BUSINESS MODELS

The output of a market strategy is a differentiated positioning within the market. Southwest competes in the highly competitive commuter airline market, which, as an industry, lost $50 billion from 2001-2012.

The idea of Southwest was born on a napkin with lines connecting the three dots titled Dallas, San Antonio, and Houston. Back in 1967, the founders of Southwest saw a hole in the commuter airline market. While the big airlines were built around national and regional hub and spoke route models, Southwest focused on intrastate point-to-point routes (initially Dallas, Houston & San Antonio). Since then, Southwest has stuck to this point-to-point route market positioning, while most other airlines relied on their hub and spoke models.

You start a business to fulfill a customer's need. Southwest started a regional point-to-point airline for customers who wanted an hour-long flight rather than waste 3.5 to 4.5 hours in a car to drive from Dallas to Houston or San Antonio. Instead of spending 7 to 9 hours behind the car windshield for a day round trip, customers could be pampered by "the best service and the most beautiful girls in the sky." Southwest had a unique perspective on how they defined the needs of their target customers, as stated in their 1975 Annual Report,

"We believe that in short-haul markets of up to 500 miles, the private automobile is a worthy competitor for those consumers representing the great majority of us who cannot logically place a value on time commensurate with the airfares now charged in those markets. Except for the businessman and woman market, a fare that does not compete with the cost of personal automobile travel will not permit any air market to reach its potential.

By focusing on this unmet customer need to substitute a flight for a car drive, Southwest was one of the key influencers in driving astronomical growth in U.S. domestic air travel. They attracted business customers with low fares, convenience, and service, and leisure travelers with ultra-discounted weekend tickets to drive up their plane utilization. At the time, the ultra-discounted weekend fares opened up a whole new segment of travel customers who wanted to fly for pleasure, to visit family, recreation, and to explore new destinations.

Over the past 45+ years, Southwest has continued its focus on the business and leisure customer segments, tailoring its value proposition and go-to-market to these two segments.

While Southwest Airlines now serves over 100 destinations, its deliberate geographic expansion strategy was one of the keys to Southwest's growth. In keeping with its low-cost provider mission, Southwest has always pursued a geographic density strategy to drive cost and capital synergies and utilization.

Over the six years after their 1971 launch, Southwest expanded just in Texas with routes to the Rio Grande Valley, Austin, Corpus Christi, El Paso, Lubbock, and Midland/Odessa. In 1977, Southwest's fleet of 12 737s carried 2.4 million customers, which equals 200,000 passengers per plane, or 548 passengers per plane per day. Considering the population of Texas was only 13 million people in 1977, the word-of-mouth of the new, cool, and cheap Southwest Airlines was unavoidable. This geographic focus also enabled Southwest to leverage its fixed costs related to airports, personnel, maintenance facilities, and advertising.

Southwest has always taken a highly deliberate geographic expansion strategy, choosing routes that are natural extensions of the existing route network, leading to 40 years of steady, profitable growth. Southwest has continuously focused on driving the economies of scale that a dense geographic strategy provides. Furthermore, Southwest has been extremely opportunistic with their airport selection, often focusing on lower-cost second-tier airports in a region such as Dallas Love Field, Houston Hobby, Chicago Midway, Baltimore-Washington International, Oakland, San Jose, Burbank, Manchester, Providence, Ft-Lauderdale-Hollywood.

And, when Southwest expanded internationally, they made the strategic acquisition of AirTran, which had few overlapping routes but did have a robust business to the Caribbean, Mexico, and select Central American cities.

In evaluating a value proposition, start with the rational benefits of the products and services. Southwest's rational benefits are getting customers and their bags from point A to B through the air, which they do efficiently and competently.

They have the highest frequency of point-to-point routes, providing customers convenience and reduced travel time versus hub and spoke airlines. Southwest has the best historical on-time and baggage performance. They have a fast and convenient check-in process. In the event of a change, they have no change penalties and make it easy to book another flight. They also have the richest and easiest-to-redeem rewards program, averaging 9.5% of passenger miles flown on Rapid Rewards flights versus ~7% on other airlines.

By consistently and efficiently getting passengers and their bags from point A to B, Southwest consistently ranks as one of the top airlines in customer satisfaction.

If you fly Southwest, you understand the difference in the emotional experience versus other airlines. It always starts with the people, and Southwest's employees have a fun, caring, and go-the-extra-mile attitude.

Then there is Southwest's physical experience of newer planes, with leather seats and extra legroom compared to other airlines in the same fare class.

Then there are the perks of free live TV, free snacks, drinks, and affordable $5 wifi and alcoholic beverages. If you're a frequent flier, they periodically send you free alcoholic beverage coupons.

There is also the emotional lift of not being taken advantage of with bag and change fees.

Southwest's service is so good, and their emotional connection with customers is so strong that they can pull off marketing campaigns centered around "Love." Imagine what a bad joke it would be if other airlines tried incorporating "love" into their marketing.

In 1993, the U.S. Department of Transportation coined the term the "Southwest Effect" for the rapid growth in total air travel in a city-to-city route once Southwest started to fly the route. The "Southwest Effect" is driven by their value equation, which equals benefits - price. While we've gone through the customer benefits of Southwest, let's flip to the other side of the coin: pricing.

Historically, Southwest has been the price leader in the airline industry. With the growth of ultra-discount airlines (e.g., Frontier, Spirit), they may no longer be the ticket price leader. However, they are probably still the leader in the total cost of flying when you factor in the extra cost of bags, seat selection, change fees and the other charges of ultra-discount airlines.

Southwest utilizes its simple pricing in its #FeesDontFly marketing campaign. While the competitive herd goes one way, Southwest goes the other way, which is the essence of competitive differentiation.

A business's value proposition comprises its products, services, and pricing. The goal of a value proposition is to drive better customer value (benefits - price) than competitors. Over the past 45+ years, Southwest has consistently delivered superior customer value, leading them to grow into the largest U.S. domestic airline.

For struggling companies, the first thing to look at is the customer value proposition, which is most likely deficient versus the competition. Even for successful companies, the bottom line is to continuously focus on differentiating the value proposition to improve benefits while driving down costs, which can translate into enhanced profit or price improvement. The Customer Value Wedge is a nice visual to understand this concept better.

With the rise of digital channels, distribution is currently a hotbed of disruption and innovation. Thousands of companies have cut out significant distribution costs from their value chain, by going directly to customers through digital channels.

Given Southwest's mission of low fares, in the late 90s, as Expedia, Priceline, Orbitz, and other travel websites grew, Southwest decided not to partner with third-party websites and only utilize Southwest.com as their online distribution.  At the time it was a risky move as many airline analysts said Southwest was going to suffer. However, given the strength of Southwest's value proposition and loyalty, the direct distribution strategy paid off.

For Southwest, the estimated savings are ~$700 million a year by not using the travel sites. Southwest can split the $700 million between higher profits and lower fares for customers. It is an example of driving the customer value wedge.

Distribution strategy is a critical element of any go-to-market strategy, and getting it right can be the difference between winning and losing.

Southwest's marketing, encapsulated in their "Tranfarency" and "Love" campaigns, reflects their low fares and high-quality service mission. "Transfarency" amplifies the rational benefits of Southwest's value proposition, while "Love" amplifies the emotional benefits.

One of the main outputs of any marketing strategy is a campaign, simply a combination of messages and media. There are three media meta-channels: advocacy, owned, and paid. The beauty of Southwest is how consistent they are in driving its brand messages across all three of these media meta-channels.

With Southwest and most B2C companies, there isn't a "Sales" element to their business model, as in most B2B business models.

Too often, companies blame marketing for their growth woes instead of addressing the lack of value in their value proposition. Two of the most successful retailers, Costco and Trader Joe's, spend almost nothing on marketing but continue to grow through the strength of their value proposition and word-of-mouth advocacy. From 2010 to 2013, Southwest kept its advertising spending almost flat but increased revenues by 46%.

From a strategic perspective, the better the management team defines the top part of the business model, the easier it is for them to define strong organizational and functional strategies. Strategically aligning the value proposition, go-to-market, and organizational strategies to the targets and "true north" is one of the easiest ways to drive the efficiency and effectiveness of the organization.

Another critical component of organizational strategy is core competencies, which are those capabilities that a business needs to be world-class at to develop and deliver the competitive differentiation and advantage of the business model.

Now, let's dive into how Southwest reinforces its business model through its organizational strategies. Southwest's mission and value proposition of low cost, high service is accomplished through Southwest's strategies related to Team Members, Infrastructure, Partners, & Processes.

A company's culture starts with its values, which are reinforced by norms and the environment. Benefits and compensation are also critical to a company's culture.

It is hard to beat Southwest's culture. What other companies celebrate their culture in their recruiting materials? And, what other companies have a Culture Services Department and Local and Companywide Culture Committees?

It all starts with Southwest's values, which are broken up into "Live the Southwest Way" (Warrior Spirit, Servant's Heart, Fun-LUVing Attitude) and "Work the Southwest Way" (Safety and Reliability, Friendly Customer Service, and Low Costs).

Southwest norms, which define how Southwest team members interact with each other, reinforce the values. Southwest's environment (offices, planes, gates, etc.) celebrates employees, travel, and Southwest. Southwest also reinforces its values and norms with spirit parties, chili cook-offs, and Luvlines (their employee magazine).

Though Southwest is a low-price airline, its compensation is some of the highest in the industry. And they align all team members to their mission and financial performance through a generous profit-sharing plan. In 2015, Southwest paid out $620 million in profit-sharing, which amounted to over $12,000 per employee. This plan reinforces the Work the Southwest Way values. Southwest's benefits are numerous and generous. There are too many to list, but you should glance at them on Southwest's website.

While culture may seem squishy and nebulous, a solid and enduring culture can take root in any company if you get the values right and reinforce them with norms, the environment, benefits, and compensation.

Strong companies infuse their mission and values into their employee journey, including recruiting, hiring, onboarding, development, evaluation, and advancement. Some companies do it better than others, but great companies like Southwest are deliberate and thoughtful in their employee journey strategy.

Southwest leadership knows that starting with the right people, who inherently embody Southwest's values, is paramount to realizing its mission and preserving its culture. Southwest hires less than 2% of applicants and 6% of interviewees. Their interview process is rigorous, with group interviews, fit interviews, and a profile guide.

New hires go through a 4-week training program that trains them on the ins and outs of the job and enculturates them in the Southwest values with fun activities such as egg balancing relays and scavenger hunts. Once a team member begins to work, they are assigned a team member sponsor and participate in new hire parties and luncheons to reinforce the Southwest norms and culture.

Evaluation and advancement are based not only on a team member's skills but also on their demonstration of living the Southwest values. Team member development is reinforced through SWA University's extensive leadership and management development programs, along with continuous feedback and coaching.

There is also a continuous celebration of Southwest team members. Customers see it in the Southwest magazine with monthly articles on team members who have gone above and beyond. Southwest advertisements use team members instead of actors. Team members can give each other SWAG (Southwest Airlines Gratitude) points, utilizing an online platform that allows team members to recognize other team members for their Warrior Spirit, Servant's Heart, or Fun-LUVing Attitude. Team members can turn their points in for gift cards and merchandise. There are also numerous employee awards, such as the Spirit Award.

Southwest has thoughtfully optimized its employee journey to elevate and realize the potential of its 50,000+ person team.

Infrastructure includes the equipment, information technology, facilities, machinery, and other physical assets a business uses. Infrastructure strategy and decisions are challenging, given the typical significant investment, sometimes long and complex implementations, against the backdrop of a continuously changing future.

In Southwest's case, its infrastructure strategy reinforces its low-cost mission. In 1971, Southwest began service with four Boeing 737s, which were introduced into the market a mere four years earlier. While competitors used 15-25 seat commuter jets for the same type of routes, Southwest's 737s seated 112 passengers, ensuring Southwest a superior cost structure once the planes were fully utilized (which took a few years). Still to this day, Southwest's fleet of 700+ planes is all Boeing 737s, compared to United Airlines, which utilizes over 20 types of aircraft.

As stated in Southwest's 10-K, "The Company's low-cost structure has historically been facilitated by Southwest's use of a single aircraft type, the Boeing 737, an operationally efficient point-to-point route structure, and highly productive employees. Southwest's use of a single aircraft type has allowed for simplified scheduling, maintenance, flight operations, and training activities."

Southwest's no-seat assignments policy massively simplifies its systems and processes, with no need to track seats and seat assignments for every plane for every flight for an entire year out.

Then there is the decision, back in the early 2000s, not to install in-flight entertainment, which would have cost multiple millions of dollars per plane and led to installation downtime. The weight of each in-seat display unit can be upwards of 13 pounds. Every pound of extra weight adds ~$1,400 per year per plane in extra fuel. 13 pounds per seat adds ~$3 million in additional operating costs per year per aircraft. In-flight entertainment didn't align with their low-cost mission. Fast forward a decade, and now Southwest has arguably the best in-flight entertainment with free live TV with BYOD (bring your own device).

Southwest has always aligned its infrastructure strategy with its mission and value proposition, leading to its unit cost leadership of 4.4 cents per available seat mile versus 5.4 to 5.8 cents for other airlines.

Every action in a business is a process, whether acknowledged as one or not. The key to processes is that they are lean and efficient by reducing non-value-added actions and inventory, otherwise known as waste. For Southwest, the foundation of processes is great people, infrastructure, and partners, which enables them to have super lean & low-cost processes and high plane utilization.

Just think about Southwest's quick gate turnaround, which originated as a 10-minute turnaround challenge, which you can read about here. They only use 737s, so their turnaround teams and training are optimized on one type of plane. They don't have food carts, and they have customers and stewards clean up during deplaning. Through the profit-sharing plan, their team members are incentivized to get planes out on time and turn them around quickly.

Or, think about their no-seat assignments, which help them lean out many processes. Customer service interactions about seat assignments are non-existent, which also lowers IT costs by eliminating the complexity of seat assignments. Furthermore, the first customers to check in are the first to get their boarding number, which drives earlier check-in and better over / under-booking metrics, eliminating the need to kick paying customers off an overbooked flight.

Southwest's lean processes also make it the historical leader in on-time and baggage performance. The collective focus on lean processes helps Southwest's team members realize their mission of being a low-cost airline.