Southwest Airline

Executive Summary

Southwest Airlines is competing with "Shuttle by United?head-to head in about 9 routes. United has just announced that it is discontinuing its Oakland - Ontario route and hiking the fares in all the 14 routes by $10, which calculated to be 14.5% increase in the fare. Southwest has to respond effectively to these unexpected developments and has to act accordingly while maintaining their current low fare image and increasing their daily operating profits. We have considered the elasticity of the market to be 1.15.

In order to achieve these objectives, Southwest has the following alternatives to choose from in order to respond effectively:

?Maintain the current fare.

?Follow United by increasing the fare by $10.

?Follow United but increase fare by only $5.

After analyzing the alternatives, we conclude that it will be appropriate for Southwest to increase its fare by $5 so as to increase its daily operating profits while maintaining the low fare airline image.

Problem Definition and Statement of Alternatives

Problem definition: The problem in this case for Southwest Airlines is to workout a strategy to respond to the unexpected developments and changes made by the United Airlines in their services and pricing. United has increased its fare on all 14 "Shuttle by United?routes by $10 and is planning to discontinue its service between Oakland-Ontario effective April.

The Decision Objective: The decision objective is to regain the lost market share and to increase the daily operating profits while maintaining the low fare carrier image.

The Success Measure: The success measure is to maximize the daily operating profit and to gain market share.

Decision Constraints: The constraints are:

?Maintain the low-fare carrier image.

?Protect the current market share.

Alternative actions: There are three alternatives that Southwest Airlines could use to respond against the action taken by United Airlines. The alternatives Southwest could consider are:

?Maintain the current fares.

?Follow United by increasing the fare by 14.5% i.e. $10.

?Follow United but increase fare by only 7.5% i.e. $5.

Analysis of Alternatives

The Air Transportation Elasticity

In order to measure the impact of United's price increase, we would need the price elasticity of the demand. The main problem is that there is no agreement as to whether, generally speaking, air transportation is or is not relatively price elastic. There is ample evidence that the introduction of deeply discounted fares by the low cost carriers can be very price elastic, although, each type of traveler has its own price characteristics. For example, it is widely known that leisure passengers are more price sensitive than business passengers and shorthaul passengers more so than longhaul ones.

For the low fare market, where competition is high and consumers seems to be price-sensitive, we define it as relatively price elastic, with elasticity equals 1.15.

The 4th Quarter Estimates without Changes

On Appendix A are estimated the fourth quarter operating profits for Southwest and for "Shuttle by United? For Southwest it was analyzed only the 9 markets that competes directly with United. On the other hand, all 14 markets operated by the "Shuttle by United?were considered for United fourth quarter estimate. It was considered that United's average fare was $20 higher than Southwest's average fare on the markets that they don't compete and 7.5% higher on the others. The total daily operating profit for Southwest is $41,509 while the "Shuttle by United?has a loss of $266,303 (Appendix A).

Alternative 1: Maintain the Same Fair as United Increases $10

The first alternative takes in consideration the $10 increase on United's fare and assumes that Southwest prices are going to remain the same. Considering a regular fare of $69, the $10 increase represents a price variation of 15.5%. The price change is going to contribute negatively to the demand for the "Shuttle by United? decreasing its load factor by 16.7%. This decrease on demand is going to more than offset the price increase and the total daily operating loss for United is going to increase to $293,097 (Appendix B).

As Southwest is going to maintain the same price, it will take advantage of the cross elasticity factor. We assumed that Southwest's load factor would change by half of the change on United's load factor. So, the $10 price increase of United's fare would provide an 8% increase on Southwest's load factor.