Southwest Airlines – aligning incentives to strategy

Volume 19 Letter 4

Herb Kelleher, co-founder and CEO of Southwest Airlines, passed away in January of 2019.  His inspiring story is one of perseverance, sticking to his strategy and aligning incentives with long term goals.

In 1966, Herb was a young lawyer when a client approached him with the idea of starting a regional Texas airline.  It made sense; Texas is a large state with highly populated metropolitan areas far enough apart to justify air travel.  Southwest was to be the first low cost airline in America.

At the time airlines were notorious for losing money. Warren Buffet once joked, “If a capitalist had shot down the Wright brothers at Kitty Hawk the economy would probably be better off.”    Yet Herb Kelleher was attracted to the allure of doing something different and chose to target a segment of the population for whom flying was too expensive by introducing a new low cost airline.

Competition for passengers in the Texas airline industry was intense.   Southwest began by pursuing a low-cost strategy through what Herb called “enormous productivity” and flew only 3 routes in Texas charging 45% less than other carriers. To make this work, Southwest flew a 4 airplane schedule with only 3 airplanes which was made possible by ensuring 10 minute gate turnarounds and streamlined boarding and baggage handling strategies.

Once, during an early price war, Braniff  Airways offered a lower ‘introductory fare’ to lure passengers away.  To combat this Southwest, already the low-cost leader, stuck to their guns and kept their fares steady.  Instead of joining the fray they differentiated themselves by telling the flying public that they’d receive a free bottle of whiskey for flying Southwest.   The campaign was so successful that they maintained their position in the market and, for a couple of months became the largest liquor distributor in Texas.

Initially, to save money, Southwest paid pilots and crew less than their peers but in 1973, when Southwest turned a profit, they set up the very first profit sharing scheme in the airline industry.  Higher profits translated into higher pay at the end of the year.  Herb himself turned down pay and bonus increases, instead keeping the same deal as the Southwest pilots including profit sharing and stock options.  Over time Southwest would pour billions of dollars into their employees’ pockets.

In 1978, congress deregulated the airline industry which meant Southwest could now fly to cities outside of Texas.  Using the same strategy honed in Texas, Southwest went national with fares 60% lower than its competitors.  Herb had one rule when it came to running Southwest; “We’re going to be flamboyant from a marketing standpoint but we’re going to be conservative from a fiscal standpoint”. The aggressive focus on profitability as opposed to market share as a strategy was enabled by a total alignment of strategy execution, goals and incentives.

Southwest Airlines has been profitable every single year since 1973 and they’ve never laid off an employee (when the rest of the industry has laid off over 1.5 million employees).  Most of the original competitors to Southwest are gone including PanAm, Braniff, and Continental.  If there is one reason that Southwest has survived, it’s been a singular focus on a low-cost strategy with a disciplined execution aligned with employee incentives.

What can we learn from Southwest’s strategy?

  • Focus on profitability. Not market share.   Herb stated that he’d prefer to have a ‘4% market share and be profitable rather than have a 90% market share and be losing money.’
  • Relentless execution of their low cost strategy.  Planes only make money when they’re in the air and Southwest was unrelenting in finding ways to reduce turnaround times.
  • Incentives aligned with the strategy:  Southwest was the first airline to have profit sharing, aligning incentive with goals.
  • Standout marketing: rather than reducing fairs to match competition – Southwest rolled out the free Whiskey promotion showing everyone how the underdog could punch above his weight.

Is your vision, your strategy,  execution plan and incentives all aligned?   If not, tear a page from Southwest’s playbook and align your strategy and stay profitable.

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