Southwest Airlines Corporation

In 2001, Southwest Airlines Corporations (Southwest) year-end results marked 29

consecutive years of profitability. Southwest, which was incorporated in Texas,

commenced customer service on June 18, 1971, with three Boeing 737 aircraft serving

three Texas cities: Dallas, Houston, and San Antonio. The company grew to become

the fourth largest U.S. airline (in terms of domestic customers carried). In 2002, it

boasted a fleet of 366 Boeing 737 jets. Southwest was the United States only major

short-haul, low-fare, high-frequency, point-to-point carrier. (Refer to Exhibit 1 for

five-year financial highlights.)

Southwest had the lowest operating-cost structure in the domestic airline industry and

consistently offered the lowest and simplest fares. Southwest also had one of the best

overall customer service records. In 2001, the airline had 35,000 employees and

generated total operating revenues of $5.6 billion from a passenger load factor of

68.1 percent. Its stock exchange symbol was LUV, representing Southwests home at

Dallas Love Field, as well as the theme of its employee and customer relationships.

Fortune magazine consistently recognized Southwest as one of the top 10 businesses

to work for in the U.S. and one of the most admired companies in the world. Among

airlines, Southwest ranked on top as the most admired airline worldwide from 1997

through 2001. In 2002,

The Wall Street Journal reported Southwest Airlines ranked first among airlines for customer service satisfaction, according to a survey by the American Customer Satisfaction Index.

Business Ethics listed Southwest in its 100 Best Corporate Citizens, a list that ranks public companies based on their corporate service to various stakeholder groups.

The Southwest Difference

Southwest did not employ the hub-and-spoke approach used by other major

airlines, such as United, American, and Delta. Instead, its approach was shorthaul

(average flight time was 55 minutes) and point-to-point (e.g., Dallas to Houston, Los

Angeles to Phoenix). Southwest had no assigned seats, paid its crews by trip, and used

less congested airports (e.g., Baltimore instead of Washingtons Dulles or Reagan;

Manchester, N.H., instead of Boston, Mass.).

Forty-six percent of Southwests passenger revenue was generated by online bookings

via southwest.com. In 2002, the cost per booking via the Internet was about $1,

compared to the cost per booking of $6-$8 through a travel agent. Terra Lycos, the

largest global Internet network, reported that Southwest received 50 percent more

searches than any other airline.

Southwest pilots were the only pilots of a major U.S. airline who did not belong to a

national union. National union rules limited the number of hours pilots could fly. But

Southwests pilots were unionized independently, allowing them to fly far more hours

than pilots at other airlines.

Other workers at Southwest were nationally unionized, but their contracts were

flexible enough to allow them to jump in and help out, regardless of the task at hand.

From the time a plane landed until it was ready for takeoff took approximately 20

minutes at Southwest, and required a ground crew of four plus two people at the gate.

By comparison, turnaround time at United Airlines was closer to 35 minutes and

required a ground crew of 12 plus three gate agents.

CEO Herb Kelleher, who founded Southwest, was deeply committed to a philosophy

of putting employees first. If theyre happy, satisfied, dedicated, and energetic, theyll take real good care of the customers. When the customers are happy, they come back.And that makes the shareholders happy.

Southwests walls were filled with photographs of its employees. More than 1,000 married couples (2,000 employees) worked for the airline. The average age of a Southwest employee was 34 years. Southwest employees were among the highest paid in the industry and the company enjoyed low employee turnover relative to the airline industry.

Southwests culture of hard work, high-energy, fun, local autonomy, and creativity

was reinforced through training at its University of People, encouragement of in-flight

contests, and recognition of personal initiative.

Being in the people business meant a rigorous approach to hiring new employees. In

2001, Southwest reviewed 194,821 resumes and hired 6,406 new employees. The

companys hiring process was somewhat unique: Peers screened candidates and

conducted interviews; pilots hired pilots, and gate agents hired gate agents. To better

understand what the company sought in candidates, Southwest interviewed its top

employees in each job function (e.g., pilots, gate agents, baggage handlers, ground

crew) and identified their common strengths, then used these profiles to identify top

candidates during the interview process. Southwest hired for attitude as much as

aptitude. Noted CEO Kelleher, We want people who do things well, with laughter

and grace.

Southwest initiated the first profit-sharing plan in the U.S. airline industry in 1974

and offered profit sharing to its employees every year since then. Through this plan,

employees owned about 10 percent of the company stock. In 2000, Southwest offered

its employees a record-setting $138Mm in profit sharing. This tax-deferred

compensation represented an additional 14.1 percent of each employees annual

salary.

Q. If you are a management accountant engaged by Southwest to do a six-month Activity-Based Costing project for the airline to improve cost control, explore what would be five of the possible cost pools (activity cost pools) and corresponding cost drivers (activity measures). Justify your choices of the cost pool and driver by explaining how they relate to the value chain, activities or operation of the airlines business.

Exhibit 1. Comparative Financial Data on Selected Companies Five-Year Average: 1995-2000 Southwest United American Delta Continental 38.1 Five-year return on equity (percentage) 16.3 27.9 12.9 19.5 Five-year sales growth (percentage) 14.5 5.4 3.0 6.S 11.2 Five-year net income growth (percentage) 26.9 -31.4 30.2 152 8.8 2000 Data Sales ($B) 9.9 5.6 19.3 18.1 16.7 As percentage of sales 87 83 Cost of goods sold 76 91 13 18 Gross margin 11 23.7 9.0 12.8 17. Operating income 11.0 Net income 10.7 0.3 4.3 3.5 18 17 Return on equity (percentage) 12 12 30 Exhibit 1. Comparative Financial Data on Selected Companies Five-Year Average: 1995-2000 Southwest United American Delta Continental 38.1 Five-year return on equity (percentage) 16.3 27.9 12.9 19.5 Five-year sales growth (percentage) 14.5 5.4 3.0 6.S 11.2 Five-year net income growth (percentage) 26.9 -31.4 30.2 152 8.8 2000 Data Sales ($B) 9.9 5.6 19.3 18.1 16.7 As percentage of sales 87 83 Cost of goods sold 76 91 13 18 Gross margin 11 23.7 9.0 12.8 17. Operating income 11.0 Net income 10.7 0.3 4.3 3.5 18 17 Return on equity (percentage) 12 12 30