Southwest Airlines Case

Southwest Airlines Case - A09-08-0014 Mary B. Teagarden...

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Unformatted text preview: A09-08-0014 Mary B. Teagarden Creating the Future at Southwest Airlines Our essential difference is minds, hearts, spirits, and souls. Herb Kelleher Gary Kelly had reason for pause as he assumed the role of president and chairman of Southwest Airlines in the summer of 2008. To begin with, he was filling the shoes of legendary and larger-than-life Southwest co-founder Herb Kelleher. The company was celebrating an astounding 35 consecutive years of profitability. Kelly had filled many other roles at Southwest, including controller, CFO, vice president of finance, and CEO. In fact, Kelly had just been named one of the best CEOs in America by Institutional Investor magazine. Southwest was known for innovation in both its business model and strategic human resource practices. Under Kelleher’s leadership, Southwest introduced innovative responses in the face of difficult industry conditions, not just once but several times. These innovations resulted in industry consolidation, ongoing profitability for the company, and Southwest was even credited with creating the discount airline industry segment. Kelly faced many challenges at a time when the airline industry was experiencing the worst environment in its history. Would Southwest’s cost advantage erode in the face of spiraling fuel costs, costly labor concessions, and the ever-increasing efficiency of rivals? As he contemplated the next moves in this increasingly turbulent environment, Kelly grappled with the most fundamental issues. What would he have to do to keep Southwest’s innovativeness alive? More importantly, was it time to reinvent the 40-year old Southwest Airlines? The Birth of Southwest The story of Southwest Airlines’ founding is legendary—the company got started in a bar. Herb Kelleher, a lawyer in San Antonio, and his client, Rollin King, a Texas banker, founded the company over drinks at a local bar in 1966. They had a simple vision: “If you get your passengers to their destinations when they want to get there, on time, at the lowest possible fares, and make darn sure they have a good time doing it, people will fly your airline.”1 Kelleher invested $10,000 of his own money to launch the business—an investment now worth more than $200 million. Their idea was revolutionary: a cut-rate airline that would fly between San Antonio, Dallas, and Houston—the three big cities in Texas. Kelleher admits that he was not sure that the idea would work. Not only did the idea work, this bold move was the start of the discount airline industry, and is considered the principal driving force for transformation of the airline industry. The major airlines, Southwest’s competitors, were determined to make sure Southwest failed by launching fights to block the company’s every move. For the first decade of their existence, Kelleher’s lawyer skills came in handy. He spent most of his time in court defending against lawsuits from incumbents. Kelleher reflected: I love battles. I think it’s part of the Irish in me. It’s like what Patton said, “War is hell, and I love it so.” That’s how I feel. I’ve never gotten tired of fighting. For the past 35 years, my job has been helping Southwest Airlines get through one battle after another. We’ve been like the French Foreign Legion—they had a firefight about every two days. That’s like us. Even before our first airplane got off the ground, we were fighting…There were already several big carriers in Texas. But then I really Copyright © 2008 Thunderbird School of Global Management. All rights reserved. This case was prepared by Mary B. Teagarden for the purpose of classroom discussion only, and not to indicate either effective or ineffective management. ecch the case for learning Distributed by ecch, UK and USA All rights reserved Printed in UK and USA N orth America t +1 781 239 5884 f +1 781 239 5885 e [email protected] Rest of the world t +44 (0)1234 750903 f +44 (0)1234 751125 e [email protected] looked into it and realized it was feasible. Of course, I also realized it was going to mean Armageddon. I knew the incumbents—Braniff, Texas International, Continental—were going to fight us tooth and nail.2 And fight tooth and nail they did. Three-and-a-half years of continual litigation later—including a rejection from the Texas Supreme Court to hear competitors’ petitions—Southwest found itself two days away from their first scheduled fight when an Austin, Texas, trial judge enjoined them from starting service. Kelleher recalled: I was very angry. The constant proceedings had gradually come to enrage me. There was no merit to our competitors’ legal assertions. They were simply trying to use their superior economic power to squeeze us dry so we would collapse before we ever got into business. I was bound and determined to show that Southwest Airlines was going to survive and was going into operation. If it didn’t, then something was very wrong about our whole system, about our whole society…So I headed back to the Texas Supreme Court to get the injunction lifted. I told Lamar Muse—who was CEO of Southwest Airlines at the time—to go ahead with our scheduled flight no matter what. Lamar said, “Gee, Herb, what do I do? Suppose the sheriff shows up and tries to prevent the flight? So I said, “Leave tire tracks on his shirt. We’re going, come hell or high water.” …And we did. We went into service the next day as scheduled. That’s how the first Southwest airplane got off the ground.3 The colorful Kelleher, well known for pranks, stunts, and outrageous behavior, became chairman of Southwest in 1978. Ron Kirk, mayor of Dallas, described Kelleher’s genius and over-the-top behavior: One more cigarette, and he’d go up in flames…When I first met Herb, to be honest with you, I thought the guy would just spontaneously combust. I just didn’t see how anybody—certainly not anyone that much older than me—could play as hard, work as hard, drink as hard, smoke as much as Herb Kelleher. I just knew one more drop of Wild Turkey or one more cigarette, and he’d go up in flames. But the man is inexhaustible. If you want to understand Herb and Southwest, you have to spend Halloween there. They shut down the whole corporate office for a day. It is the most insightful, outrageous, fun-filled eight hours anybody could spend…When your standard-bearer is Herb Kelleher, you can’t be outrageous enough. Every department gets this huge budget—they plan this for months—and every department is transformed into some theme. That’s when I really understood the genius behind what Herb does. I found out how much he loves the company, and how much everyone in that company loves him.4 Kelleher’s learning curve was steep when he assumed the role of CEO in 1982. He had thoroughly enjoyed the outside role he had played as the Southwest legal representative. More importantly, he had no experience running a company. Nevertheless, he took over the reins at a most challenging time. He commented: In my first year as CEO…I had to learn how to run a company—in a big hurry. Wow, that was some year: Twelve thousand air-traffic controllers were on strike—they had all walked out on the same day. It was a huge crisis. Whether or not you got the right to fly your new airplanes was determined by a lottery in Washington…We had new airplanes coming in , and airplanes don’t do very well if you just put them against a fence and plant geraniums in them. I came back from Washington and thought, “Man, this is an emergency.”5 When Herb took over, the airline had 27 planes, $270 million in revenues, and 2,100 employees. They flew to 14 cities, and, as a small start-up, an underdog, they had to fight hard. Kelleher commented, “We didn’t make much for a while…It was like being the tallest guy in a tribe of dwarfs.”6 In response to the lottery, in characteristic Southwest fashion, Herb used a bold approach to gain advantage. They had an inoperative subsidiary called Midway Southwest Airlines. Even though it was not operating, it was considered a new airline, and new airlines got preference in the lottery on drawing for flight slots. Southwest used Midway to get flight slots, which they then transferred to Southwest. Kelleher commented: It wasn’t against the rules, but people started getting very angry about it. The FAA summoned me to Washington, and they said what we were doing was not what was intended. I said, “Well, I don’t care what was intended. The rules permit you to do it.” They said, “Well, you have to be an operating carrier to participate in the slot lottery.” So I sold Midwest Southwest to a guy who operated one 2 A09-08-0014 Lear jet, and that made it into an operating carrier. He would get the slots and then transfer them to us. After we started doing that, I got summoned to Washington by Lynn Helms, the administrator of the FAA. When I walked into his office, he said, “Close the door.” So I closed the door. He said, “Herb, I think this is the funniest thing I’ve ever seen. You’ve completely taken advantage of the rules!” And he started laughing. He thought the whole thing was funny as hell. But he told me that the general counsel’s office was really peeved, and he was supposed to be telling me off. “When you walk out of here, I want you to look like I’ve really given you a good hiding, that I have just cleaned your clock,” he told me. So I left this office, walking along with my shoulders slumped like I’d just gotten caned.7 Getting Southwest up and running was just the tip of the iceberg. The bold challenge to the FAA was followed by a brutal fare war with Braniff Airlines. At one point, Braniff cut the price of one-way fares from Houston to Dallas from $26 to $13. Kelleher credits Lamar Muse with a brilliant way to match this price cut. “We’d offer customers a choice: They could pay $13—or they could pay $26 and we’d throw in a free bottle of whiskey. That made us the largest liquor distributor in Texas for a couple of months.”8 The head-to-head battle escalated, and Keller recalled: The fare war turned into a real war. I mean a physical war. We were the barroom brawlers of the American airline industry. One time, some Braniff people went up to the roof of the terminal in Houston and hung a sign over the edge to advertise their service to Dallas. Our station manager went up there and tried to cut it down with a knife. He ended up getting into a tussle with their people right there on the top of the terminal. Another time, Braniff didn’t have enough room to move one of its planes away from the terminal. They asked us to move our airplane. We said no. So they tried to power it out using all their engines and blew two of them out. That was a great day. Finally, the FAA told us, “Guys, unless you two quit this, we’re going to throw you both out of here.” Still, those early battles were the basis of Southwest’s warrior spirit. They bred a consciousness that life can be very short— even in business—very precarious. And that’s how we learned to endure and survive.9 The ability to think out of the box and the willingness to consistently push the limits paid off for the Southwest warriors. With 35 consecutive years of profitability, the most productive workforce in the industry, and the best customer service ratings in the business, Southwest dominated the low-fare, high-frequency, shorthaul, point-to-point market. From their humble beginnings, they grew to more than 34,000 employees and flew to 64 cities throughout the U.S. Southwest’s market capitalization, $11 billion, was more than twice that of American Airlines, United Airlines, and Continental combined. When Southwest came into a market, they lowered fares by 30 to 50 percent. Braniff, the early nemesis with whom they had brutal fare wars, is no longer in business. Southwest’s extraordinary success made it difficult to maintain the original “underdog” value among employees, but the “warrior spirit” remained alive and well. Southwest Operations and the Copycats Southwest gave birth to the discount airline industry. They pioneered the point-to-point operating model, no-frills service, generally fewer amenities, fewer restrictions on low fares, and more leniency with itinerary changes. No frills meant that expensive meals were not served, there were no seat reservations, and baggage was not transferred to other airlines, which all made fast aircraft turnarounds a reality. Faster turnarounds resulted in higher airport gate utilization, a major cost saving. It was claimed that the discount airlines successfully reduced customer expectations by offering fewer amenities, which resulted in fewer disappointed customers.10 The airline industry relied on two significantly different operating models—the “point-to-point” model, pioneered by Southwest, and the “hub-and-spoke” model. The hub-and-spoke operating model, used by most airlines in the airline industry, was designed to maximize traffic through the hubs in which many airlines were “headquartered.” The cost of establishing a major hub in a city like Chicago or Atlanta required an investment of as much as $150 million for gate acquisition and terminal construction.11 The spokes fed customers into the hub where they transferred and flew to their final destination. This model’s flight schedules were constructed to attract high volumes of low-yield connecting flights, resulting in airport congestion, slow aircraft turnaround, and thus an inefficient use of equipment (planes), facilities (gates), and people (air and ground staff ). A09-08-0014 3 In contrast, the point-to-point discount airline operating model was designed to maximize traffic on a route. The airports used in point-to-point flights were often smaller and less congested than those used by the majors. This lean operating approach did not require the variety of aircraft used by the majors. Southwest flew more than 500 Boeing 737 aircraft between 64 cities (the top ten are shown below). In the early 1990s, discount airline routes overlapped the majors by only 15 percent. In 2003, Southwest’s success and the proliferation of Southwest imitators resulted in a 55 percent overlap of majors’ routes by discount carriers. City Las Vegas Chicago-Midway Phoenix Baltimore/Washington Houston-Hobby Dallas-Love Field Oakland Los Angeles (LAX) Orlando San Diego Southwest Airlines Top Ten Airports Daily Number Nonstop Departures of Gates Cities Served 243 21 55 228 29 47 205 24 43 168 26 38 148 17 29 144 14 16 134 13 21 128 11 19 114 14 37 110 10 19 Service Established 1982 1985 1982 1993 1971 1971 1989 1982 1996 1982 Source: Southwest Airlines Fact Sheet; While competitors relied on large hubs, Southwest flew point-to-point. Unlike competitors who flew a variety of aircraft, Southwest used one type of plane, the Boeing 737, for all of its routes, which meant less expensive maintenance; smaller parts inventories; fewer, focused crew training facilities; and a more flexible workforce. This, in turn, resulted in overall lower operating costs. They were the largest single operator of the Boeing 737 in the world. They did not assign seats or transfer baggage to other airlines. They were the pioneer of online ticket purchase, thus cutting out the middleman. Instead of “airplane food,” Southwest served passengers peanuts and beverages by flight attendants wearing polo shirts and shorts, not uniforms like the competition. Kelleher consistently maintained the discipline to keep Southwest focused on what it did well. This low-cost, low-fare, no-frills operating strategy reduced maintenance costs, training and inventory costs, and operating costs. It also increased safety and flexibility. Southwest had the best safety record in the industry and more flexibility for crew and flight schedules. In response to the discount airlines, some majors launched their own low-cost imitators—the airline within an airline approach. TED by United, which replaced United Shuttle, was an example. Continental’s CALite and Delta’s Song, other examples, are no longer operating. Southwest’s business model was repeated many times around the world. Europe’s easyJet and Ryanair were two of the best-known airlines to follow Southwest’s business strategy on that continent. Other international imitators included Canada’s WestJet, Malaysia’s AirAsia, Qantas’ Jetstar, and Thailand’s Nok Air. Many companies tried to replicate Southwest’s operating strategy, one that appeared relatively transparent and easy to understand. Unfortunately, most misunderstood the extraordinary power of Southwest’s unique culture and the extent to which the culture supported the operating strategy. The Southwest culture emphasized team effort, flexibility, family orientation, fun, and outrageous customer service. Its “people first” philosophy contributed to its distinction as one of Fortune magazine’s best places to work in America. Herb Kelleher always believed that people—including himself—should not “check their personalities at the door” when they came to work. He expected employees to think and act like owners of the business. 4 A09-08-0014 Crisis or Key Inflection Point? Do you know how to make millions in the airline industry? Start with billions. Richard Branson, Virgin Air. The domestic U.S. majors—American, Continental, United, Delta and Northwest (soon to merge)—flew a variety of long, short, low-traffic, and high volume routes. This approach required a variety of aircraft types that resulted in more expensive maintenance, large and expensive spare parts inventories, redundant crew training facilities, and highly specialized, and thus inflexible, employees. It was common practice among the majors to impose costly fare increases on customers for last-minute itinerary and upgrade changes.12 Cost increases in fuel, equipment, or labor were passed on to customers and, historically, there was little price competition among the majors. By the end of 2000, the weaknesses of this model were becoming apparent. The economy was slipping as a result of the dotcom bust, and a general economic downturn had begun. Travelers were seeking lower fares, fuel costs were increasing, and there were fewer travelers. To make matters worse, the high labor cost concessions that had been granted to keep peace with the unions had trapped the majors in money-losing competitive positions. The terrorist attacks of September 11, 2001, further exacerbated the industry’s woes since it further decreased passenger traffic. The excessive expenses of the hub-and-spoke model, plus the other challenges, were taking a toll on the largest airlines. American, Delta, and United accounted for 60 percent of the industry’s revenue, but their collective net loss of $2.14 billion during the third quarter of 2002 represented 95 percent of the industry’s losses. United lost $47 for every passenger that boarded one of its planes, and burned through an average of $7million each day, while rival American burned through $4 million to $5 million per day. American planned to park 42 of its 800 aircraft in the desert in 2003, and Delta planned to idle many planes and lay off 8,000 employees.13 The situation was desperate for the major competitors. Discount airlines—Air Tran, ATA, Frontier, JetBlue, and Spirit—stood in sharp contrast to the majors, and all were trying to emulate Southwest’s low-cost model. The discount airlines offered lower fares, resulting in increased demand for air travel. Most of the growth in the airline industry was from leisure travelers for whom point-to-point flights were an alternative to other means of transportation, such as buses and personal automobiles. In the 20-year period 1975-1995, domestic air travel increased from 200 million travelers to 500 million travelers. The economic downturn that threatened the majors gave a boost to the discount airlines, which now flew 32 percent of domestic passengers.14 In 2005, Southwest once again was identified as one of the top 10 most admired companies in the prestigious ranking by Fortune.15 Herb’s Style and Strategy Herb Kelleher was characterized as the “airline industry’s jokemeister, the High Priest of Ha-Ha, a man who had appeared in public dressed as Elvis and the Easter Bunny, who had carved an antic public persona out of his affection for cigarettes, bourbon, and bawdy stories.”16 Fortune described his antics as a guest speaker while he was chairman of Southwest: Members of a professional aviation society called the Wings Club are gathered for a speech by Herbert D. Kelleher, the 63-year-old chairman of Southwest Airlines, and many are already chuckling to themselves…A fair percentage of the crowd has been up late swapping lies with Herb a time or two, and now they are waiting for him to say something…outrageous…Herb does not disappoint. A lean man just a shade over six feet, with a weathered face and thinning white hair, he glides to the microphone, Merit Ultra Lite in hand, and begins speaking in a honeyed baritone. “You know,” he says, “a fellow introduced me on the podium the other day, and he said that if I were proud of anything I had accomplished that I should probably go ahead and talk about that. Well, I’m here to tell you that I am proud of a couple of things.” He pauses and rocks back and forth—teasing the faces in the crowd, letting them know the good stuff is coming. “First,” he says, “I am very good at projectile vomiting.” Another pause as a great hoot of laughter erupts throughout the ballroom. “Second, I’ve never had a really serious venereal disease.” The laughter is sustained this time…Kelleher owns this crowd, as he would any gathering even faintly familiar with the U.S. airline industry.17 A09-08-0014 5 Behind Kelleher’s antics, called lunacy by some, lurked a formidable leader. His credo was to take the business, not himself, seriously. Herb was relentless in controlling the financials. One of Herb Kelleher’s most significant contributions to Southwest was his ability to manage trade-offs and maintain differences. These tradeoffs resulted in a powerful and enduring business model. Like the operating model, Herb Kelleher’s management philosophy was fairly simple, resting on three pillars—preparation, action, and an unswerving focus on people, customers, and employees. His first pillar was preparation for every scenario. In a 2001 interview with Fortune, Kelleher reflected: The way I’ve approached things is to be prepared for all possible scenarios of what might happen. I usually come up with four or five different scenarios. I do this all the time. I do it in the shower. I do it when I’m out drinking. Right now I’m thinking through the scenarios of the possibility of United Airlines and American dividing US Airways, the scenarios of American’s acquiring TWA. You have to think, “Okay, American’s bought TWA: How’s it going to integrate it? What is its emphasis going to be?” You have to do that sort of thing so you’re prepared to go one way or the other way depending on what American does. You have to think that way all of the time.18 A second pillar of his philosophy was a bias for quick action. He again reflected: The way you have to be in the airline business is “ready, fire, aim,” because if you take too much time aiming, you never get to fire. You have to strike quickly with blinding speed. When US Airways announced it was pulling out of six cities in California, I got on the phone and I said, “Get out there, get extra airplanes, get extra gates.” I called our properties department to get busy getting those gates lickety-split because they’d only be available for a nanosecond. I called finance and said we’d probably need five or six extra airplanes just as soon as we could get them—scour the market and get some as soon as you can. We’ve got to move. If you don’t do it, someone else is going to.19 Kelleher was identified as the kind of leader who would “stay out with a mechanic in some bar until four o’clock in the morning to find out what is going on. Then he will fix whatever is wrong.”20 Employees were encouraged to generate ideas and then to try them. The third pillar of the Kelleher philosophy of management was to listen to your customers and employees. Kelleher continued reflecting: Reading letters from customers is extremely valuable. Customers have given us some tremendous ideas. Employees have given us tremendous ideas as well. So the rule at Southwest is, if somebody has an idea, you read it quickly, and you respond instantaneously. You may say no, but you give a lot of reasons why you’re saying no, or you may say we’re going to experiment with it in the field, see if it works. But I think showing respect for people’s ideas is very, very important because as soon as you stop doing that, you stop getting ideas. We tell people that if you need a suggestion box, then you’re not doing what you should be doing. You shouldn’t have to interpose the box between you and your people with ideas. You ought to be talking to them on a regular basis. You ought to be with your people enough that they are comfortable to just pop on in and give you their ideas.21 Herb stayed relentlessly focused on the future. When asked about his typical day, Kelleher responded, “I never look back, really I don’t…When people ask me what I did yesterday, I can’t answer them. I’m not faking it. I try to remain directed forward.” “Besides,” he chuckled, “it’s convenient to forget about all the mistakes I’ve made.”22 Herb surrounded himself with people he trusted and to whom he happily delegated: Why get bogged down in the details of scheduling when there are mechanics to chat up, government panels to sit on, new markets to shake up, and competitors to poke fun at. Herb has executive vice president Colleen Barrett construct his day. Barrett started out as his legal secretary before Southwest took off, so she knows exactly what meetings, trips, and interviews will make Kelleher tick. Make no mistake: her control is pretty complete. When Barrett slaps a jacket on his back, Kelleher says, he feels like asking, “Am I cold, or am I going somewhere?” And any Southwest employee knows she takes this job quite seriously. A few years back, Barrett realized that Kelleher was blowing appointments by sneaking off to hobnob with employees. Solution: She had the door between his office and the hallway sealed….Kelleher admits that left to his own devices, he would probably ignore most matters that just don’t seem important or fun. So he arrives in the office each day to find a list pre6 A09-08-0014 pared by Barrett that contains two categories: things that must absolutely get done and things that can be postponed until no later than the following morning. “It’s a magical thing,” says Kelleher, who disregards the list now and then “just to be contrary.”23 Southwest’s Culture and Commitment Herb Kelleher built commitment the “old-fashioned” way by building loyalty between employees and the company. Veteran airline analyst Michael Derchin commented, “To an extreme degree, Herb has been able to make working in this business an adventure for his people.”24 The bond between Southwest and its employees was cult-like. In response to the cult comparison, Kelleher commented, “I feel that you have to be with your employees through all their difficulties—that you have to be interested in them personally. They may be disappointed in their country. Even their family might not be working out for them way they would wish it would. But I want them to know that Southwest will always be there for them.”25 Kelleher was the glue that bound this culture, the “Maximum Leader” of Southwest: Kelleher reigns over his band of 12,000 loyalists like some sort of manic father figure. He is often at the center of the festivities that break out frequently on the headquarters party deck overlooking the flat Texas countryside. Whatever the occasion—a holiday, someone’s retirement, Friday—Kelleher can be found in the middle of a worshipful crowd, drink and cigarette ever at hand. The Southwest chief works his way through the five packs of smokes a day, and only after he lost his voice a while back did doctors persuade him to move to the lower-tar variety26. Kelleher said that from the beginning he tried to instill “an insouciance, an effervescence” in employees. One result was that Southwest employees went out of their way to amuse, surprise, or somehow entertain customers. For example: During delays at the gate, ticket agents will award prizes to the passenger with the largest hole in his or her sock. Flight attendants have been known to hide in the overhead luggage bins and then pop out when passengers start filing onboard. Veteran Southwest fliers looking for a few yuks have learned to listen up to announcements over the intercom. A recent effort: “Good morning, ladies and gentlemen. Those of you who wish to smoke will please file out to our lounge on the wing, where you can enjoy our feature film, Gone with the Wind.” On that same flight, an attendant later made this announcement: “Please pass all plastic cups to the center aisle so we can wash them out and use them for the next group of passengers.”27 Many companies tried to replicate Southwest’s operating strategy without understanding the power of its unique culture. Kelleher commented, “Our esprit de corps is the core of our success. That’s the most difficult for competitors to imitate. They can [buy] all the physical things. The thing you can’t buy is dedication, devotion, loyalty—feeling you are participating in a cause or a crusade.”28 At Southwest, culture was by design: It was not an accident, as can be seen below from an internal communication with Southwest employees: To Our Employees We are committed to provide our Employees a stable work environment with equal opportunity for learning and personal growth. Creativity and innovation are encouraged for improving the effectiveness of Southwest Airlines. Above all, Employees will be provided the same concern, respect, and caring attitude within the organization that they are expected to share externally with every Southwest Customer.29 Warrior Spirit • • • • • • • Work Hard Desire to be the Best Be Courageous Display a Sense of Urgency Persevere Innovate Embrace the SWA Family Servant’s Heart • • • • • • Follow the Golden Rule Adhere to the Basic Principles Treat Others with Respect Put Others First Be Egalitarian Demonstrate Proactive Customer Service Fun-LUVing Attitude • • • • • • Have FUN Don’t Take Yourself Too Seriously Maintain Perspective (Balance) Celebrate Successes Enjoy Your Work Be a Passionate Team Player Source: A09-08-0014 7 Recruiting and Selection Southwest hired for attitude and trained for skill. Kelleher said, “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.”30 In 2007, they received 329,200 resumes and from these filled 4,200 jobs.31 The primary selection criteria were attitude and cultural fit. The interview process, like the company, could be unconventional, as a finance executive discovered as noted in the example cited below: Mary Ann Adams, 44, recently landed a job as a finance executive at Southwest Airlines…She had to prove she knew her weighted average cost of capital, but then the interviewing got really tough: She had to prove she had a sense of humor. Adams met the company’s levity test by recounting a practical joke in which she turned an unflattering picture of her boss into a computer screensaver for her department. “I get results, but I like to have fun, too,” she says…A sense of humor is a very serious requirement. If a candidate seems particularly taciturn, the interviewer may go for the jugular, demanding, “Tell me a joke.” Even candidates in such mirth-deficient disciplines as finance and infotech are required to mesh with the company’s famously jocular culture.32 Despite the very high rejection rate, Southwest remained sensitive to the possibility that it was rejecting potential customers. “The recruiting process is designed not to make applicants feel inferior or rejected.”33 Ann Rhodes, former head of Southwest’s People Department, claimed “…that some people have told her they had a better experience being rejected by Southwest than they did being hired by other companies.”34 The emphasis on selecting for attitude and fit and the importance of culture naturally led to a very important role for training at Southwest. Training and Development Southwest’s University for People provided professional and personal training for its entire workforce. The University for People was an umbrella department of Southwest’s highly decentralized training department. All new employees participated in the “New Hire Celebration”—a course designed to get new employees enthused and excited. New flight attendants go through four weeks of classes, typically with less than five percent attrition. Much of this training is oriented towards customer service—“the care and feeding of customers.” Customer expectations about service are 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.”35 Coordination and Control Hiring, training, and development practices were designed to enhance coordination and control at Southwest. Their coordination and control mechanisms were embedded in their strategic human resource management practices. For example, many customer service failures were based on problems between two or three different employee groups. American Airlines held the specific function involved accountable. According to one American employee, if a delay occurred, managers on duty were responsible for figuring out which function caused it. Referring to Robert Crandall, former CEO and chairman, he asserted, “Crandall wants to see the corpse. It is management by intimidation.”36 On the other hand, Southwest used a “team delay” concept to point out problems between two or three different employee groups working together. Performance management was less precise at Southwest, but the benefit was increased problem-solving and enhanced productivity. At American Airlines, conflict resolution was designed to address grievances that employees filed against managers. Their managers were not rewarded for supporting good work relationships. At Southwest, there was a proactive approach to conflict resolution. Conflict was seen as inevitable and there were processes to attempt to resolve it at the source, and emphasize understanding the other person’s perspective. The following table highlights differences between approaches to coordination and control taken by American and Southwest. 8 A09-08-0014 Element Accountability of Front-Line Employees Accountability of Field Managers Supervision Employee Selection Conflict Resolution American Functional Accountability Focus on Measurement Large Supervisory Spans of Control (30-40) No Regard for Teamwork Minimal Southwest Cross-Functional Accountability Focus on Learning Small Supervisory Spans of Control Selection for Team Fit Proactive Source: Adapted from Paradox of Coordination and Control. Labor Relations Michael E. Levine, former dean of Yale’s School of Organization and Management and executive vice president for marketing at Northwest Airlines, commented, “Herb 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.”37 Like the rest of the airline industry, nearly 90 percent of Southwest’s workforce was organized into nine unions. The pilots and three small technician unions were independent organizations. The flight attendants and ramp workers were members of the Transportation Workers Unions (TWU), the customer service and reservation agents were represented by the International Association of Machinists (IAM), and the mechanics and cleaners were represented by the Teamsters (IBT).38 Southwest enjoyed peaceful labor relations from its beginning. Its founders had a collaborative philosophy, and were not opposed to unions and invited them into the organization. Southwest’s management worked hard to ensure that the unions maintained the same objectives as the company. Unlike many companies that had cumber some formal structures and processes for consultation and representation, Southwest only had negotiation and grievance procedures. Southwest did, however, keep the union representatives informed of new developments. None of Southwest’s achievements would have been possible without its unusually good labor-management relations, attributed to Kelleher’s hands-on efforts, as exemplified by the following anecdote: A Wall Street analyst recalls having lunch one day in the company cafeteria when Kelleher, seated at a table across the room with several female employees, suddenly leapt to his feet, kissed one of the women with gusto, and began leading the entire crowd in a series of cheers. When the analyst asked what was going on, one of the executives at his table explained that Kelleher had at that moment negotiated a new contract with Southwest’s flight attendants.39 Developing and maintaining empathy is part of the skill of good labor-management relations. At one point, tensions broke out between flight attendants and their schedulers—the ones with the sorry job of telling flight attendants they have to work on a day off—because the flight attendants believed the schedulers were overworking them. The schedulers claimed the flight attendants were hostile and uncooperative. The solution was very Southwest: both sides had to switch jobs for a day and see how difficult the other side had it. The solution eased the tension and developed empathy between flight attendants and schedulers. Colleen Barrett, who was credited with masterminding the Southwest culture, believed that competitors did not enjoy Southwest’s success, “Because they don’t get it…What we do is simple, but it’s not simplistic. We really do everything with a passion. We scream at each other and we hug each other.”40 This zany environment in which Barrett was so comfortable was described by an analyst: To truly understand why this company continues to be such a hit with customers, you have to go behind the wall and take a look. Pay a visit to Southwest’s headquarters just off Love Field in Dallas, and you’ll probably think you’ve wandered onto the set of Pee -wee’s Playhouse. The walls are festooned with more than ten thousand picture frames—no exaggeration—containing photos of employees’ pets, of Herb dressed as Elvis or in drag, of stewardesses in miniskirts, of Southwest planes gnawing on competitors’ aircraft. Then there are teddy bears, and jars of pickled hot peppers, and pink flamingos. There is cigarette smoking, and lots of chuckling, and nary a necktie to be seen.41 A09-08-0014 9 Southwest’s pep-rally culture was not just window dressing, according to an industry analyst: Southwest employees are more productive than most others in the industry…so maintaining morale is critical…While Southwest has tweaked its formula over the years—adding more long-distance flights, for instance—it’s still mainly a point-to-point, short-hop airline that uses one aircraft type to simplify training and maintenance.42 Herb and His Successors “Herb is going to be very hard to replace,” sighed board member June Morris in an extraordinary understatement. Nevertheless, Herb Kelleher announced his intention to retire in 2000, and stepped down as president and CEO in 2001. He commented: I had an agreement with the board that when I got to be 70, we ought to do something about succession. I guess the board just thought it might be embarrassing to have a chairman and president and CEO who was 70. You should never become infatuated with power. If you have any common sense, you know the time will come when you have to let go.43 Kelleher said he thought about his successor very seriously for quite a long time. He said, “My biggest concern was that I wanted someone who would be respectful of Southwest’s culture and would be the sort of person who was altruistic in nature.”44 He decided that Jim Parker, Southwest’s general counsel and Herb’s friend since 1979, and Colleen Barrett, who had been with Herb since the beginning of Southwest and had risen through the ranks, fit the criteria. Parker was selected to fill the CEO position and serve as vice-chairman of the board, and Barrett was selected to be president and COO—the first man-and-woman team to run an airline. Although controversial, Herb remained as chairman with responsibility for managing strategy and government relations. Jim and Colleen assumed their new responsibilities the day Southwest turned 30. Soft-spoken and bespectacled James Parker, who joined Southwest in 1986 after seven years as a partner at Kelleher’s law firm, commented, “I told Herb I had put too much of my life into Southwest Airlines to walk away from a chance to try and move ahead.”45 He was a thoughtful University of Texas-trained lawyer who looked like he would be more comfortable writing wills in a country town than running an airline. Parker was a stark contrast to Herb. Nevertheless, Kelleher sang Parker’s praises and wryly observed, “Parker is exactly the kind of leader Southwest needs… [Although] I think we have different personalities…” Some noted that it was not likely that Parker would engage in Kelleher’s attention-getting antics, such as dressing up like the King of Rock and Roll. “He is more English professor than Elvis impersonator,” contended one long-time industry observer.46 In his self-effacing style, Parker observed, “I’m not Herb. Colleen’s not Herb…So we are just going to have to be ourselves.”47 Parker planned to continue the Southwest business model by keeping the low-cost, low-fare, no-frills airline it had always been. Kelleher contended, “There will be no change in our core philosophy and basic business model…”48 The Southwest model was one that Parker helped refine and reinforce during his tenure at Southwest, often in a very hands-on way. For example, prior to taking the CEO role, he negotiated a ten-year contract with Southwest pilots that significantly controlled costs. It was typical for airlines to lock in labor costs for a three- or four-year period only. In addition, Parker was the champion of Southwest’s move to sell tickets on the Internet. These online sales later accounted for more that $1 billion in revenues. Colleen Barrett began her career as Kelleher’s secretary in his San Antonio law firm. She followed Herb to Southwest, and was at his side every step of the way. She was considered an unsung hero at Southwest, and was selected to replace Kelleher as president. This made her the highest ranking woman in the U.S. airline industry. She described herself as a passionate and emotional communicator, and said, “Some CEOs will still introduce me as Herb’s secretary.”49 She did not care when people mistook her for Kelleher’s secretary. Reflecting on her considerable accomplishments, she said, “Actually, I just laugh at it…I loved being a secretary.”50 Prior to taking over the role of president and COO, Barrett oversaw Southwest’s marketing, advertising, customer service, and human resources activities. She was also considered chief guardian of Southwest’s esprit de 10 A09-08-0014 corps. According to Glenn Engle of Goldman Sachs, “She built the infrastructure on which Southwest’s culture is based.”51 Some identified her as Herb’s alter ego. Kelleher once commented, “One of our strengths is that we are so complementary.”52 Once Kelleher and Barrett took the Myers-Briggs personality assessment, and scored at opposite extremes. Barrett elaborated: Herb could have a dream in the middle of the night and say, “Okay, this is what I want to do.” But he wouldn’t have a clue, God love him, what steps have to be taken to get there… I’m not the most brilliant person in the whole world, but I can see systematically from A to Z, and I know what has to be done.53 Jim Parker had taken on probably the toughest job in business, replacing Herb Kelleher, just as the airline industry was facing the most severe economic downturn in years. When someone asked Parker how he was going to handle succeeding Herb, he quipped, “Well, Colleen’s going to handle the smoking, and I’m going to handle the drinking.”54 Later, he commented, “Nobody can replace Herb. I’d never try to. Actually, I‘m fairly boring. I’m not as zany as Herb is—no Elvis suits or anything. When I moved into Herb’s office, they had to totally detoxify it. They pulled out the carpet, took out the wall cover, took out the ceiling tiles to get all that cigarette smoke out of there. Fortunately, our people have been very accepting of the fact that I’m just trying to be myself.”55 Then the terrorist attacks of September 11, 2001, happened. Parker was able to call on Herb for backup. He commented: I felt no pressure in becoming CEO after Herb because this was not exactly a turnaround situation. My biggest challenge was to maintain direction and focus of the company. Still, it’s been a uniquely stressful year in the airline industry, and one of the things I am grateful for is the fact that Herb has been a total failure at retirement. He continues to be actively involved as our chairman of the board. It was very comforting to me that he was here after September 11. After all, if you had a chance to get advice or guidance from any living human being about the airline industry, who would you seek out? I can’t think of anyone better than Herb Kelleher.56 Running Southwest Airlines was not as easy as Herb made it look. A year after Jim and Colleen assumed their new responsibilities, an analyst commented: Southwest Airlines is rapidly approaching middle age. While it may once have been the little guy, the upstart who had to try harder, today the eternal underdog is a national institution which passed its 30th birthday last year. Not only has it outlasted old giants such as Pan-Am and TWA, but its post-September 11 market capitalization at $17 billion exceeds American, Delta, and United combined. With age has come maturity, and with maturity a move away from reliance on the founder Herb Kelleher and his legendary charisma. In his place come executives who have grown up within the airline, and who have the very clear duties of institutionalizing the two things that have served Southwest so well: its business model, and its corporate culture.57 Cracks in the Façade? Southwest was now 37 years old. As the fifth largest airline in the U.S. by revenue, it had lost its credibility as an underdog. Additionally, this giant’s no-frills flights were starting to look “chintzy,” as competitors like JetBlue matched low fares while adding frills like satellite TVs and assigned seating. As long as Kelleher was around, employees would go the extra mile in the name of Herb. Prior to his retirement in 2001, “he was able to implement Southwest’s unique cost structure and work rules,” says an executive of another airline. “If you were a union leader, you couldn’t badmouth Kelleher: he was an icon. But anybody new was going to be just another corporate executive.”58 The problem with being the one profitable major airline post 9/11 was that airline workers got greedy. Concessions by unions at the six major carriers stood in sharp contrast to the big wage and salary demands by employees of Southwest. The pilots of its 737s had the highest compensation in the industry, “making $190,000 in salary and profit sharing, plus up to another $100,000 in stock option grants.”59 Southwest had also seen its A09-08-0014 11 stranglehold on low-cost, young labor erode. Kelleher was pressed back into service to help end the stalemated, embittered flight attendant negotiations. He got the deal done, but at a significant cost. An industry analyst observed: When Southwest Airlines flight attendants gathered for the camera this summer, it was the antithesis of the warm-and-fuzzy photo ops on which the low-cost carrier built its image. Instead, the attendants were showing off a banner calling for “Discount Fares—Not Discounted Employees and Families.”… Its attendants’ contract resulted in 31 percent average wage hikes, so that within three years they will be the best paid in the sky, earning up to $56,350 annually. In one fell swoop, its labor cost, at 3.2 cents to fly one seat mile, soared above the 3.0 cents at Texas rival Continental…Under the new wage scale, Southwest’s overall cost to fly a seat one mile jumped from 7.6 cents to 8.1 cents…60 A Morgan Stanley analyst commented, “It’s worth asking whether Southwest is finally facing the same issues and challenges that legacy carriers have experienced for some time.” He continued, “We believe there is a risk that as a generational change occurs and the oldest Southwest employees retire (who remember the early years of struggle), the company’s low-cost culture will change.”61 Another analyst commented: From 20 percent to 25 percent annual growth in the mid-1990s, earnings have fallen an average of two percent annually the past five years. The market may be catching on. Southwest’s stock is down 30 percent the past year to a recent $13.80. Even so, its lofty $10.9 billion market value is more than that of the nation’s ten other largest airlines combined.62 Southwest had weathered a dizzying series of events since 2001. Parker and Barrett were grappling with important strategic decisions in the face of major industry setbacks—terrorism, spiraling fuel prices, and labor unrest. They were trying to figure out how to respond to increasing, credible competition. Then, in September 2004, CEO James Parker suddenly resigned. Reorganizing for the Future? Parker’s resignation was followed by reorganization at the low-cost carrier in which CFO Gary Kelly, who had devised Southwest’s fuel-hedging strategy which insulated it from fuel cost shock, stepped into the role of CEO. Kelly’s first job at Southwest had been to bring the accounting and information management systems into the computer age. He had an uphill battle convincing the waste-averse, penny-conscious, skeptical Kelleher that investment in technology could lead to cost-cutting, revenue-generating innovations. Kelly was characterized as a demanding “born leader” with character, a straightforward and honest communication style, integrity, and a track record of treating people right. Kelly’s nurturing style made his followers “willing to run through walls for him.”63 Kelly commented that costs “are rising much faster than the overall rate of inflation and our own revenue growth.”64 Kelly had been with Southwest for 19 years, and had seen all of the easy growth opportunities exploited. Upon taking the reins, he observed, “Growth opportunities have become more precious.”65 But the balance sheet was a financial manager’s dream. According to Tammy Romo, Southwest’s VP and treasurer, “We ended the year with $1.3 billion in cash, and our leverage…is well under 40 percent.” Despite the financial strength, Kelly commented, “There is a lot of competition. There is a weakened air traffic demand environment. And that’s before you even get to the cost side of the equation.”66 The commercial aviation environment had changed dramatically in the last eighteen months. The larger legacy rivals—the majors—had achieved considerable labor restructuring agreements, which eroded Southwest’s “once considerable” wage advantage. Overcapacity was putting pressure on passenger yields, pushing them lower than Southwest would prefer. Other low-cost carrier rivals like JetBlue, AirTran, and Spirit were establishing niches that eroded opportunity for Southwest in the “underserved and overpriced markets” at the core of their niche. Southwest had seen three chief executives in four years, compared to the twenty years that Kelleher filled the role. Parker had been in the post for what were characterized as the three worst years in the history of aviation. Barrett remained president until the summer of 2008, and retained her title and role as chief morale officer. Less 12 A09-08-0014 than a year into the new job, Kelly gave the annual “Message to the Field” speech to the employees, where he told the crowd, “The Southwest brand is under attack. These next years are going to be some of the hardest the airline has ever had. Be prepared for some sacrifices.” The crowd got very quiet.67 Kelly believed, “The issue right now is that there is a glut of seats, there is an energy-price crisis for our industry, and it’s time to get through as opposed to making a lot of bets on what customers do or don’t want.”68 Kelly’s foresight into the energy-price crisis could not have been more accurate, and his response more strategic. The price of fuel skyrocketed in the spring of 2008, and rising fuel costs hit airlines hard. Industrywide fuel expenses were expected to total $61 billion in 2008, compared to $41 billion in 2007, according to the Air Transport Association. Southwest benefited from Kelly’s fuel price-hedging strategy, and had been able to hold down its fuel costs while competitors struggled to cope as the price of crude spiraled ever higher. In 2007, Southwest locked in the price it would pay for fuel in 2008 based on a crude oil price of $51 per barrel, far less that the $162 per barrel that crude reached in July 2008. With this huge cost advantage, Southwest did not have to increase fares as much as other airlines or follow other carriers in imposing new baggage or beverage service fees and cutting flights by as much as 15 percent. Southwest had four modest fare increases in 2008, compared to more than twenty by other major airlines. Kelly commented, “Right now, it comes as a sweet advantage, and we are trying to take advantage of it. Reservation agents tell me the first question they get when customers call right now is, ‘Do you charge for the first bag?’ I believe deeply we are gaining passengers because of our approach.”69 This advantage would not continue. Southwest was not able to hedge as much as it wanted for fuel it would need in 2009 and 2010, and faced the very real possibility of having to raise airfares significantly. Kelly had many issues to weigh as he continued to pursue the conservative management and aggressive expansion that built Southwest Airlines and kept it profitable for 35 of the last 37 years. Could Southwest preserve the Herb-centric culture now that Kelleher had turned operations over to successors? Was the Southwest culture critical to their continued success, especially as they were becoming more like the majors they once mocked? Would Southwest lose its leadership position to copycat competitors? Would they have to copy the copycats to meet customer expectations for things like assigned seats, baggage transfer, and personal entertainment systems? Would their cost advantage erode in the face of spiraling fuel costs, costly labor concessions, and the ever-increasing efficiency of rivals? Should they provide service to those routes being abandoned by the majors? As he contemplated the next moves in this increasingly turbulent environment, Kelly grappled with the most fundamental issues. Were minds, hearts, spirits, and souls sufficient to continue to differentiate Southwest? Was it time to reinvent the 40-year-old Southwest Airlines? Notes K. Brooker, “The Chairman of the Board Looks Back as Herb Kelleher Hands Over the Controls,” Fortune, May 28, 2001. 3 Ibid. 4 Ibid. 5 Ibid. 6 K. Labich and A. Hadjian, “Is Herb Kelleher America’s Best CEO?” Fortune, Volume 129, Issue 9, 1994. 7 Brooker, “The Chairman of the Board Looks Back as Herb Kelleher Hands Over the Controls.” 8 Ibid. 9 Ibid. 10 J. Clark, “Low-Cost Airlines Get a Lift in Fiscally Turbulent Times,” USA Today, April 18, 2003, pp. 1D, 2D. 11 A. Inkpen, “Southwest Airlines 2002,” Thunderbird Case, #A07-02-0009, 2002, p. 3. 12 T. Hansson, J. Ringbeck, and M. Franke, “Flight for Survival: A New Operating Model for Airlines, Strategy + Business, December 9, 2002. 13 S. McCartnery, “Big Three Airlines Face Tough Tasks,” The Wall Street Journal, October 24, 2002, p. D5. 14 Ibid. 15 J. Useem, “America’s Most Admired Companies,” Fortune, Vol. 151, Issue 5, 2005, pp. 66-70. 16 Ibid. 17 Ibid. 18 Brooker, “The Chairman of the Board Looks Back as Herb Kelleher Hands Over the Controls.” 19 Ibid. 20 Labich and Hadjian, “Is Herb Kelleher America’s Best CEO?” 1 2 A09-08-0014 13 Brooker, “The Chairman of the Board Looks Back as Herb Kelleher Hands Over the Controls.” S. Branch, “So Much Work, So Little Time,” Fortune, Volume 135, Issue 2, 1997. 23 Ibid.. 24 Labich and Hadjian, “Is Herb Kelleher America’s Best CEO?” 25 Ibid. 26 Ibid. 27 Ibid. 28 K. Brooker, “Can Anyone Replace Herb?” Fortune, Volume 141, Issue 8, 2000. 29 30 S. Chakravaty, “Hit ’em Hardest with the Mostest,” Forbes, September 16, 1991. 31 32 Ibid. 33 C. O’Reilly and J. Pfeffer, “Southwest Airlines; Using Human Resources for Competitive Advantage (A),” Graduate School of Business, Stanford University, 1994. 34 Ibid. 35 Ibid. 36 Jody Hoffer Gittell, “Paradox of Coordination and Control,” California Management Review, 42 (3), 2000, pp. 101117. 37 Labich and Hadjian, “Is Herb Kelleher America’s Best CEO?” 38 T. A. Kochan, “Southwest Airlines,” Working Paper #WP09, May 1, 1999. 39 Labich and Hadjian, “Is Herb Kelleher America’s Best CEO?” 40 A. Serwer, “The Hottest Thing in the Sky,” Fortune, Volume 149, Issue 5, 2004, p. 86. 41 Ibid. 42 W. Zellner, “Southwest: After Kelleher, More Blue Skies,” BusinessWeek, Volume 45, Issue 3726, 2001. 43 Brooker, “Can Anyone Replace Herb?” 44 Ibid. 45 D. Fisher, “Is There Such a Thing as Nonstop Growth?” Forbes, Volume 170, Issue 01, 2002. 46 Ibid. 47 Ibid. 48 Ibid. 49 Brooker, “The Chairman of the Board Looks Back as Herb Kelleher Hands Over the Controls.” 50 Ibid. 51 Ibid. 52 Ibid. 53 Ibid. 54 Ibid. 55 J. Parker, “Replacing a Legend,” Fortune (Europe), Volume 146, Issue 9, 2002, p. 36. 56 Ibid. 57 D. Field, “Southwest Succession,” Airline Business, Volume 18, Issue 4, 2002. 58 J. Helyar, “Southwest Finds Trouble in the Air,” Fortune (Europe), Volume 150, Issue 3, 2004, p. 15. 59 M. Tatge and N. Weinberg, “What Goes Up….,” Forbes, Volume 174, Issue 8, 2004, p. 116, 3p, 4c. 60 Ibid. 61 Helyar, “Southwest Finds Trouble in the Air.” 62 B. Gimbel, “Southwest’s New Flight Plan,” Fortune, Volume 151, Issue 10, May 16, 2005. 63 D. Reed, “Southwest CEO Puts Emphasis on Character,” USA Today, September 26, 2004. 64 Ibid. 65 “Kelly Becomes CEO at Southwest,” AirFinance Journal, Issue 273, September 2004, p. 7. 66 Ibid. 67 Ibid. 68 Ibid. 69 P. Pae, “Southwest Airlines Will Soon Be No. 1 at Four of Five Area Airports,” Los Angeles Times, July 25, 2008. 21 22 14 A09-08-0014 ...
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This note was uploaded on 10/14/2010 for the course MGMT 551 taught by Professor Chrisdoran during the Spring '10 term at HKUST.

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