
after Southwest,
the pioneer of this strategy and keeper of the healthiest balance
sheet in the
industry.2
The reasons for this competition were easy to understand. Over
45 percent of United’s revenues
came from passengers who flew through its California hubs. As
a market, the California corridor
was the most heavily traveled in the United States, which had
80 percent more traffic than the
Boston-New York-Washington corridor. Yet United’s share in
this market had fallen from 38
percent in 1991 to 30 percent in 1993.
During the same period, Southwest’s share had increased from
26 percent to 45 percent. Other
airlines, like Continental, had also been hurt by Southwest’s
competition. Southwest’s success
1 Peter Elsworth, “Southwest Air’s New Push West.” New
York Times, June 16, 1991.
2 Adam Bryant, “United’s Bid to Rule Western Skies,” New
York Times, September 16, 1994.
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OTHER from October 2016 to April 2017.

9. Southwest Airlines (A) HR-1A p. 2
spawned a number of imitators, including new airlines like Kiwi
and Reno Air as well as major
airlines like United and Continental. Concerned with this new
competition, the market had
driven down Southwest’s stock price and analysts were raising
questions about how sustainable
Southwest’s advantage really was.
Rhoades, a former marketing executive with an MBA from the
University of New Mexico and a
background in banking, had joined Southwest in 1989 to help
transform the People Department
(Human Resources in most organizations). Southwest had
always believed that an important part
of its competitive advantage rested with its people and how they
were managed. Ann’s job was
to help leverage this advantage. At tomorrow’s meeting she
would be asked to review
Southwest’s current position in light of the new competition.
She had prepared a brief overview
of what she saw as the major threats and opportunities of the
competition and an assessment of
Southwest’s strengths and weaknesses in light of these changes.
However, she wanted to reflect
one last time on these issues to be sure she was not missing
anything. Her major concerns were
whether Southwest was getting the most in competitive
advantage from its own people, and
whether the competition could imitate Southwest’s successful
human resource practices.
BACKGROUND
On June 18, 1971, Southwest Airlines, headquartered at Love

10. Field in Dallas, began flying with
three Boeing 737 aircraft serving the Texas cities of Dallas,
Houston, and San Antonio.
Southwest’s competition was Texas International and Braniff,
and, to a lesser extent,
Continental. Continental used every political and regulatory
means to ensure that Southwest
would not get off the ground, including keeping Southwest out
of the recently built Dallas-Fort
Worth airport and waging a four-year legal battle that left
Southwest almost bankrupt at the time
of its first flight. One outcome of the legal battle was the so-
called Wright Amendment, named
after James Wright, then Speaker of the U.S. House of
Representatives. The Wright Amendment
prohibited any air carrier from offering direct service into Love
Field from any place beyond
Texas and the four contiguous states of Oklahoma, Louisiana,
Arkansas, and New Mexico. This
law meant that passengers flying into Southwest’s central
location at Love Field from
destinations beyond these four states would have to purchase
separate tickets for each leg of the
trip and could not check baggage through to their final
destination. Furthermore, neither airlines
nor travel agents were permitted to advertise connections
through Love Field. Ostensibly, this
law was intended to encourage traffic through the new Dallas-
Fort Worth hub. In fact, it was
aimed at stopping Southwest.
Herb Kelleher, CEO and one of the airline’s founders, and
Southwest’s corporate counsel at the
time said, “You know, anger can be a great motivator. For me,
this became a cause. I was a
crusader freeing Jerusalem from the Saracens.”3 More recently,

11. he was quoted as saying, “I have
told people that I would retaliate if I became very angry, but
now I think I would revise that.
Let’s just say that if I become peckish, I will attack.4 This
aggressive, underdog spirit still
pervades the company, especially among longer serving
employees. Many see the goal of
keeping this spirit alive as one of the firm’s great challenges.
Delise Zachry, an instructor from
3 Edward Welles, “Captain Marvel,” Inc., January 1992.
4 Kenneth Labich, “Is Herb Kelleher America’s Best CEO?”
Fortune, May 2, 1994.
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This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 3
the People Training Department, noted, “In 1971, 198 people
got together and did something
that was impossible. Now we need to update the culture to
today’s problems.”
In the early days, Southwest gained attention by putting its
flight attendants in hot pants and
using its location at Love Field to launch an advertising
campaign (“Make Love, Not War”), a
theme that is still used today when Southwest refers to itself as
the “Love” (LUV) airline. This

12. designator is Southwest’s stock ticker symbol. All Southwest
aircraft have a small heart
emblazoned on their sides and hearts are used prominently on
corporate communications and
advertising. From its inception, Southwest has encouraged its
employees to identify with others
at the company, deliver great customer service, and have fun.
They have also pursued a low fare
strategy.
In the mid-1980s USAir and American, attempting to increase
their share of the valuable
California market, purchased Air California and Pacific
Southwest Airlines (PSA), two
successful regional carriers. However, American soon withdrew
from some cities and routes
when they could not be served profitably. USAir made a number
of marketing and service
mistakes and also cut back service in the region. Southwest
seized the opportunity to expand in
California. From a zero market share in California in 1989,
Southwest became the leading airline
in passenger boardings in 1993 and by 1995 it served 10 cities
in the state with more than a 70
percent average market share for city pairs served.
THE CURRENT SITUATION (1995)
From the beginning, Southwest has maintained the same
strategy and operating style that it
maintains to the present. It concentrates on flying to airports
that are underutilized and close to a
metropolitan area—e.g., Love Field in Dallas, Hobby in
Houston, San Jose and Oakland in the
Bay Area, Midway in Chicago—although it does fly to major
airports like LAX and SFO. The

13. company also began flying fuel-efficient 737s, and now has
over 200 of them, the only type of
aircraft it flies. Southwest service involves frequent on-time
departures as well as low cost fares.
It emphasizes point-to-point routes, with no central hub and an
average flight time of 65 minutes.
According to its 1993 annual report, 80 percent of its customers
fly non-stop to their final
destination. By avoiding a hub and spoke system, Southwest is
able to avoid the delays often
associated with connecting flights. This makes short-haul trips
more attractive to travelers who
might otherwise consider driving. It also pays off in shorter
turnaround times (70 percent of its
flights had a 15 minute ground time in 1991) and higher
equipment use. For example, Southwest
aircraft spent an average of 11 hours in the air daily compared
to an industry average of 8, and it
averaged 10.5 flights per gate versus 4.5 for the industry.
Following this strategy, Southwest has always seen itself as
competing not so much with other
airlines as with surface transportation. For instance, in 1993 the
average passenger fare was
roughly $60 for a trip of 500 miles. In 1984 the comparable
numbers were $49 and 436 miles. In
August 1994, the roundtrip fare from Oakland to San Diego, a
distance of over 1,000 miles, was
$135. Southwest uses these low fares and frequent flights to
increase passenger volume two to
three times. For example, approximately 8,000 people used to
fly between Louisville and
Chicago weekly. After Southwest entered the market, that
number climbed to 26,000. Southwest
dramatically lowered the fares and increased the frequency of
flights. In August 1994, it flew 39

14. For the exclusive use of Y. Li, 2016.
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Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 4
times roundtrip daily between Dallas and Houston, 25 times
between Phoenix and Los Angeles,
and 20 times between Sacramento and Los Angeles. When
American moved out its San Jose hub
because it was losing money, Southwest moved in and was
profitable from the first day of
service. In 1992, Southwest was the leading carrier in passenger
boardings in 27 of the 34
airports served. In 1994, it dominated most of its major markets,
with almost 70 percent of the
intra-Texas and over 50 percent of the intra-California markets.
Consistent with its strategy of low costs, low fares, and frequent
flights, Southwest also keeps its
fares simple. Unlike other airlines that rely heavily on
computers and artificial intelligence to
maximize flight revenue, Southwest typically offers only two
fares on a route, a regular coach
fare (there is no first- or business-class) and an off-peak fare. It
also tries to price all fares the
same within a state (for instance, currently $69 to fly anywhere
within California). Southwest
has never sold interline connections to other carriers and has
been unwilling to pay to be part of
other airlines’ reservations systems. As a result, only 55 percent

15. of Southwest’s seats were
booked by travel agents compared to 90 percent of tickets for
major airlines. In 1994, United
announced that its Apollo System would no longer carry
Southwest’s schedules or issue its
tickets. This makes issuing tickets more difficult for travel
agents who often have to call the
airline rather than work through a computer as they do with
other airlines—a clear incentive to
travel agents not to book Southwest flights.
To further simplify its operations, Southwest has never offered
meal service on its flights. Meals
can add $40 per passenger to the cost of a flight. Instead,
passengers on Southwest are served
beverages, peanuts (referred to as “frill”), and on longer flights,
crackers or other light snacks
such as cookies. There is no assigned seating. Upon arrival at a
Southwest gate, each passenger
holding a reservation is given a reusable plastic boarding pass
with numbers from 1 to 137, the
maximum load of their 737 aircraft. Passengers are loaded in
groups of 30 and the boarding
passes are collected for use on the next flight. Standby
passengers are boarded if seats are
available in the order in which they sign up at the departure
gate.
Although it is not connected to other airlines’ reservation
systems or affiliated with other
frequent flyer programs, Southwest does have its own frequent
flyer club (“The Company
Club”), also a model of simplicity. It is based on the number of
trips flown, not the mileage.
Members keep a card that is stamped every time a plane is
boarded. After accumulating 16

16. segments, a free ticket is awarded and a Company Club card is
issued. The card is then read into
the computer system for each trip. This approach economizes on
operating costs since it requires
no effort to keep track of mileage. Based on some negative
advertising by United about
Southwest’s frequent flyer program, Herb Kelleher recently sent
a letter to all Company Club
members detailing how awards from Southwest took less
mileage to obtain and were more
widely available than other airlines. Kelleher argues that
Southwest’s program “is the greatest
value because it gives you free travel faster, for much less
money, without giving up great
service.” For instance, after 50 roundtrips within a 12-month
period, a companion flies free with
a Company Club member, even if the person is traveling on an
award ticket.
Overall, Southwest Airlines has been profitable in every one of
the last 21 years, a record
achieved by no other major U.S. airline. It was consistently
profitable even during the 1991–
1992 period, during which some 40 percent of the total capacity
of the U.S. airline industry was
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Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 5

17. seeking bankruptcy protection or ceased operation completely.
(Exhibit I presents selected
financial and operating data from 1984 to 1993.) According to
Money magazine, for the 20-year
period 1972–1992, Southwest’s stock earned the highest returns
of any publicly traded U.S.
stock—compounded return of over 21,000 percent. Only Wal-
Mart came close to being as good
an investment over this period.
COMPETITIVE ADVANTAGE
Although the reasons for Southwest’s success were many, one
highly visible advantage could be
seen in the company’s cost structure. Kelleher recognized that
short-haul flying was inherently
more costly than longer flights (the plane is taking off and
landing more often and has to be
handled at every gate). He understood that the lowest-cost
provider could leverage that cost
advantage most where costs are highest. (Exhibit 2 shows the
costs per available seat mile for
two comparable quarters in 1993 and 1994.) Southwest’s costs
averaged roughly 7.1 cents,
while the larger airlines had costs up to 10 cents or more per
mile—20 to 30 percent higher. This
achievement is even more striking when noting that Southwest’s
costs in 1984 were 5.86 cents.
So, over a decade its costs had increased by only about 20
percent.
Part of this cost advantage derives from the remarkable
productivity Southwest gets from its
work force. For example, they routinely turn around an aircraft
in 15 minutes from the time it
arrives at the gate (see Exhibit 3 for the anatomy of a 15 minute

18. turnaround). United and
Continental average 35 minutes. Southwest’s gates are typically
manned by a single agent and
have a ground crew of six or fewer, rather than the three agents
and twelve ground crew that are
common at other airlines.
These low costs also come from other sources. Southwest pilots,
for example, spend more time
in the air than pilots at other airlines. While pilots at United,
American, and Delta earn up to
$200,000 a year for flying an average of 50 hours a month,
Southwest’s pilots average $ 100,000
a year flying 70 hours a month. Flight attendants and pilots help
clean the aircraft or check
passengers in at the gate. Harold Sirkin, airline specialist with
BCG said, “Southwest works
because people pull together to do what they need to get a plane
turned around. That is a part of
the Southwest culture. And if it means the pilots need to load
bags, they’ll do it.”5
Southwest’s employees also routinely volunteer to help
customers in need. Once a customer
arrived at the airport for a vacation trip with his dog in tow,
only to learn that he couldn’t bring
the dog with him. Rather than have him cancel the trip, the gate
agent took care of the dog for
two weeks so the fellow could enjoy his holiday. Another
employee accompanied an elderly
passenger to the next stop to insure that she was able to change
planes. Stories of this sort
abound.
These efforts pay off in employee productivity. In 1993, for
example, Southwest had an average

19. of 81 employees per aircraft while United and American had
157 and 152, respectively. The
industry average was in excess of 130. Southwest served an
average of 2,443 passengers per
employee while United and American served 795 and 840, about
the industry average. This
5 E. Scott Rechard, “Shuttle Dogfight Good News for Air
Travelers,” San Francisco Chronicle, October 2, 1994.
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 6
means that Southwest needs a smaller load factor to break even
than the other carriers (usually
around 55 percent). Second, the point-to-point strategy and the
use of less congested airports
improve the efficiency of flight operations and helps insure high
levels of aircraft utilization.
Finally, by using a single type of aircraft, Southwest was able
to save on maintenance and
training costs.
But Southwest is not just a low fare/low cost carrier. It also
emphasizes customer service. In fact,
the word “Customer” is always capitalized in all Southwest
corporate communications, whether
it is the annual report or an internal newsletter. Colleen Barrett,

20. executive vice president of
customers and highest-ranking woman executive in the airline
industry, insists on this. She is
also adamant about treating employees as internal customers
and tries to make sure that
Southwest is a comfortable and fun place to work. “If you’re
comfortable, you’re smiling more
and you give better service,” Barrett says. “It doesn’t take a
rocket scientist to figure that out.”6
The results are undeniable. In the airline industry, service is
measured by on-time performance,
having the fewest lost bags, and having the fewest number of
customer complaints. If an airline
is the best in all three categories in a single month, it wins the
so-called “Triple Crown.”
Southwest has won the monthly Triple Crown 24 times. In 1992,
the Department of
Transportation began giving an annual Triple Crown award.
Southwest won the award in 1992,
1993, and 1994.
Leadership at Southwest
While a number of industry experts attribute Southwest’s
accomplishments to its unwavering
adherence to its low-cost niche strategy, others disagreed and
argued that its real competitive
advantage lay in its leadership. A recent Fortune article, for
instance, was titled “Is Herb
Kelleher America’s Best CEO?”7 The piece cites a U.S.
Department of Transportation report that
Southwest was the “principal driving force for changes
occurring in the airline industry,” and
credits Kelleher with much of this. The author quotes Michael
Derchin, a veteran airline analyst
who has been monitoring Southwest almost from its beginning,

21. who said, “I think Herb is
brilliant, charming, cunning, and tough. He is the sort of
manager who will stay out with a
mechanic in some bar until four o’clock in the morning to find
out what is going on. And then he
will fix whatever is wrong.” In his view, the difference between
Southwest and other carriers is
“in the effort Herb gets out of the people who work for him.”
The Fortune writer, Ken Labich,
concluded his article by noting, “The greatest obstacle to long-
term prosperity at Southwest may
be Kelleher’s mortality.”
Although Southwest is headquartered in Dallas, Herb Kelleher
isn’t a native Texan. He is not a
pilot either. He’s a lawyer who grew up on the East Coast,
majored in philosophy and literature,
graduated from NYU Law School, clerked for a New Jersey
Supreme Court justice, and
practiced law in Newark, New Jersey. After visiting his wife’s
parents in San Antonio, he
announced that he wanted to move to Texas. By the mid-1960s
he was happily practicing law in
San Antonio. One day in 1966, a client named Rollin King
described his experience in California
6 Jeff Pelline, “Southwest Air’s Driving Force,” San Francisco
Chronicle, June 10, 1993.
7 Labich, “Is Herb Kelleher America’s Best CEO?”
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.

22. Southwest Airlines (A) HR-1A p. 7
on PSA, a short-haul commuter airline, and suggested that
Texas could benefit from a similar
operation. The two sketched out some plans, borrowed money,
and started Southwest.
From the beginning, Kelleher has adopted a visible, hands on,
slightly over-the-top style—
always ready to promote a party and have fun. He appeared one
Halloween at a Southwest
maintenance hanger dressed in drag with a feathered boa
imitating Corporal Klinger from the
television program, M*A*S*H. He’s also appeared in print
advertisements and at company
parties dressed as Elvis Presley. (Ann Rhoades suggested that
this was fine, but they try not to
encourage him to dress like Ethel Merman.) He’s renowned for
his love of Wild Turkey
bourbon. When Herb met the president of the company that
produces it, he told him that he may
be just a man to most people, “but to me you are a god.”8 While
recovering from minor surgery,
he received over 3,000 cards and gifts from employees,
including an intravenous drip set-up—
but with Wild Turkey rather than saline solution. He also
smokes five packs of cigarettes a day.
He said, “I’ve always felt that there’s no reason that work has to
be suffused with seriousness,
that professionalism can’t be worn lightly. Fun is a stimulant to
people. They enjoy their work
more and work more productively.” He believes that “you don’t
have to surrender your

23. individuality to work for Southwest Airlines.” This is seen in
the phrase sometimes heard at
Southwest, “work is important ... don’t spoil it with
seriousness.” 9
And Kelleher does have fun. He constantly interacts with
customers and Southwest employees.
He routinely visits maintenance facilities in the early morning
hours. Tom Burnett, the Teamster
leader who represents Southwest mechanics and cleaners, said,
“Let me put it this way. How
many CEOs do you know who come into a cleaners’ break room
at 3 a.m. on a Sunday passing
out doughnuts or putting on a pair of overalls to clean a
plane?”10 Once while rushing to catch a
flight at Love Field he stopped his car in the loading zone and
began talking with a Southwest
employee. After an animated few minutes, he realized he was
late and rushed off to make his
plane. When he arrived in Houston, a Southwest employee
asked him if he knew where his car
was? He’d left it idling at curbside. Kelleher has also appeared
in television ads for American
Express—not because he’s such a big user, but because he has
lost more cards during a year than
any other AMEX customer. Colleen Barrett is always sticking
money in his pockets since he
routinely forgets his wallet. Reflecting on Herb’s propensity to
engage people in conversation,
she says, “I could add four hours to Herb’s day if I could get
him to walk and talk at the same
time.” One friend says, “There is an unwritten rule that, if you
don't want to stay up all night
drinking and talking, then you stay the hell away from Herb.”11
This philosophy pervades the entire company. Serious attention

24. is paid to parties and
celebrations. Every year, for instance, each station (city) is
given a budget for parties for the
employees and their families. Most stations supplement this by
doing their own fund raising. Up
until several years ago, all Southwest employees used to fly to
Dallas for the annual company
party. Now that the company has grown too large for that, they
hold a rolling party in several
cities with Herb and the senior managers moving from one
location to another. Celebrations and
8 Labich, “Is Herb Kelleher America’s Best CEO?”
9 Evan Rarnstad, “Cattle Call Carrier Lassos Riders, Profits,”
San Francisco Chronicle, April 7, 1991.
10 Bridget O’Brian, “Southwest Airlines is a Rare Carrier: It
Still Makes Money,” Wall Street Journal, October 26,
1992.
11 Labich, “Is Herb Kelleher America’s Best CEO?”
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OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 8
contests occur continually, including chili cook-offs and
Christmas parties. The Love Field
corporate headquarters in Dallas is filled with pictures of
Southwest employees at parties,
awards, trips, celebrations, and banners. In fact, there is no

25. corporate art in the headquarters. All
paintings and sculptures, and there are many, are those donated
by employees.
Barrett also reflects the relaxed management style. Officially,
she is responsible for
communication, marketing, public relations, people (human
resources), governmental affairs,
and scheduling (see Exhibit 4 for an organization chart). She is
also heading the merger efforts
with Southwest’s recent acquisition of Morris Air. Unofficially,
she has been described as a
combination of den mother, management guru, and customer
ombudsman. She is a stickler for
detail and provides the organizational counterweight to
Kelleher’s sometime chaotic style.
“She’s the backbone of the airline,” said one employee. Barrett
claims that “The company is only
as good as its people,” and constantly reinforces that theme.
“We'll never jump on an employee
for leaning too far toward the customer, but we come down on
them hard for not using common
sense.”
For instance, about four years ago she became concerned with
the size and geographic dispersion
of the company and set up a culture committee consisting of 65
people from all levels and
regions of the company. This committee meets with Barrett four
times a year for a full day to
preserve and enhance the Southwest spirit. After determining
that some distant locations were
operating functionally but without the teamwork that Southwest
values, they decided to try to
reduce this tendency. One outcome was a systematic effort for
groups of employees to express

26. their appreciation to others for their contributions. So, for
instance, the pilots held a barbecue for
the mechanics on the flight line at 3:00 a.m. Other groups,
including pilots, decided to thank the
reservations agents by coming in and spending a shift with
them. Even the officers and directors
of the company have a program, called “Day in the Field,” that
requires them to spend one day
per quarter working in a front line job. Barrett is adamant that
this means really work, not stand
around and drink coffee.
The People Department
About five years ago the human resources function at Southwest
was renamed “The People
Department.” This reflected a concern that the old human
resources group was, in the words of
John Turnipseed, manager of people services, “a police
department.” To counteract this, Ann
Rhoades first threw away the 300 page corporate handbook and
brought in new people with
marketing backgrounds. Currently, to join the department an
employee must first have line
experience. She sees the role of the People Department as
saying “yes” rather than “no” and
wants them to “do what it takes to make the Customer happy.”
Employees are the customers of
her group. Although they deal with approximately 18,000
employees, the People Department has
a staff of about 100. All members of the department sign the
department's mission statement,
which is prominently displayed in a very large poster on the
wall of their headquarters’ office. It
reads:

27. Recognizing that our people are the competitive advantage, we
deliver the
resources and services to prepare our people to be winners, to
support the growth
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Southwest Airlines (A) HR-1A p. 9
and profitability of the company, while preserving the values
and special culture
of Southwest Airlines.
Ann takes this charge seriously and believes in what she calls
the two Cs: compassion and
common sense. She worries about maintaining the culture and
tells people to break the rules if
they need to. While in many companies human resources is
considered a backwater, the People
Department at Southwest is “like the keeper of the flame,” says
Treasurer John Owen.12 Ann
notes that, “Most HR people have no courage. They never take a
chance. No guts. No capability
of making a decision. They’re so afraid of being fired... We
need to have confidence in people
doing the right thing.” To do this, she believes that it is
imperative that you get the right people
into HR to begin with. This also underlies the Southwest policy

28. of hiring and firing for attitude.
Her department is also continually feeding back information to
employees such as on-time
performance, turnaround times, number of customers boarded or
the cost of a day’s health care
for the airline in terms of the number of bags of peanuts served
on their flights. The intent is to
keep people focused and make them aware of how their actions
affect costs.
Recruiting
To insure that it gets the right people, Southwest is
extraordinarily selective in its recruiting. In
1993, it had 98,000 job applicants. Of these, roughly 16,000
were interviewed, and 2,700
hired—including one aspiring employee who submitted her
resume on the icing of a large sheet
cake, demonstrating the creative spirit that Southwest looks for.
To insure fit, there is an
emphasis on peer recruiting. For example, pilots hire other
pilots, often coming in on their day
off to do background checks. As Ann noted, “They can get far
more information in a phone call
to the chief pilot of another airline than anyone else.” They
even turned down a top pilot who
worked for another major airline and did stunt work for movie
studios. Even though he was a
great pilot, he made the mistake of being rude to a Southwest
receptionist. Teamwork is critical.
As Ann noted, “If they say ‘I’ too much in the interview, they
don’t get hired.” She described
how one group of eight applicant pilots was being kidded about
how seriously they were dressed
(dark suits and black shoes and socks). They were encouraged
to loosen up. Six of them accepted

29. the invitation to wear the standard Southwest Bermuda shorts
and interviewed for the rest of the
day in suit coats, ties, Bermuda shorts and dress shoes and
socks. They were the six hired.
To further screen for the Southwest Spirit, customers are
sometimes involved in the interviewing
for new flight attendants. The process consists of an
application, a phone screening interview, a
group interview, three additional interviews (two with line
employees), and a consensus
assessment and a vote. During the interview process, the
applicant will come into contact with
other Southwest employees. These people are also invited to
give their assessments of whether
the person would fit in at the company. The entire process
focuses on a positive attitude and
teamwork. For example, applicants are given crayons to draw a
picture that tells the story of their
life. Southwest looks for people who are willing to draw outside
the lines. Even its
advertisements emphasize the Southwest spirit. One ad for
people with computer skills showed a
picture of a techno-nerd, with tape holding his glasses together,
and emphasized that "We're not
12 Wendy Zellner, “Go-Go Goliaths,” Business Week, February
13, 1995.
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OTHER from October 2016 to April 2017.

30. Southwest Airlines (A) HR-1A p. 10
looking for your average computer geek." Other ads convey a
sense for the type of employee
Southwest wants to attract (see Exhibit 5 for several
illustrations).
As befits a company in which selection is important, Southwest
has spent a lot of time
identifying the key components that comprise effective
performance and behavior. For instance,
the People Department identified its top 35 pilots and
systematically interviewed them to
identify common characteristics. One key trait identified was
the ability to work as a part of the
team. This is now used as a part of their pilot selection process.
The company believes that most
skills can be learned and doesn’t screen heavily for these except
for certain specialist jobs, like
pilots and mechanics. Attitudes are what count. Kelleher says,
“We draft great attitudes. If you
don’t have a good attitude, we don't want you, no matter how
skilled you are. We can change
skill levels through training. We can't change attitude.”13 For
example, John Turnipseed
described an EEO complaint for not hiring a person for a
position who had 15 years of
experience while selecting a person who had no experience.
Southwest successfully made the
case that the culture was critical and had to be considered in
selection.
An important awareness on the part of the People Department is
that the company rejects more

31. than 95,000 applicants each year. These are all potential
customers. Therefore, the recruiting
process is designed to not make applicants feel inferior or
rejected. Ann claims that some people
have told her they had a better experience being rejected by
Southwest than they did being hired
by other companies. Rita Bailey, a corporate employment
manager, always tries to call any
internal or managerial applicants that are turned down. She uses
this as a chance to counsel them,
trying to be honest but not damaging their self-esteem. She
invites them to call again if they want
to talk more. She is concerned not only how well a person will
do at the job they are applying
for, but also how they'll do in the next job. She says, “It’s
important to do it this way or you're
setting people up to fail when they get promoted.”
The company hires very few people with MBAs, and even those
that do get hired are selected for
their fit, not for their credentials. In fact, they prefer people
without extensive industry
experience. For example, 40 percent of their pilots come
directly from the military, 20 to 30
percent from small commuter airlines, and the rest from the
major airlines. To encourage
employees to help in the recruitment effort, Southwest offers a
free space-available pass (which
permits a person to travel free when the plane isn’t full) to any
employee who recommends
someone who is hired to fill a position that is difficult to fill,
such as in finance or information
systems. Southwest doesn’t have a nepotism policy (except for
officers) and has 481 couples that
work for the company. When these people describe the firm as
“family,” a common reference

32. throughout the airline, they really mean it.
Training
Given the emphasis on selecting for attitudes and fit and the
importance of culture, it follows that
training is an important part of Southwest. In 1993 alone, 6,500
employees went through
Southwest's University for People. Headed by Liz Simmons and
run with a staff of eight, the
training group offers a variety of courses ranging from the
“New Hire Celebration” (it’s not
13 Subrata Chakravaty, “Hit ’Em Hardest with the Mostest,”
Forbes, September 16, 1991.
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OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 11
called orientation) designed to get new employees enthused and
excited, to senior management
courses. Delise Zachry believes that “Our level of external
service is only as good as our internal
service.” She worries that the success of the company may
induce a sense of complacency and
noted that all the positive press accounts don’t help.
New flight attendants go through four weeks of classes,

33. typically with less than 5 percent
attrition. Much of this training is oriented towards customer
service—“the care and feeding of
customers.” Customer expectations about service are quite high,
and these are communicated to
both new and experienced employees. All new hires are exposed
to the history, principles,
values, mission, and culture of the company. They are also told
how the company views
leadership and management. In all training, there is an emphasis
on teamwork and team building,
all in good humor. For instance, new hires often do a
celebratory skit at the conclusion of their
training. One new pilot class donned dark sunglasses and white
canes and stumbled into
Kelleher’s office.
For managers, there is a three and a half day course on
leadership, pricing, revenue management,
and on how the business works. A member of senior
management always attends a two-hour
session and talks openly with the participants. Training is
virtually 100 percent internal. “If it
ain’t born and bred here, they don’t want any part of it,” said
Zachary. Front-line leadership gets
a specially designed two-day course each year. These programs
are designed to address
particular needs, like cross-functional teamwork, and are
heavily experiential. They involve
managers from different levels and different parts of the
organization, but never have a superior
and a subordinate in the same session. Each year as the new
program begins, the senior team is
always the first to go through it. In addition to this special
program, supervisors receive 80 hours
of training per year. Courses includes the usual offerings of

34. communication, time management,
and career planning, as well as others emphasizing the
employee's role in creating legendary
customer service and more interpersonal explorations around
accepting responsibility and
developing trust.
For the past 18 months, training has offered a course called
“The Climb,” a two and a half day
ropes and outward bound course. This course is open to the
entire company, but is attended by
intact work teams. Zachary noted that it’s hard to get people to
change in their normal work
setting. To generate the emotional contact necessary to foster
change, the entire team lives for
the time together, completely cut-off from phones, cars, and
contact with other outside issues. At
the end of the program, each team develops an action plan to
insure that their new behaviors are
transferred to the work setting. The senior executive team
attended this course during 1994.
The other highlighted training is “The Front-Line Forum,” in
which 12 to 15 individuals with 10
to 15 years experience in the company are brought together to
discuss how the company is doing
and how it has changed. They meet with top nine officers and
explore questions like, “We
promised you something around the culture and spirit of the
company. Have we delivered?”
Although the selection is done randomly, the idea is to assemble
some people in the group who
may be a bit beaten down to see what needs to be done to keep
the culture alive.
Southwest does not have any tuition reimbursement program for

35. taking outside courses. It also
tends not to sponsor people to attend outside training.
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Southwest Airlines (A) HR-1A p. 12
Overall, it is clear that training is an important form of two-way
communication. Not only are
the values of hard work, fun, and cost consciousness inculcated,
but the training is also used to
get internal customer feedback. For Zachary the issue is “To
figure out how we can get better
everyday, not worry about American Airlines or Delta.”
The Southwest Work Force
The company is 89 percent unionized with nine separate unions,
but has had only one six-day
walkout by the machinists over a decade ago. Mike Levine,
former dean of Yale’s School of
Organization and Management and current vice president for
marketing at Northwest Airlines
notes that “Herb really is an extremely gifted labor-relations
talent, especially when you consider
he has somehow managed to get union people to identify
personally with this company.”14
Obviously, those covered by a contract are paid on the basis of
seniority. Kelleher insists that

36. there be few work rules in union contracts. Exhibit 6 displays
rates of progression over time for a
number of different job classifications. These data are from
recent contracts and illustrate the
general relationship between pay and seniority for those
covered by collective bargaining
agreements. Part of this includes a system whereby employees
can bid for shift and work hours.
In almost every job class there are people earning between
$40,000 and $60,000 a year.
Everyone receives a raise on the anniversary of his or her
employment. Libby Sartain, director of
benefits and compensation, notes, “There’s no miracle
compensation program here. The story is
low pay at the beginning and high pay after you get seniority.”
Below market wages are offered
to clericals and management positions. Most people take a
salary cut to join Southwest. One
former manager at EDS who left to join Southwest was offered
two and a half times his starting
salary to stay with EDS.
The only big difference is that at Southwest pilots and flight
attendants are paid by the trip. As
Kelleher says, “Those airplanes aren’t making any money while
they’re sitting on the ground.”15
While comparisons are a bit tricky, Fortune reported that for
1992 the average wage at
Southwest was $44,305 compared to $45,801 at American and
$54,380 at United. Derek Deck of
the Air Conference (a trade group that gathers comparable wage
data across airlines) believes
that Southwest employees may earn less per hour than at other
airlines, although they do have
the flexibility to work more hours and earn more. Controlling
for seniority, he estimates that a

37. flight attendant at Southwest would earn about $18 an hour,
compared to $20 an hour at
Continental and $23 at USAir. Deck also believes that
Southwest personnel can, and often do,
fly more trips, giving them 10 to 15 hours more per month.
Executive compensation is modest by some firm’s standards. In
1992, Kelleher earned a salary
of $393,042 and a bonus of $120,000. In 1994, he was named
one of the five lowest-paid CEOs
in Dallas, and the lowest-paid on a performance-adjusted basis,
an award he is particularly proud
of He does hold stock worth around $90 million, a paltry sum
besides the likes of Larry Ellison
at Oracle or Bill Gates at Microsoft. In fact, there was no
executive stock option plan until a few
14 Labich, “Is Herb Kelleher America’s Best CEO?”
15 O’Brian, “Southwest Airlines is a Rare Carrier.”
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Southwest Airlines (A) HR-1A p. 13
years ago. There are no country club memberships, no company
cars, and officers stay in the
same hotels as the flight crews.
However, profit sharing covers all employees who have been

38. with the firm for over a year, and
they are required to invest 25 percent of their profit sharing
money in Southwest stock in a
retirement account. In 1993, those eligible received 8 percent of
their salary as a bonus.
Employees can also take advantage of a discounted stock
purchase program. This has produced
several millionaires.
Approximately 80 to 90 percent of the employees own stock in
the company, and about 11
percent of Southwest’s outstanding shares are owned by
employees. However, Libby Sartain
notes that she tries to encourage employees to diversify and not
hold too much of the company's
stock.
Because of its conservative hiring policies and growth,
Southwest has a young work force; the
average age is 34. Twenty three percent of the employees are
minorities, with 10 to 12 percent at
the managerial level Women are widely represented also at the
highest levels of the company.
John Turnipseed described how when an EBO audit team arrived
in Dallas, he simply gave them
an office and pointed out where the files were. In most
companies, auditors have to request
specific documents, which are then retrieved and brought to the
auditors. He acknowledged that
they weren’t perfect, but intended to correct any problems. He
described how apologetic the
auditors were at having to write up several violations.
As might be expected, turnover is low, running 4.5 percent in
1991, less than half that of other
major airlines. The company has never had a furlough or layoff.

39. Because of limitations in its
labor contracts, it uses few temporary or part-time employees.
Southwest does have a pool of ex-
employees (e.g., retirees, people who want to stay at home) that
it can call on in case of
emergencies. All temporary workers are paid benefits on a pro-
rata basis. There is little cross
training although the company encourages “days in the field” so
employees can try front-line
jobs. Only in the marketing and reservations departments are
there formal teams. The culture,
however, promotes informal teamwork and employees routinely
help each other out.
The Southwest Spirit
Southwest tries hard to manage and maintain its culture. Wander
around the halls at the Dallas
headquarters and you will hear several themes over and over:
customer service, hard work,
equality, cost consciousness, dedication, fun, and, most
frequently of all, family. Of course, this
invites the cynic in all of us. One employee who had worked at
several other large companies
said, “I was pretty dubious at first, having been at places where
everyone but the top two or three
people were considered commodities. Put I have come to
appreciate a place where kindness and
the human spirit are nurtured.”16 In addition to the efforts of
Colleen Barrett and the culture
committee (and its 35 local subcommittees), there are continual
efforts to preserve the values
that brought Southwest to its current position. John Turnipseed
says that trust is built by
constantly sharing information. “The level of trust has never
been broken. In many

40. 16 Labich, “Is Herb Kelleher America’s Best CEO?”
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OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 14
organizations, everybody’s against someone-union versus
management, head office versus the
field, etc. Not here.”
The family spirit can be seen in many ways. For instance, there
is the catastrophe fund, which in
the last two years raised $500,000 in voluntary contributions for
distribution to other Southwest
employees who needed help. During the last oil crisis,
unbeknownst to management the
employees raised $130,000 to help defray fuel costs. When a
former employee developed a drug
problem, the company arranged to pay for his medical care so
long as he stayed in the
rehabilitation program.
Kelleher and his management team seem acutely aware of the
potential problems as they
continue to grow. He says, “The bigger we get, the smaller I
want our employees to think and
act.” Ann Rhoades said, “You have to work at the culture. It
doesn't just happen.” Rita Bailey

41. described how there is plenty of peer pressure “not to ‘bad
mouth’ the family. Employees don’t
put up with a lot of complaining.” Colleen Barrett described
how when she talks to people, they
are always skeptical and want to know the “real” story. She
says, “There are no deep, dark
secrets here. It’s so simple. It’s a cult. It’s a religion with us.”
Kelleher echoes this view when
describing the spirit of Southwest employees. “The people who
work here don’t think of
Southwest as a business. They think of it as a crusade.”17 This
doesn't mean that people are
unrealistic. A pilot indicated, “It’s not a Mary Kay-type
atmosphere where we’re all starry-eyed.
It’s mutual respect”18 A longtime observer of the airline
industry said, “At other places,
managers say that people are their most important resource, but
nobody acts on it. At Southwest,
they have never lost sight of the fact.”
THE COMPETITIVE THREAT
As she finished gathering up papers for tomorrow’s meeting,
Ann Rhoades reflected on the
airline industry in general and Southwest’s position in
particular. The industry overall, with few
exceptions, had been characterized by notoriously poor labor
relations and authoritarian
management. In 1983, Frank Lorenzo led Continental Airlines
into bankruptcy so he could rid
the airline of its union. Carl Icahn faced numerous strikes
during the time he controlled Trans
World Airlines, and hired replacement workers during some of
them. Eastern Airlines ultimately
failed because of the conflict between Lorenzo and the unions.
Robert Crandall of American

42. Airlines pioneered the two-tiered wage structure in which newly
hired employees would be
brought in at lower wages than the currently employed workers.
During the 1993 Thanksgiving
season, American Airline flight attendants struck in an attempt
to roll back wages. In this light,
Southwest’s policies stood out-labor peace, trust, non-
adversarial relations, open sharing of
information, and high productivity.
More recently, several other airlines were undergoing employee
buyouts. By 1994, TWA was
largely employee owned. Northwest narrowly avoided
bankruptcy when its unions agreed to an
eleventh-hour swap of wage concessions for an ownership stake.
United has followed suit.
USAir was offering stock and board seats in return for employee
wage concessions. Continental
17 Richard Teitelbaum, “Where Service Flies Right,” Fortune,
August 24, 1992.
18 Frank Gibney, Newsweek, May 30, 1988.
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OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 15
Airlines had also emerged from Chapter II with what the press
claimed was a more employee-

43. oriented management. Executives at Delta said they would
announce their plans for a new low-
fare strategy in the coming months. The pilots at American
suggested a similar strategy to
management.
But it wasn’t these general trends that concerned Rhodes as
much as two direct threats. Both
United and Continental had begun low cost airlines-within-an-
airline to challenge Southwest
directly. They were not only directly imitating the Southwest
strategy, they were also using their
policies and procedures. An old adage at Southwest was not to
provoke their major competitors.
Obviously, they had done more than provoke them; they had
challenged them directly.
Continental Lite
Under the guidance of CEO Bob Ferguson, Continental Airlines
emerged from its second
bankruptcy in April 1993. In May, Ferguson announced his plan
to split the company into two
operations; one that would concentrate on short-haul, low fare
flights (named Continental Lite or
CALite), and the other that would feature first-class service at
business class prices. He believed
that because of its low cost structure, lower even than
Southwest, Continental would be able to
compete successfully. By imitating many of Southwest’s
practices, including the use of humor
by flight attendants, Ferguson believed that he could attract the
business traveler. By
concentrating primarily on the East Coast market, he could take
advantage of greater density,
shorter flights, and avoid competing directly with Southwest, at

44. least in the short-term.
Continental Lite was rolled out in October, 1993, with 173 daily
departures from 14 cities. By
summer, it had expanded to 28 percent of Continental’s
capacity, with plans to ultimately grow
to 40 percent. Fares were cut dramatically. For example, the
Newark-Greensboro went from
$273 to $99 and the Greensboro-Greenville from $226 to $59.
The early results, however, were
mixed. CALite currently is flying with about 59 percent of its
seats filled. Customer reaction is
not always positive. Some frequent flyers were miffed that there
was no priority boarding or
meal service. Flight attendants were concerned about the
increased workloads (like Southwest,
they clean cabins between flight segments) and lack of breaks
between flights. Ground crews
were trying hard, but turnarounds were still taking over 30
minutes rather than the hoped for 20.
Even the pilots were upset until the company began providing
meals for them during their busy
schedules. (In one instance, a flight was delayed while the
pilots ate in the airport terminal.) In
March 1994, Continental had the worst marks of any domestic
airline in terms of customer
complaints, on-time performance, and mishandled baggage.
Financial results were also not yet up to expectations.
Continental lost $38.5 million on revenues
of $3.9 billion from April 1993, when it emerged from
bankruptcy protection, through the end of
1993. Management expected to break even in the second half of
1994 and did not see these
results as a disaster. Chief Financial Officer Daniel Garton said
that only 20 percent of CALite’s

45. routes were losing money and noted that because USAir and
Delta responded aggressively to
Continental’s fare cuts, profits have been weaker than
expected.19 Some airline industry
observers believed that Continental’s costs may still be too
high.
19 Wendy Zellner , “Why Continental’s CEO Fell to Earth”
Business Week, November 7, 1994.
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 16
This is also complicated because CALite still relied more
heavily on one-stop and connecting
passengers than did Southwest. The clear trend in the industry
has also been for fewer business
travelers. In 1982, over 50 percent of travelers paid full-
economy fare or higher (e.g., business-
class). In 1995, that figure was less than 40 percent. Gordon
Bethune, Continental’s COO, said,
“Up to a two-hour flight, it’s already a commodity business. A
$10 difference will grab
anybody’s passenger these days.”20 Flights of up to two hours
represent over 60 percent of
domestic traffic.

46. Ferguson, whose style has been described as “harsh and
uncommunicative,” was undeterred. A
1972 graduate of Lehigh University with a degree in finance, he
began his career at Bankers
Trust making loans to the airline industry. He left Banker’s to
move to one of his clients, Braniff
International, and subsequently left it to join Frank Lorenzo at
Texas Air. While there, he helped
Lorenzo buy People Express, a successful low-fare carrier in the
early 1980s that failed in 1986
after over expanding. A harsh taskmaster, Ferguson has been
known to drive executives away.
Since taking over in 1991, at least a dozen top managers have
left. One commented on his
management style by noting that, “It’s very pointed, even nasty.
If he doesn’t like an idea, he
seems to go out of his way to ridicule it.”21 Another said, “He
can’t resist reverting to Lorenzo-
style management.” Ferguson admitted to not suffering fools
easily and said, “I will not tolerate
not doing a good job. I will tell you in front of yourself, 20
people, or 100 people.” A person
familiar with his style claimed that, “Ferguson has to become
more people-oriented and depend
more on the recommendations of his management team.”22 He
denied that he has people-skill
problems and has plans to give as much as 4 percent of the
stock to employees. He has also hired
Donald Valentine as marketing chief for CALite; Valentine was
previously head of marketing
for Southwest. Ferguson conceded that CALite has had some
start-up pains and hasn’t operated
very efficiently so far but saw this as just the usual problems of
changing the organization.
United's Shuttle

47. On July 28, 1994, United announced what had been the year’s
worst-kept secret: On October 1,
it would begin its own airline-within-an-airline on the West
Coast. The goal of this operation,
named “The Shuttle,” was to cut costs by 30 percent on these
routes and regain the market share
that Southwest had captured. To do this, United aimed at
reducing its costs per available seat
mile to 7.4 cents. The Shuttle was scheduled to begin with 184
daily flights on 13 routes,
expanding to almost 300 flights by year-end. United announced
that it would match the going
price on all routes on which it went head-to-head with
Southwest. Service would include
advance seat assignments, a first-class cabin, and United’s
frequent flyer mileage program.
“People want to fly us because they can consolidate their
frequent flier miles and get better
service,” said United’s senior vice president for planning.23
Kelleher referred to United’s announcement as a “declaration of
war” and intimated that
Southwest might begin flying other United routes to drain
revenue. He also talked about raising
20 Howard Banks, “A Sixties Industry in a Nineties Economy,”
Forbes, May 9, 1994.
21 Wendy Zellner, “This is Captain Ferguson, Pease Hang On
To Your Hats,” Business Week, May 23, 1994.
22 Ibid.
23 Wendy Zellner, “Dogfight over California,” Business Week,
August 15, 1994.
For the exclusive use of Y. Li, 2016.

48. This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 17
fares on longer routes to generate revenue to lower the bar
without hurting Southwest’s own
profits. On August 30, Kelleher sent a memo entitled
“Commencement of Hostilities” to all
Southwest employees detailing Southwest’s response to
United’s challenge. This memo
concluded:
Southwest’s essential difference is not machines and “things.”
Our essential
difference is minds, hearts, spirits, and souls. Winston Churchill
stated: ‘Success
is never final.’ Indeed, success must be earned over and over
again or it
disappears. I am betting on your minds, your hearts, your souls,
and your spirits to
continue our success. Let’s win this one and make aviation
history again!
The president of America West, a Phoenix-based low-fare
airline that had been bloodied by
Southwest, said, “Taking on Southwest head-to-head is unwise
for anyone.”24
On July 12, United had completed negotiations for an employee
buyout. In return for 55 percent

49. of the company, employees, excluding the 17,000 flight
attendants who voted not to participate
in or agree to work rule changes, promised $4.9 billion in wage
cuts and productivity gains. As a
part of this agreement, Steve Wolf, the former CFO, was
required to step down and was replaced
by a Chrysler executive, Gerald Greenwald, who had no
previous airline industry experience, but
who was reputed to be a good people-person. Wolf claimed that
he left United in good financial
shape with great success on its overseas’ routes and a fleet that
was only nine years old on
average. Wolf estimated that the $1 billion in losses in 1992
would have been a $700 million
profit if United hadn’t been competing with Southwest. “We
just need to come up with a strategy
that will offset their competitive advantage,” he said.25
Unfortunately, not everyone is sure that The Shuttle can
succeed. The culture at United is almost
the opposite that of Southwest. One pilot claimed, “We live by
the letter of the law, in every
way.” Another noted that, “Mechanics and pilots have always
had a rift between them... That’s a
conflict as old as aviation history.” Another worried, “As for
management, I don’t know if they
can change their culture. There’s a lot of dinosaurs over there at
headquarters. There are a lot of
power struggles over there, and they worry more about those
than they do running the airline.”
One cynic claimed, “Most of the expansion we’ve done over the
past few years a blind man
could have accomplished. I wouldn’t really credit Steve Wolf
with any of that.” These
sentiments were not restricted solely to the pilots. Based on
interviews around the airline, Ken

50. Labich at Fortune reported mixed opinions about the future
among United employees.26
“You’ve also got to hope that the way we do things will change.
[United] is the kind of place
where management usually thinks they are way up there, and the
rest of us are way down here.
They want to make sure the shareholders get what they want,
but they don't care much about the
employees. All that’s got to change.”
—Mechanic
24 Ibid.
25 Kenneth Labich, “Will United Fly?” Fortune, August 22,
1994.
26 Ibid.
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 18
“I’m afraid a lot of people are still looking at the situation as us
versus them—management versus
labor, union versus non-union; there are clearly union people
out there who are saying, ‘Wait till
we take over.’ I don’t know how we will ever get out of that.”

51. —Planner
“We’ve always been treated like angry children who don't
deserve what they get. Upper
management has been adversarial and confrontational with us
for over 10 years now; I don’t think
Mr. Wolf liked the flight attendants at all. We are managed
differently from the other groups.
We’re disciplined if we’re sick more than 3 days per month or if
we arrive late for a flight...
We’re the only group that has to hop on a scale every month.
Pilots certainly aren’t held to those
standards. When it comes to the boys in the cockpit, things are
different. The pilots stay in
downtown hotels, and we’re stuck out at the airport. When we
have to deadhead, they fly in first
class and we’re in the back of the plane. That says it all... The
irony, of course, is that the bosses
ought to think a lot harder about how we feel if they want to
keep their customers happy. We’re
the people who spend all the time with the passengers. To the
public, we are United.”
—Flight Attendant and Union Representative
“People think a reservation job is easy, but it’s actually very
difficult. Customers aren’t nice on
the phones any longer, like they were when I came here 15
years ago... they’re rude to us. Then
we get so busy, with so many calls on hold, that we can’t spend
time with people and provide the
good service.”
—Reservation Agent

52. “I’d say there has been an intense lack of trust toward
management among the people I work with.
We feel that they haven’t been dealing straight with us for a
long time. They wanted to satisfy
shareholders and if people lost their jobs—well, that’s business
these days... There’s been turmoil
since 1985, when people on Wall Street started looking at us
like we were some cash cow they
could milk.”
—Ramp Agent
Although the head of the new airline had not yet been
announced, the betting was on Alan “Sky”
Magary. Magary, a veteran with 24 years in the industry, was an
innovator, credited with ideas
such as footrests and smoke-free flights. A former Northwest
executive described how when
Magary was there, he came up with the idea of using patterned
fabrics for the seats to disguise
coffee stains. Magary had spoken publicly about the potential
for The Shuttle and United’s plans
to reduce costs to 7.4 cents a seat mile. There was some
skepticism about this goal among
industry analysts, one of whom commented that, “Only a
deranged MBA could have thought this
up.”27
The Off-Site Meeting
As Ann Rhoades pondered the situation, she wondered if this
competitive threat could seriously
damage Southwest, and what actions, if any, Southwest’s senior
management should take. Could
United and Continental really imitate the Southwest approach?
Of course, the threat was made

53. more complicated because of the size and growth of Southwest.
With 14,000 employees, it was
no longer the small firm it had been. She worried that this could
affect the family feeling. She
also worried about the overconfidence Southwest’s success
could breed. Kelleher had been
quoted in a recent interview as saying, “We have to be the
world’s first company to refute the
27 Susan Chandler, “‘Sky’ Magary Picks a Dogfight,” Business
Week, September 19, 1994.
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 19
old law that companies die from excessive prosperity.”28 How
could they avoid these attitudes?
There was also the tricky problem of succession. Kelleher had
been at the head of the company
since 1963. How would the organization deal with this problem
if it became necessary? It was
clear to her that the success of the company really did rest with
the human resources, and her job
was to insure that these were managed effectively. But what
should the management team be
doing to deal with these problems? Well, she had seven hours
before tomorrow’s 7 a.m. meeting
to reflect on her options.

54. 28 Banks, “A Sixties Industry in a Nineties Economy.”
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
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For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 21
Exhibit 2
Airline Costs per Available Seat Mile
3rd Quarter 3rd Quarter
1993 1994
Southwest 7.13 7.03
Continental 7.64 7.56
United 8.11 8.32

104. American 8.06 8.08
TWA 9.23 8.66
Delta 8.66 8.95
Northwest 9.36 9.79
USAir 10.94 10.74
Source: Company reports
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 22
Exhibit 3
Anatomy of a 15-minute Turnaround29
7:55 Ground crew chat around gate position
8:03.30 Ground crew alerted and moved to positions
8:04 Plane begins to pull into gate; crew moves toward plane
8:04.30 Plane stops; jetway telescopes out; baggage door opens

105. 8:06.30 Baggage unloaded; refueling and other servicing
underway
8:07 Passengers off plane
8:08 Boarding complete; most of ground crew leave
8:15 Jetway retracts
8:15.30 Pushback from gate
8:18 Pushback tractor disengages; plane leaves for runway
29 Subrata Chakravaty, “Hit ’Em Hardest with the Mostest,”
Forbes, September 16, 1991.
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
So
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t A
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110. e
P
re
si
de
nt
C
us
to
m
er
s
C
ol
le
en
B
ar
re
tt
E
xe
c
V

111. ic
e
P
re
si
de
nt
In
te
rn
al
A
ud
it
A
l D
av
is
V
ic
e
P
re

112. si
de
nt
In
te
rn
al
A
ud
it
A
l D
av
is
V
ic
e
P
re
si
de
nt
C
or

113. po
ra
te
S
er
vi
ce
s
Jo
hn
D
en
is
on
E
xe
c
V
ic
e
P
re
si
de

114. nt
C
or
po
ra
te
S
er
vi
ce
s
Jo
hn
D
en
is
on
E
xe
c
V
ic
e

115. P
re
si
de
nt
O
pe
ra
tio
ns
G
ar
y
B
ar
ro
n
E
xe
c
V
ic
e
P

116. re
si
de
nt
O
pe
ra
tio
ns
G
ar
y
B
ar
ro
n
E
xe
c
V
ic
e
P
re

117. si
de
nt
•F
in
an
ce
•G
en
er
al
C
ou
ns
el
•R
es
er
va
tio
ns
•R
ev

118. en
ue
M
gm
t
•S
ys
te
m
s
•C
or
po
ra
te
C
om
m
un
ic
at
io
ns

119. •C
us
to
m
er
R
el
at
io
ns
•E
xe
cu
tiv
e
O
ff
ic
e
•M
ar
ke
tin

120. g
•P
eo
pl
e
•P
ub
lic
R
el
at
io
ns
•S
pe
ci
al
M
ar
ke
tin
g
•In
te

121. rn
al
A
ud
it
•C
or
po
ra
te
S
ec
ur
ity
•F
lig
ht
O
pe
ra
tio
ns
•F

122. ue
l a
nd
A
dm
in
is
tr
at
iv
e
S
er
vi
ce
s
•G
ro
un
d
O
pe
ra

123. tio
ns
an
d
P
ro
vi
si
on
s
•M
ai
nt
en
an
ce
a
nd
E
ng
in
ee

124. ri
ng
•S
ch
ed
ul
e
P
la
nn
in
g
C
ha
ir
m
an
, P
re
s.
&
C
E
O

125. H
er
b
K
el
le
he
r
C
ha
ir
m
an
, P
re
s.
&
C
E
O
H
er
b
K

126. el
le
he
r
C
us
to
m
er
s
C
ol
le
en
B
ar
re
tt
E
xe
c
V
ic
e

127. P
re
si
de
nt
C
us
to
m
er
s
C
ol
le
en
B
ar
re
tt
E
xe
c
V

128. ic
e
P
re
si
de
nt
In
te
rn
al
A
ud
it
A
l D
av
is
V
ic
e
P
re
si

129. de
nt
In
te
rn
al
A
ud
it
A
l D
av
is
V
ic
e
P
re
si
de
nt
C
or

130. po
ra
te
S
er
vi
ce
s
Jo
hn
D
en
is
on
E
xe
c
V
ic
e
P
re
si
de

131. nt
C
or
po
ra
te
S
er
vi
ce
s
Jo
hn
D
en
is
on
E
xe
c
V
ic
e
P

132. re
si
de
nt
O
pe
ra
tio
ns
G
ar
y
B
ar
ro
n
E
xe
c
V
ic
e
P
re

133. si
de
nt
O
pe
ra
tio
ns
G
ar
y
B
ar
ro
n
E
xe
c
V
ic
e
P
re

134. si
de
nt
•F
in
an
ce
•G
en
er
al
C
ou
ns
el
•R
es
er
va
tio
ns
•R
ev
en

135. ue
M
gm
t
•S
ys
te
m
s
•C
or
po
ra
te
C
om
m
un
ic
at
io
ns

136. •C
us
to
m
er
R
el
at
io
ns
•E
xe
cu
tiv
e
O
ff
ic
e
•M
ar
ke
tin
g

137. •P
eo
pl
e
•P
ub
lic
R
el
at
io
ns
•S
pe
ci
al
M
ar
ke
tin
g
•In
te

138. rn
al
A
ud
it
•C
or
po
ra
te
S
ec
ur
ity
•F
lig
ht
O
pe
ra
tio
ns
•F
ue

139. l a
nd
A
dm
in
is
tr
at
iv
e
S
er
vi
ce
s
•G
ro
un
d
O
pe
ra
tio

140. ns
an
d
P
ro
vi
si
on
s
•M
ai
nt
en
an
ce
a
nd
E
ng
in
ee
ri

141. ng
•S
ch
ed
ul
e
P
la
nn
in
g
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
So
ut
hw
es
t A
ir
lin

142. es
(A
) H
R
-1
A
p.
2
4
E
xh
ib
it
5
So
ut
hw
es
t R
ec
ru
it

143. in
g
A
dv
er
ti
se
m
en
t
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
So
ut
hw
es
t A
ir
lin
es

144. (A
) H
R
-1
A
p.
2
5
E
xh
ib
it
5
(C
on
t’
d.
)
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.

145. So
ut
hw
es
t A
ir
lin
es
(A
) H
R
-1
A
p.
2
6
E
xh
ib
it
5

146. (C
on
t’
d.
)
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
Southwest Airlines (A) HR-1A p. 27
Exhibit 6
Pay Scales for 3 Selected Jobs
Period Flight Attendant Reservation Agent Customer Service
Agent
1st 3 months
2nd 3 months
2nd 6 months
2nd year
3rd year
4th year
5th year
6th year
7th year
8th year

147. 9th year
10th year
11th year
$ 13.37
13.37
14.99
16.06
17.13
18.20
19.27
26.20
28.17
33.06
34.03
34.96
35.88
$ 5.75
6.25
6.75
7.50
8.15
8.68
9.12
9.57
10.05
10.56
11.09
11.64
12.22
$ 6.00
6.50
7.00

148. 7.79
8.41
8.82
9.27
9.73
10.22
10.73
11.26
11.83
12.42
Flight attendant pay progression ends after the thirteenth year.
Customer service and reservation
agent salary increases stop after the eighteenth year of
employment, although after that time they
are eligible for a bonus based on the cost of living index and a
profitability factor for the
company.
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
TB0333
Copyright © 2013 Thunderbird School of Global Management.
All rights reserved. This case was prepared by Professor
Andrew
Inkpen, with research assistance from Chee Wee Tan, Valerie

149. Degroot, Wes Edens, Jairaj Mashru, Sandip Patil, and Arturo
Wagner,
for the purpose of classroom discussion only, and not to
indicate either effective or ineffective management.
Andrew Inkpen
Southwest Airlines
You are now free to move about the country.™
In 2013, Southwest Airlines (Southwest), the once scrappy
underdog in the U.S. airline industry, was one of the
largest U.S. airlines and, based on number of passengers, one of
the largest in the world. The company, unlike
all of its major competitors, had been consistently profitable for
decades and had weathered energy crises, the
September 11 terrorist attacks, and the 2008-09 recession. An
insight into Southwest’s operating philosophy can
be found in the company’s 2001 annual report:
Southwest was well poised, financially, to withstand the
potentially devastating hammer blow of September
11. Why? Because for several decades our leadership
philosophy has been: we manage in good times so that our
Company and our People can be job secure and prosper through
bad times.…Once again, after September 11,
our philosophy of managing in good times so as to do well in
bad times proved a marvelous prophylactic for
our Employees and our Shareholders.
As Southwest entered its 42nd year of service, the company was
facing some major challenges. Legacy car-
riers in the United States had become more efficient, and the
recent mega-mergers involving Delta/Northwest,
Continental/United, and American/US Airways were shaking up
the industry. Smaller companies like JetBlue,

150. Alaska, and Spirit were pressuring Southwest’s cost advantage
and low-fare focus. A major internal challenge for
Southwest would be managing its acquisition of AirTran, a deal
completed in 2011. To make the acquisition a
success, the company would have to integrate a workforce of
more than 8,000 (about 25% the size of Southwest)
and manage a fleet of aircraft different from the Boeing 737s
used by Southwest.
The U.S. Airline Industry
The U.S. commercial airline industry was permanently altered
in October 1978 when President Carter signed
the Airline Deregulation Act. Before deregulation, the Civil
Aeronautics Board regulated airline route entry
and exit, passenger fares, mergers and acquisitions, and airline
rates of return. Typically, two or three carriers
provided service in a given market, although there were routes
covered by only one carrier. Cost increases were
passed along to customers, and price competition was almost
nonexistent. The airlines operated as if there were
only two market segments: those who could afford to fly, and
those who couldn’t.
Deregulation sent airline fares tumbling and allowed many new
firms to enter the market. The financial
impact on both established and new airlines was enormous. The
fuel crisis of 1979 and the air traffic control-
lers’ strike in 1981 contributed to the industry’s difficulties, as
did the severe recession that hit the United States
during the early 1980s. During the first decade of deregulation,
more than 150 carriers, many of them start-up
airlines, collapsed into bankruptcy. Eight of the 11 major
airlines dominating the industry in 1978 ended up
filing for bankruptcy, merging with other carriers, or simply
disappearing from the radar screen. Collectively,
the industry made enough money during this period to buy two

151. Boeing 747s.1 The three major carriers that
survived intact—Delta, United, and American—ended up with
80% of all domestic U.S. air traffic and 67% of
1 P. S. Dempsey, “Transportation Deregulation: On a Collision
Course,” Transportation Law Journal, 13, 1984, p. 329.
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
2 TB0333
trans-Atlantic business.2 Exhibits 1A and 1B provide summary
financial data for the major airlines. The rapid
growth of Southwest was in stark contrast to the much slower
growth of its major competitors.
Competition and lower fares led to greatly expanded demand for
airline travel. Controlling for inflation,
the average price to fly one domestic mile dropped by more than
50% since deregulation. By the mid-1990s,
the airlines were having trouble meeting this demand. Travel
increased from 200 million travelers in 1974 to
700 million in 2007 in the U.S. Demand fell significantly during
the recession and then started to grow again in
2010. Despite the overall growth in demand, from 2001 through
2011 total financial losses for the U.S. airline
industry exceeded $50 billion.
The financial performance notwithstanding, new firms
continued to enter the airline industry. For example,

152. during the period 1994 to 2004, 66 new airlines were certified
by the FAA. By 2004, 43 had shut down. Most of
the new airlines competed with limited route structures and
lower fares than the major airlines. The new airlines
created a second tier of service providers that saved consumers
billions of dollars annually and provided service
in markets abandoned or ignored by major carriers.
Although deregulation fostered competition and the growth of
new airlines, it also created a regional dis-
parity in ticket prices and adversely affected service to small
and remote communities. Airline workers generally
suffered, with inflation-adjusted average employee wages
falling from $42,928 in 1978 to much lower levels
over the subsequent decades. About 20,000 airline industry
employees were laid off in the early 1980s, while
productivity of the remaining employees rose 43% during the
same period. In a variety of cases, bankruptcy
filings were used to diminish the role of unions and reduce
unionized wages. Between 2000 and 2011, 51 U.S.
passenger and cargo airlines filed for bankruptcy—13 of them
in 2008.3 In the most recent round of bankrupt-
cies, airline workers at American, Delta, and other major
airlines were forced to accept pay cuts of up to 35%.
Industry Economics
About 80% of airline operating costs are fixed or semi-variable.
The few variable costs per passenger included
travel agency commissions, food costs, and ticketing fees. The
operating costs of an airline flight depended
primarily on the distance traveled, not the number of passengers
on board. For example, the crew and ground
staff sizes were determined by the type of aircraft, not the
passenger load. Therefore, once an airline established
its route structure, most of its operating costs were fixed.

153. Because of this high fixed-cost structure, the airlines developed
sophisticated software tools to maximize
capacity utilization, known as load factor. Load factor was
calculated by dividing RPM (revenue passenger
miles—the number of passengers carried multiplied by the
distance flown) by ASM (available seat miles—the
number of seats available for sale multiplied by the distance
flown).
On each flight by one of the major airlines (excluding
Southwest and a few other carriers), there were
typically a dozen categories of fares. The airlines analyzed
historical travel patterns on individual routes to de-
termine how many seats to sell at each fare level. All of the
major airlines used this type of analysis and flexible
pricing practice, known as a “yield management” system. These
systems enabled the airlines to manage their
seat inventories and the prices paid for those seats. The
objective was to sell more seats on each flight at higher
yields (total passenger yield was passenger revenue from
scheduled operations divided by scheduled RPMs). The
higher the ticket price, the better the yield.
Although reducing operating costs was a high priority for the
airlines, the nature of the cost structure limited
cost reduction opportunities. Fuel costs (17% of total operating
costs at Southwest in 2004; 37% in 2012) were
largely beyond the control of the airlines, and many of the
larger airlines’ restrictive union agreements limited
labor flexibility. The airline industry’s extremely high fixed
costs made it one of the worst net operating margin
performers when measured against other industries. Airlines
were far outpaced in profitability by industries such
as banks, health care, consumer products, and oil and gas.

154. 2 W. Goralski, “Deregulation Deja Vu,” Telephony, June 17,
1996, pp. 32-36.
3 Office of Inspector General, Aviation Industry Performance:
A Review of the Airline Industry, 2008-2011, September 24,
2011.
For the exclusive use of Y. Li, 2016.
This document is authorized for use only by Yuxue Li in
Strategic Management Fall 2016 taught by Donohoo, HE
OTHER from October 2016 to April 2017.
TB0333 3
In recent years, a la carte or ancillary revenues such as baggage
fees and change fees had become increasingly
important for most airlines. Some low-cost airlines, such as
Spirit and Allegiant, generated more than 25% of total
revenue from ancillary fees. In contrast to most of its
competitors, Southwest did not charge for checked bags.
To manage their route structures, the major airlines (except
Southwest) maintained their operations around
a “hub-and-spoke” network. The spokes fed passengers from
outlying points into a central airport—the hub—
where passengers could travel to additional hubs or their final
destination. For example, to fly from Phoenix to
Boston on Northwest Airlines, a typical route would involve a
flight from Phoenix to Northwest’s Detroit hub.
The passenger would then take a second flight from Detroit to
Boston.
Establishing a major hub in a city like Chicago or Atlanta
required a huge investment for gate acquisition