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9-707-414R E V : M A R C H 1 5 , 2 0 1 0
________________________________________________________________________________________________________________ Professors Ramon Casadesus-Masanell, Tarun Khanna, Jorge Tarziján (Pontificia Universidad Católica de Chile), and Research Associate Jordan Mitchell prepared this case. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2006, 2008, 2009, 2010 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
R A M O N C A S A D E S U S - M A S A N E L L
T A R U N K H A N N A
J O R G E T A R Z I J Á N
J O R D A N M I T C H E L L
Two Ways to Fly South: Lan Airlines and Southwest Airlines
Prologue
This case describes how two different airlines have achieved competitive advantage and sustained profitability in their respective markets: Lan Airlines in Chile and other parts of South America, and Southwest Airlines in the United States.
Lan Airlines (Lan) Background1
Lan was the main provider of domestic and international passenger and cargo air services in Chile and one of the leading full-service airlines in Latin America. It served destinations to several Latin American countries, the United States, Europe, and the South Pacific (Australia and New Zealand). Lan provided cargo service to its 56 passenger destinations and to more than 15 additional international freighter destinations. The company also offered courier, handling, and logistics services.2
In 2005, Lan posted revenues of $2.5 billion, of which 58.3% was from passenger revenues, 36.3% from cargo operations, and the remaining 5.4% from other activities. The company’s net income in 2005 was $146.6 million, 10.4% lower than in 2004. At year-end
Southwest Airlines (Southwest) Background27
Based on the number of originating domestic passengers boarded on scheduled domestic departures, Southwest was the largest carrier in the United States as of the end of 2005. The company provided point-to-point, low-fare service and served 374 nonstop city pairs in the United States only.
In 2005, the company enjoyed a 16% rise from the previous year in revenues, to $7.6 billion. Ninety-six percent of the company’s revenues were derived from passenger services. The remaining revenues were split between freight and other services. Since its inception as Air Southwest (later Southwest) in 1967, the company had posted profits every year. In 2005, net income grew by 75.1% to $548 million. Market capitalization was $13.2 billion at the close of 2005. (Exhibit 1B shows
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2005, Lan’s market capitalization was more than US$2 billion. The company was one of the few airlines rated as investment-grade (it was rated as BBB- by Fitch Ratings). (Exhibit 1A shows the company’s financial statements and operating revenues by activity and by geographic location.) History3
Established in 1929 by the Chilean government as Lan Chile S.A., the airline expanded with its first international route to Buenos Aires, Argentina, in 1946. It commenced service to the United States in 1958 and to Europe in 1970. Lan was wholly owned by the government until 1989, when 51% of the company’s stock was sold to a combination of national investors and SAS (Scandinavian Airlines System). In 1994, the government fully divested itself of the airline, and 98.7% of the company’s stock was purchased by two independently held companies: Cueto Group and Piñera Group. Subsequently, the airline offered shares on the Santiago and New York stock exchanges (the latter in the form of American Depositary Receipts, or ADRs). In the 1990s, the company expanded its passenger business to Peru, Ecuador, and the Dominican Republic, and its cargo operations to Brazil and Mexico, among others. The company introduced e-tickets in 1997 through its website. It joined the oneworld alliance in 2000 and made flight and service agreements with other carriers such as American Airlines, Iberia, and Qantas. To reflect its increasing international footprint, the company changed its corporate name and logo from Lan Chile to just “Lan.” In 2005, the company launched Lan as a domestic carrier within Argentina to service national routes. Operational Approach4
Lan’s approach was to integrate the planning and scheduling of the cargo business with passenger routes. Lan sought to maximize cargo in passenger planes by
the company’s financial statements.) History28
Rollin King and Herb Kelleher formed Air Southwest in 1967. They changed the name to Southwest Airlines in 1971 with the intention of creating a very different airline. The original idea was to offer the lowest possible fares on direct short-haul routes. The company made its maiden voyage in 1971 and six years later hit the five-million passenger mark. It was listed on the New York Stock Exchange as “LUV” to signify its early days at Love Field, the small Dallas-based airport where the operation began. To promote the idea of the “Love Airline,” the company referred to drinks served on-board as “love potions” and employed an all-female attendant staff wearing “hot pants” and boots. In 1979, the company offered self-ticketing machines to speed up service. Throughout the 1980s, it expanded rapidly by adding new routes. In 1990, Southwest was designated a “major” airline after hitting a billion dollars in sales. By the mid-1990s, the company introduced ticketless travel across its entire system. While the company did not have any official alliances, in 2005 it implemented its first “code-sharing” agreement with ATA (American Trans Air) to complement routes that the other did not serve. Some observers believed that Southwest would look at expanding its route network internationally.29 Operational Approach30
Southwest’s strategy hinged on making air travel as affordable and convenient as traveling by car or train. The company had the lowest cost per mile of any U.S. airline and believed this was due to its use of a single type Do
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working with aircraft manufacturers Boeing and Airbus to configure Lan’s aircraft to allow for maximum cargo weight and space in the belly of passenger aircrafts. Lan was able to adjust the passenger/cargo load of each aircraft and the routes in less than 24 hours, depending on the demand for each service and on each pair of cities. On any given domestic or international route, passenger and cargo demand were not perfectly correlated, that is, demand for passenger and cargo transport could follow different paths and peaks.
Lan targeted turnaround times of 45 minutes for domestic routes and between one and two hours for international routes, depending on the size of the plane, the distance traveled, and the scheduled service. Fares
Lan’s fare structure consisted of three levels: economy, business, and first class. With approximately 10 different fare rates, Lan adjusted its fares using revenue management models, which involved the statistical analysis of pricing and demand based on factors such as date, length of stay, Saturday night stay-over, and cancellation rights. The company frequently promoted major routes in economy class during off-season to stimulate bookings. Even though Lan did not employ a “low-cost” philosophy, all of its rates were competitive with those of other airlines. For example, a search on Lan.com for a trip from New York to Santiago, Chile, for two weeks in October 2006 produced a price of $889,5 whereas Delta’s rate was $923.6 For the same trip, Lan offered a business-class ticket for $7,000 and a first-class ticket for $10,379. Cost Structure
Lan aimed to maintain a low-cost structure through high use of its aircraft. The most
of aircraft (Boeing 737s), its point-to-point route structure, and its hardworking and productive employees (see the section of this case titled “Leadership and Human Resources” for information on employee incentive plans).
Inspired by studying pit crews at the Indianapolis 500, Southwest had an average turnaround time of 24 minutes, which was 30 minutes faster than other U.S.-based airlines. A contributing factor to the quick turnaround time was that flight attendants were expected to clean the aircraft interior after each flight. One observer believed that it was the ability of Southwest’s employees to coordinate activities like departure preparation that gave it an advantage over other airlines.31 Fares
Southwest offered unrestricted and restricted fares. All fares corresponded to the same class: economy. Fares were determined using revenue management models. The highest-price, one-way, unrestricted walkup fare in 2005 was $299 for any flight in the Southwest stable.32 Many restricted flights were much cheaper and depended on the location and timing. Cost Structure33
In 2005, Southwest had a total cost of 7.94 cents per available seat miles (ASM), which Do
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relevant cost measure for Lan was cost per ATM (available ton miles) because it took into account the availability of both passengers and cargo (measured in tons as opposed to seats). In 2005, Lan had a total cost of 62.4 cents per ATM.7 Lan did not use cost per available seat miles (ASM) as a corporate cost measure because ASM excluded the cargo business.
The four largest cost items were fuel (27.2% of operating costs), wages and benefits (15.7%), commissions to agents (14.6%), and other rentals and landing fees (12.8%).8
Like all airlines, Lan had to confront rising fuel costs, which had increased 15.9% compound annual growth rate (CAGR) from 2001 to 2005.9 For example, Lan paid 91 cents per gallon in 2001, 84 cents per gallon in 2002, 99 cents per gallon in 2003, $1.35 per gallon in 2004, and $1.91 per gallon in 2005.10 (Exhibit 2A shows Lan’s key operating statistics.) The increased cost of fuel contributed to 22% of the rise in cost in Lan’s ATM from 2004 to 2005.11 The airline combated rising fuel prices in two ways: by seeking greater fuel efficiency through an updated fleet and by engaging in financial hedging instruments (derivatives) for jet fuel. The company estimated that a one-cent increase or decrease in jet fuel costs would signify a positive or negative swing of $2.7 million for 2006.12 Routes and Alliances13
As of the end of 2005, Lan flew to 56 destinations: 15 in Chile, 32 in other Latin American countries, 3 in the United States, 2 in Europe, and 4 in the South Pacific. Through its alliances, it flew to 54 additional destinations.
Lan had a number of hub locations in South America: Santiago (Chile), Lima (Peru), Quito (Ecuador), and Buenos Aires (Argentina). Referred to as “local hubs,” these South American locations distributed the “local” demand to Lan’s “international hubs”
represented a 2.2% increase over 2004. Other major U.S. airlines had the following operating costs per ASM in 2005: United Airlines, 10.59 cents,34 American Airlines, 10.50 cents,35 and Delta, 11.60 cents.36 Other low-cost U.S. carriers had the following costs per ASM: JetBlue, 6.98 cents,37 AirTran, 9.35 cents,38 and Frontier, 9.06 cents.39
Southwest’s two major cost components were its salaries, wages, and benefits, accounting for 36% of sales, and its fuel, accounting for 18% of sales.40 Even though all airlines were confronted with rising jet fuel costs, the company was often credited with hedging fuel costs by managing financial instruments better than many other airlines. The company was involved in more than 400 “over-the-counter” financial derivatives for jet fuel and was hedging more than 70% of its anticipated fuel consumption for 2006.41 As a result of its hedging, Southwest paid 68 cents per gallon in 2002, 72 cents per gallon in 2003, 83 cents per gallon in 2004 and $1.03 per gallon in 2005.42 (Exhibit 2B shows Southwest’s key operational measures.) Routes and Alliances43
Southwest flew to 61 cities across 31 states. Historically, the company had focused on high-frequency, short-haul flights, but had expanded recently to include medium- to long-haul flights. As of 2005, average flights were 1.7 hours and 607 miles. Approximately 79% of Southwest’s passengers flew nonstop. Examples of short-haul flights were: 29 round-trips per weekday Dallas to Houston Hobby, 19 round-trips per weekday Phoenix to Las Vegas, and 22 round-trips per weekday Los Angeles International to Oakland. Common long-haul services included Baltimore to Los Do
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such as Miami, Los Angeles, New York, Frankfurt, Madrid, and Sydney. From these “international hubs,” the company distributed its passengers and cargo to different locations around the world through its alliance network. Lan also provided direct service between “local hubs” (e.g., from Santiago to Lima).
In both the passenger and cargo businesses, Lan had several agreements and alliances. For example, in 2002, LanCargo and Lufthansa Cargo signed an agreement to operate jointly between Europe and Latin America. Through this agreement, the two airlines allocated space to each other between Latin America and Europe. In passenger services, Lan belonged to the oneworld alliance (jointly with American Airlines, Aer Lingus, British Airways, Cathay Pacific, Finnair, Iberia, and Qantas). Additionally, the company signed agreements with AeroMexico and Mexicana in 2004 and with Korea Airlines and JAL in 2005 to strengthen its presence in the Asia-Pacific market. The Cargo Business14
Lan’s cargo business made up 36.3% of revenues in 2005. The company provided cargo for a wide variety of customers, including other international air carriers, freight-forwarding companies, and individual customers. During 2005, LanCargo solidified its competitive position as international courier companies like FedEx and UPS reduced operations and/or exited from many Latin American markets.
Lan carried cargo in four ways: in the bellies of passenger aircraft, in the company’s dedicated cargo planes, in belly space purchased from other airlines, and in short- and medium-term charter planes.
The company’s international cargo operations were headquartered in Miami. In Europe, the company operated two gateways: Madrid and Frankfurt. In Latin America,
Angeles, Phoenix to Tampa Bay, Las Vegas to Nashville, and Houston to Oakland. Besides the major airports, the company serviced secondary or downtown airports because these were less congested and were often more convenient and cheaper for passengers.
Southwest did not have any official alliances with other airlines, but did participate in certain code-sharing activities with the U.S.-based low-cost airline, ATA. Under the code-sharing agreement, Southwest and ATA were able to exchange passengers on certain flights. The Cargo Business44
SouthwestCargo accounted for 1.8% of revenues in 2005. The business was divided between cargo shipments and U.S. Postal Freight. Under cargo, Southwest offered different services such as the Next Flight Guaranteed and the RUSH Priority service, which promised a 24- to 48-hour delivery time (depending on location) or 100% refund. The company had 67 drop-off points around the United States, of which 39 had cooler facilities for perishables. The U.S. Postal Service split its mail between a combination of commercial and freight carriers. Do
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707-414 Two Ways to Fly South: Lan Airlines and Southwest Airlines
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LanCargo operated in Brazil, Chile, Ecuador, Mexico, and Peru. The company maintained refrigerated warehouses in Chile and the United States. The cargo service included tracking of shipments via the Internet and storage warehouses at points throughout the region. Lan’s system guaranteed a specific delivery time based on the itinerary of Lan’s passenger operations.
To enable its return flights to generate income, Lan transported different products each way. For example, on the southbound route (from the United States to South America), Lan transported products such as cellular phones, computers, spare parts for machinery, and vehicles; on the northbound routes (principally, from South America to the United States and Europe), Lan carried products such as salmon, seafood, fresh fruits, flowers, wine, and vegetables. Lan’s primary export markets were located on the Pacific coast of the United States; imports were destined for Latin America’s east coast. In 2005, the appreciation of local Latin American currencies caused a decrease in exports and an increase in imports. To counter this movement, Lan increased southbound capacity and made rate adjustments to spur northbound shipments.15 Fleet16
Lan had a total of 76 jet aircraft: 67 passenger aircraft17 and 9 dedicated cargo planes. For domestic flights, Lan maintained a fleet consisting of Boeing 737s, Boeing 767s, Airbus A320s, and Airbus A319s. For international passenger or passenger/cargo services, the company primarily used Boeing 767s, Airbus A320s, and Airbus A340s. The average age of the entire fleet was 13 years. (Exhibit 3A shows the composition of Lan’s fleet as of the end of 2005. See Exhibit 4A for a photograph of one of the planes.)
For the short- and medium-haul passenger market, the company was modernizing its fleet through the acquisition and leasing of
Fleet45
As of 2005, Southwest had 445 total Boeing 737 planes made up of three model types (737-300, 737-500, and 737-700). The average age of the planes was 9.1 years. The company leased 93 planes and owned 352 planes. (Exhibit 3B shows more details about Southwest’s fleet.) Some planes in the fleet were christened with a particular name. Examples included the “Lonestar,” the “New Mexico,” and even a plane after Southwest’s cofounder, the “Herbert D. Kelleher.” (See Exhibit 4B for a photograph of a Southwest plane.)
In 2005, Southwest added 33 new 737-700 planes and retired five 737-200 planes. The change in fleet composition increased the company’s net available seat mile (ASM) by Do
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new Airbus aircrafts that would gradually replace the Boeing 737s. Airbus’s A319 and A320 served Lan’s domestic and Latin American routes. For medium- and long-haul routes, Lan used the Boeing 767, and for ultra- long-haul routes, the company used the Airbus 340, one of the few aircrafts capable of traveling from Santiago to Auckland, New Zealand, nonstop. The Airbus 340 was used 16 hours per day, while the Boeing 737 (for shorter flights) was used an average of 6.1 hours per day. For strictly cargo, the company relied heavily on the Boeing 767-300F. The company’s freighters flew an average of almost 17 hours daily. Distribution and Sales18
In 2005, indirect sales through travel agents accounted for 67% of passenger tickets. The company participated in all major Global Distribution Systems—Sabre, Amadeus, Galileo, and Worldspan. For access to these systems, Lan paid fees based on the number of reservations per system.
The other 33% of sales were handled through direct channels, such as Lan’s own ticket offices, call centers, and the company’s websites. Lan focused on enhancing direct- sales channels and was in the process of reducing standard commissions to travel agents (Lan paid up to 8% to agents). Internet sales increased 87% in 2005 and accounted for 6.2% of passenger sales. Electronic tickets—through all sales channels—were available for 97% of Lan’s routes and accounted for 80% of all tickets sold in 2005.
In the cargo business, the company was part of GF-X, one of the largest transaction platforms in the airfreight industry, which enabled customers to make their reservations directly and electronically with 24-hour access availability.
Lan employed an advanced yield management system that adjusted prices in real time depending on demand, time to
10.8%. On average, the company’s fleet flew 12 hours per day.46 The company had firm orders with Boeing for 33 737-700 aircrafts in 2006, 29 in 2007, and 6 in 2008. Southwest also had options to purchase more than 250 planes from 2006 to 2008. The company could choose to have off-the-balance-sheet leasing agreements. However, with these agreements, Southwest would still be responsible for all maintenance, insurance, expenses, and risk of loss for each leased airplane. Distribution and Sales47
Of Southwest’s passenger revenues, 65% were generated through its website. More than 93% of the customer base opted for ticketless travel. In addition to its Internet site, the company had six reservation centers, of which three were leased and three were owned. The reservation centers took incoming calls from 1-800-IFLYSWA. The remaining passenger revenues came via third-party travel agents. However, since December 2003, Southwest had not paid any commissions to travel agents. Southwest dealt solely with the Sabre computer reservation system.48
Southwest used a revenue management system (also referred to as yield management), which compared historical travel patterns and recent bookings to assess supply and demand. The system then tracked the demand of each flight and adjusted the restricted fares accordingly. Southwest’s revenue manage-ment team also carefully reviewed the output, evaluating it against other factors, such as one-time international sporting events, which occur rarely and unpredictably. Do
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departure, stay restrictions, and anticipation in reservations, among other parameters. Marketing and Branding19
Lan promoted the concepts of punctuality, service, alliances, and route network, and stressed service to major destinations such as Miami, New York, Frankfurt, Madrid, Rio de Janeiro, Sao Paulo, Buenos Aires, and Sydney. In 2005, the company spent $19.5 million on advertising, using a combination of television, print, radio, and direct marketing.
In early 2004, the company changed its branding strategy, launching the new brand “Lan” for both passenger and cargo operations. The “Lan” name applied to all international services that were previously operated by local brands such as “LanChile,” “LanPeru,” “LanEcuador,” and “LanDominicana.” The company changed its logo and aircraft painting to homogenize the new corporate image. For domestic flights, the company operated with the LanExpress logo. To encourage customer loyalty, the company operated a frequent-flyer program called LanPass; members could earn points for any flights within the oneworld network to be applied toward future air travel with Lan. LanPass also allowed the company to generate targeted promotions to different customer segments listed in the company’s database. Flight Experience
Lan sought to deliver high-quality service in both the passenger and cargo businesses. Nearly all planes had a business and economy class, and most flights featured multilingual television shows or in-flight movies. In-flight magazines In and InPremiere were published monthly and were available on all flights. Lan offered complimentary meals, snacks, or
Marketing and Branding
Since the company’s inception, its marketing had revolved around promoting a fun and cheap way to fly. Heralded for its wacky sense of humor and off-beat consumer messages, Southwest used taglines such as the infamous “Love Airline,” “A symbol of freedom,” and “You are now free to move about the country.”49 The company spent $173 million on advertising in 2005, concentrating on billboard, magazine, and other promotional activities.50
The company had two types of frequent- flyer reward programs. The first was the Award Ticket, which offered passengers one free round-trip to any destination after flying 16 one-way or 8 round-trips. The second was the Companion Pass, which was given to passengers who flew more than 50 round-trips or 100 one-way trips within a 12-month period. The passenger could then invite another person to travel with him or her for free.51 Flight Experience
Many observers believed that Southwest’s in-flight experience was one of the features that set it apart from other airlines. For example, in the early days in-flight staff hosted contests between passengers for the largest holes in their socks.52 Southwest’s management encouraged in-flight attendants to sing out announcements or to add humor Do
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beverages on nearly every flight over one hour. All flight attendants were dressed in formal blue suits with neckties for men and silk scarves for women.20
The company’s passenger services had been recognized by several industry players. Accolades included the “Best airline in South America” by the official Airline Guide; the “Best Latin American airline” by Global Finance Magazine; one of the 10 best airlines in the world by the German magazine Reise & Preise; and the best A-340 operator in the world by Airbus. In addition, the 7,500-square-foot VIP lounge at the Comodoro Arturo Merino Benítez International Airport in Chile was ranked as one of the top 10 VIP lounges in the world by Forbes magazine, and Latin Trade magazine chose it as the “Best Airline Lounge” in Latin America.21
Along with the greater proliferation of e-tickets, the company promoted the use of its Internet check-in services to reduce airport waiting times and streamline the boarding process. All passengers were assigned seats through the check-in desk or through the Internet.
For domestic flights, Lan allowed carry-on luggage of up to 17.6 pounds (8 kilos) and checked baggage of up to 44 pounds for economy class and up to 88 pounds for first class. On international flights, the company allowed two pieces of luggage of up to 50 pounds each.22 Beyond the weight restrictions, Lan charged extra tariffs depending on the location. Operations, Safety, Training, and Maintenance23
Lan provided all its own ground services and handling of passenger and cargo at all Chilean airports. The company also provided services to most of the principal foreign
wherever possible by saying things such as, “Can the people in the back calm down a little?” during flight turbulence or by making irreverent comments like, “Please make sure all carry-on items are crammed in the tiny space under the seat in front of you, leaving absolutely no room for your feet.”53 On commuter routes, frequent Southwest fliers were often addressed by the in-flight staff on a first-name basis.54
Southwest did not offer any meals and distributed only small packets of honey-roasted peanuts and Wheat thins (called “Love bites”). The company did not assign seats, instead allowing passengers to choose their seats based on first arrival.55 The airline did not show television programs or movies during the flight. The company offered two complimentary magazines, Spirit and SkyMall. The latter contained items available for sale onboard such as barbecue kits and novelty golf-club covers.56 While the days of “hostesses” wearing hot pants had long since passed, Southwest’s in-flight staff was adorned casually in khakis, white running shoes, and a Southwest shirt.57
To facilitate check-in and reduce customer lines, Southwest had implemented its Rapid Check-In self-service kiosks in all airports. The Rapid Check-In service included a baggage check, a gate reader, and Internet check-in.58
The company allowed one piece of carry-on luggage under 22 pounds and one personal item such as a purse or laptop. For check-in, Southwest permitted three pieces of baggage up to 50 pounds each, charging for bags over the weight threshold.59 Operations, Safety, Training, and Maintenance60
Southwest leased all of its passenger facilities at each of the airports. The company had four main maintenance centers located at Dallas Love Field, Houston Hobby, Phoenix Sky Harbor, and Chicago Midway. At each Do
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airlines that operated at Santiago, Chile’s main airport, Arturo Merino Benitez. Lan contracted ground services to foreign airport service companies at most of the international airports. Since 2004, Lan had owned and operated two ground-handling companies for passenger and cargo services in Ecuador, which provided the bulk of Lan’s service needs within Ecuador. Lan performed all ground training in its centers in Chile, Argentina, Ecuador, and Peru. In 2004, the company signed an agreement with the Canadian flight-training company, CAE, to operate a joint-venture training facility with three full flight simulators.
The company’s main maintenance facilities were certified by a number of different aviation authorities (FAA, JAA, DGAC, and others), and flight operations were in accordance with ISO 9001-2000 standards. Other Services24
Lan generated revenues from a variety of other services. In 2005, the company garnered $23.8 million from aircraft leases, $18.8 million from ground services, $15.6 million from duty-free in-flight sales, $39.9 million from logistics and courier businesses (called LanCourier), and $10.7 from storage and customs brokerage operations (called LanLogistics). The remaining $26.4 million came from sales to third parties by Amadeus Chile CRS (computer reservation system), aircraft maintenance services to third parties, security, tour operations, and other activities. Leadership and Human Resources25
Lan was governed by a nine-person board of directors. The senior management team was composed of 10 people and was led by Enrique Cueto Plaza, who had held the post since 1994. Cueto was a member of the Cueto Group, a controlling shareholder of Lan.
airport, Southwest performed most of the maintenance itself except for major component inspections or repairs, which were contracted out to third parties. The company performed all of its pilot training at a dedicated facility at Love Field, which included seven Boeing 737 simulators.
Southwest was required to be certified for all aspects of maintenance and operations under the Federal Aviation Administration. In addition, the company had to meet the guidelines set out by other U.S. agencies such as the Occupational Safety and Health Administration and the Food and Drug Administration. Other Services61
Apart from freight (described above under “The Cargo Business”), Southwest was engaged in programs with a company-sponsored Chase® Bank Visa card, whereby Southwest was entitled to commissions from financial institutions. Revenues from these activities totaled $172 million in 2005. Leadership and Human Resources
Southwest had been led from 1971 to 2001 by cofounder Herb Kelleher. Kelleher was renowned for his unorthodox approach, which included arm-wrestling with an advertising executive to settle litigation, impersonating Elvis in front of Southwest’s employees, and appearing in the maintenance hangar in a purple boa and woman’s dress to settle a Do
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As of December 31, 2005, Lan had a total of 15,099 employees. The company had a performance-related pay structure for administrative, management, and flight personnel, including performance-based bonuses and pay scales. For example, counter, technical, and administrative employees’ pay scales were linked to skills like foreign- language proficiency. While the company did not offer stock options to its employees, approximately 90% of the employees were eligible to receive performance-related bonuses based on individual, team, and overall company results.
Unions represented the majority of Lan’s employees. Lan staggered union expiration contracts to avoid having to renegotiate terms with all groups at the same time. Most contracts were negotiated for a period of four years (a limit under Chilean law). Competition and Operating Context26
Lan’s competitors in Chile were Sky Airline and Aerolineas del Sur (which began service in 2004). Lan competed against Aerolineas Argentinas, AeroMexico, Avianca, COPA, TACA, TAM, and Varig for routes within Latin America. For international routes outside of the region, the company competed against major carriers such as American Airlines, Delta Airlines, Air Canada, Iberia, Air France, and Lufthansa for traffic entering and exiting Chile. (For more information on selected Lan competitors, see Exhibit 5. Exibit 6 shows share prices for Lan. Exhibit 7 shows key facts about Lan’s country of origin—Chile.)
performance challenge to the maintenance crew.62 Many observers believed that Kelleher set the tone for Southwest’s offbeat image.
As of 2005, the company was led by 50-year old Gary Kelly, CEO, and 60-year old Colleen Barrett, president and COO. Kelly—previously the CFO—was the company’s second CEO since Kelleher retired in 2001.
Southwest had 31,729 employees as of December 2005. While the company’s relationship with its employees had been historically strong due to its policy of no furloughing and its fun culture, Southwest had been embroiled in a two-year battle with its flight-attendant union from 2002 to 2004, resulting in a 31% pay hike over the existing contract.63 However, the company typically had longer-term pilot contracts than other major airlines. The company offered profit-sharing mechanisms and stock-option plans to its employees. Competition and Operating Context64
Southwest competed against all major U.S. airlines, including United Airlines, U.S. Airways, Delta, Northwest, and Continental. After September 11, 2001, a number of smaller low-cost carriers such as AirTran, JetBlue, and Frontier emerged with a similar no-frills approach. (See Exhibit 5 for Southwest’s competitor information. Exhibit 6 shows share prices for Southwest. Exhibit 7 shows key facts about the United States.)
Do Not
Cop
y or
Pos
t
This document is authorized for educator review use only by Wilbert Zevallos, until April 2016. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or 617.783.7860
707-
414
-1
2-
Exh
ibit
1A
Lan
Pro
fit a
nd L
oss
Stat
emen
t E
xhib
it 1
BSo
uthw
est P
rofi
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Los
s St
atem
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Lan
P&L
Sout
hwes
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LIn
US
$ m
illio
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1)20
0320
0420
05In
US
$ m
illio
ns (y
ear e
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0320
0420
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OP
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0
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go60
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4
OP
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EXP
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W
ages
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240.
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S
alar
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259.
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-33
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19.5
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R IN
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Sou
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Lan
Ann
ual R
epor
t, w
ww
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.gov
, 20-
F, D
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1, 2
005,
p. F
-5.
S
ourc
e: S
outh
wes
t Airl
ines
, Ann
ual R
epor
t, 10
-K, w
ww
.sec
.gov
, Dec
embe
r 31,
200
5, p
. 29.
Do Not
Cop
y or
Pos
t
This document is authorized for educator review use only by Wilbert Zevallos, until April 2016. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or 617.783.7860
707-
414
-1
3-
Exh
ibit
1A
(con
tin
ued
)L
an B
alan
ce S
heet
E
xhib
it 1
B (c
onti
nu
ed)
Sout
hwes
t Bal
ance
She
et
Lan
Airli
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Sout
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ines
in m
illion
s (U
S$)
2001
2002
2003
2004
2005
2001
2002
2003
2004
2005
Asse
tsC
ash
& Eq
uiva
lent
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2
21
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et16
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18
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0
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vent
orie
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33
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tal C
urre
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oper
ty, P
lant
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ross
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0
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on-E
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-
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iabi
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res
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78
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0
80
1.6
Sou
rce:
T
hom
son
One
Dat
abas
e.
Do Not
Cop
y or
Pos
t
This document is authorized for educator review use only by Wilbert Zevallos, until April 2016. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or 617.783.7860
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414
-1
4-
Exh
ibit
1A
/1B
(con
tin
ued
)
L
an
S
outh
wes
t
Yea
r 20
0320
0420
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2003
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1 33
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Sour
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Lan
Ann
ual
Rep
ort,
20-F
, ww
w.s
ec.g
ov, D
ecem
ber
31, 2
005,
p. F
-35;
Sou
thw
est A
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es, A
nnu
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epor
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ww
.sec
.gov
, Dec
embe
r 31
, 200
5.
Not
e:
Rev
enue
s fo
r L
an h
ave
been
take
n d
irec
tly
from
the
P&
L. N
orth
Am
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a fo
r So
uth
wes
t is
the
U.S
. onl
y.
Do Not
Cop
y or
Pos
t
This document is authorized for educator review use only by Wilbert Zevallos, until April 2016. Copying or posting is an infringement of copyright. Permissions@hbsp.harvard.edu or 617.783.7860
707-
414
-1
5-
Exh
ibit
2A
Lan
’s O
pera
ting
Sta
tist
ics
Exh
ibit
2B
Sout
hwes
t’s O
pera
ting
Sta
tist
ics
La
n So
uthw
est
20
03
2004
20
05
Ave
rage
20
03
2004
20
05
Ave
rage
PA
SSEN
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BU
SIN
ESS
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s - A
vaila
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Seat
Mile
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illio
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Inte
rnat
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l
9,0
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1
0,80
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443.
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1
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l
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To
tal P
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ld (U
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ents
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11.
7
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4
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4
12.
5
12.
0
11.
8
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1
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9 To
tal P
asse
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d Fa
ctor
(%)
69.1
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73.8
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66.8
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70.7
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Ave
rage
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enue
/ Pa
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ger
1
66.7
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177
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175
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57
93.
68
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89
C
AR
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ESS
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(car
go) -
Ava
ilabl
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n M
iles
(car
go)*
(mill
ions
)
In
tern
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nal
1737
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13.8
2204
.719
85.4
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32
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ot a
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n
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l 17
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RTM
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Ton
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l
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omes
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tal
1
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1
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ried
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l
3
97.4
4
81.3
5
04.2
4
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omes
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2
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5.6
not
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tal
424
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506
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529
.0
486
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not
ava
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ava
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not
ava
il.
Tota
l Car
go Y
ield
(US$
cen
ts)
50.
67
56.
96
61.
25
56.
30
not
ava
il.
not
ava
il.
not
ava
il.
To
tal C
argo
Loa
d Fa
ctor
(%)
67.1
%68
.7%
66.5
%67
.4%
not
ava
il.
not
ava
il.
not
ava
il.
FUEL
CO
ST P
ER G
ALL
ON
(US$
)
0.9
9
1.3
5
1.9
0
1.4
1
0.7
2
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3
1.0
3
0.8
6 EM
PLO
YEES
(ful
l num
bers
)
11,
173
1
3,41
4
15,
099
1
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9
32,
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3
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1
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3
1,86
2
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707-
414
-1
6-
Exh
ibit
2A
/2B
(con
tin
ued
)
Def
initi
ons
ASM
(Ava
ilabl
e Se
at M
iles)
Th
e nu
mbe
r of s
eats
mad
e av
aila
ble
for s
ale
mul
tiplie
d by
the
mile
s flo
wn.
ATM
(A
vaila
ble
Ton
Mile
s) (c
argo
) Th
e nu
mbe
r of t
ons
of c
apac
ity a
vaila
ble
for t
he tr
ansp
orta
tion
of c
argo
mul
tiplie
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mile
s flo
wn.
RPM
(Rev
enue
Pas
seng
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iles)
Th
e nu
mbe
r of r
even
ue p
asse
nger
s ca
rrie
d m
ultip
lied
by th
e m
iles
flow
n.
RTM
(Rev
enue
Ton
Mile
s) (c
argo
) Th
e nu
mbe
r of r
even
ue to
ns c
arri
ed m
ultip
lied
by th
e m
iles
flow
n.
Tota
l Pas
seng
er Y
ield
Re
venu
e fr
om p
asse
nger
ope
ratio
ns d
ivid
ed b
y RP
Ms
Tota
l Car
go Y
ield
Re
venu
e fr
om c
argo
ope
ratio
ns d
ivid
ed b
y RT
Ms
(car
go)
Tota
l Pas
seng
er L
oad
Fact
or
RPM
s ex
pres
sed
as a
per
cent
age
of A
SMs
Tota
l Car
go L
oad
Fact
or
RTM
s (c
argo
) exp
ress
ed a
s a
perc
enta
ge o
f ATM
s (c
argo
)
Sour
ce:
Lan
inf
orm
atio
n ad
apte
d f
rom
Lan
Air
lines
Ann
ual
Rep
ort,
20-F
, w
ww
.sec
.gov
, D
ecem
ber
31,
2005
, pa
ge 5
7. S
outh
wes
t in
form
atio
n ad
apte
d f
rom
Sou
thw
est
Air
lines
Ann
ual
Rep
ort,
10-K
, w
ww
.sec
.gov
, Dec
embe
r 31
, 200
5, p
age
14.
• W
e na
med
this
figu
re A
TM (c
argo
) to
dist
ingu
ish
it fr
om A
TM to
tal,
whi
ch is
the
mea
sure
in w
hich
Lan
exp
ress
es c
apac
ity
in it
s w
hole
sys
tem
(pas
seng
er a
nd c
argo
).
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707-
414
-1
7-
Exh
ibit
3A
Lan
Fle
et, y
ear-
end
200
5 E
xhib
it 3
BSo
uthw
est F
leet
Lan
Sout
hwes
tLe
ased
Ow
ned
Tota
lA
vg. Y
ears
Leas
edO
wne
dTo
tal
Avg
. Yea
rs
Pass
enge
r Fle
etB
oein
g 73
7-20
014
1024
26.6
Boe
ing
737-
300
134
1710
.282
112
194
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ing
737-
500
916
2514
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oein
g 73
7-70
02
224
226
3.8
Airb
us 3
19-1
005
27
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Airb
us 3
20-2
0011
415
4.8
Airb
us 3
40-3
004
04
5.1
Tota
l Pas
seng
er
Airc
raft
4720
6713
.793
352
445
9.1
Car
go F
leet
Boe
ing
767-
300F
17
84.
4B
oein
g 73
7-20
0F0
11
36To
tal C
argo
Airc
raft
18
98
Tota
l Airc
raft
4828
7613
9335
244
59.
1
Sour
ce:
Com
pile
d b
y ca
sew
rite
rs f
rom
: L
an A
irlin
es,
Ann
ual
Rep
ort,
20-F
, w
ww
.sec
.gov
, D
ecem
ber
31,
2005
, p.
32;
Sou
thw
est
Air
lines
, A
nnua
l R
epor
t, 10
-K,
ww
w.s
ec.g
ov,
Dec
embe
r 31
, 200
5, p
. 8.
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t
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707-414 Two Ways to Fly South: Lan Airlines and Southwest Airlines
18
Exhibit 4A Photograph of Lan Plane
Source: Lan Annual Report, December 31, 2004, p. 2.
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Two Ways to Fly South: Lan Airlines and Southwest Airlines 707-414
19
Exhibit 4B Photograph of Southwest Plane
The “New Mexico” Plane
Source: Southwest website, http://www.southwest.com/about_swa/photos.html, accessed April 10, 2006.
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t
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707-
414
-2
0-
Exh
ibit
5L
an a
nd S
outh
wes
t Com
peti
tors
Airl
ine
Hea
dqua
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(USD
m
illio
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1-Ye
ar S
ales
G
row
thN
et In
com
e (U
SD
mill
ions
)
Flee
t Siz
eA
llian
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Lan
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ompe
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%(1
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50N
one
Sour
ce:
Com
pile
d b
y ca
sew
rite
rs fr
om: h
ttp:
//
ww
w.h
oove
rs.c
om p
rofi
les;
flee
t siz
es fr
om: h
ttp
://
ww
w.p
lane
-spo
tter
s.ne
t (C
urre
nt F
leet
Det
ails
).
Do Not
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y or
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t
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707-
414
-2
1-
Exh
ibit
6
Clo
sin g
sha
re p
rice
La
n So
uthw
est
Pr
ice
(USD
)*
Retu
rn**
Pr
ice
(USD
)*
Retu
rn**
2002
5.
9
13.7
7
2003
2.
77
-53.
05%
1616
.19%
2004
5.
37
93.8
6%16
.16
1.00
%
2005
6.
37
18.6
2%16
.34
1.11
%
Sour
ce:
Blo
ombe
rg L
.P.,
Lan
Air
lines
S.A
. (ht
tp:/
/w
ww
.blo
ombe
rg.c
om/
apps
/qu
ote?
tick
er=
LA
N%
3AC
I): B
loom
berg
L.P
., So
uthw
est A
irlin
es
(htt
p:/
/w
ww
.blo
ombe
rg.c
om/
apps
/qu
ote?
tick
er=
LU
V%
3AU
S), a
cces
sed
Au
gust
3, 2
009.
* C
losi
ng p
rice
adj
uste
d fo
r div
iden
ds a
nd s
plits
.
** R
etur
n ov
er p
revi
ous
year
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t
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707-414 Two Ways to Fly South: Lan Airlines and Southwest Airlines
22
Exhibit 7 2006 Key Facts: Chile and the United States
Chile U.S. Land Area 756,950 sq km 9,631,420 sq km Border Countries Argentina, Bolivia, Peru Canada, Mexico Population 16,134,219 298,444,215 Median age 30.4 years 36.5 years Population growth rate 0.9% 0.9% Literacy 96.2% 99.0% Legal system Based on Spanish law with influences from
France and Austria Federal court system based on English common law. Each state has its own legal system.
GDP 187.1 billion 12.36 trillion GDP—real growth rate 6.0% 3.5% GDP—per capita 11,300 41,800 Ranking of GDP—per capita 82 of 232 countries (between Libya and
Costa Rica) 6 of 232 countries (between Norway and Ireland)
GDP Composition Agriculture 6.2% 1.0% Industry 46.5% 20.7% Services 47.3% 78.3% Labor force 6.3 million 149.3 million Unemployment rate 8.0% 5.1% Population below poverty line 18.2% 12.0% Inflation rate 3.2% 3.2% Public debt of GDP 8.1% 64.7% Industries Copper, other minerals, foodstuffs, fish
processing, iron and steel, wood and wood products, transport equipment, cement, textiles
Petroleum, steel, motor vehicles, aerospace, telecommunications, chemicals, electronics, food processing, consumer goods, lumber, mining
Exports—partners US 14%, Japan 11.4%, China 9.9%, South Korea 5.5%, Netherlands 5.1%, Brazil 4.3%, Italy 4.1%, Mexico 4%
Canada 23%, Mexico 13.6%, Japan 6.7%, UK 4.4%, China 4.3%
Exports—commodities Copper, fruit, fish products, paper and pulp, chemicals, wine
Agricultural products (soybeans, fruit, corn) 9.2%, industrial supplies (organic chemicals) 26.8%, capital goods (transistors, aircraft, motor vehicle parts, computers, telecommunications equipment) 49.0%, consumer goods (automobiles, medicines) 15.0%
Exports (billions) 38.03 927.5 Approx. 5 year CAGR—Exports 13.3% 3.0% Imports (billions) 30.09 1,727 Approx. 5 year CAGR—Imports 9.3% 6.5% Current account balance (billions) 0.309 -829.1 Imports—commodities Petroleum and petroleum products,
chemicals, electrical and telecommunications equipment, industrial machinery, vehicles, natural gas
Agricultural products 4.9%, industrial supplies (crude oil 8.2%) 32.9%, capital goods (computers, telecommunications equipment, motor vehicle parts, office machines, electric power machinery) 30.4%, consumer goods (automobiles, clothing, medicines, furniture, toys) 31.8%
Imports—partners Argentina 16.8%, US 13.7%, Brazil 11.2%, China 7.5%
Canada 17%, China 13.8%, Mexico 10.3%, Japan 8.7%, Germany 5.2%
Roadways 0.5% are expressways, 19.5% other paved 1% are expressways, 64% are other paved roads, Do Not
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Two Ways to Fly South: Lan Airlines and Southwest Airlines 707-414
23
Chile U.S. roads, 80% unpaved roads. 35% unpaved roads.
Airports 363 14,893 Airports—with paved runways 72 5,120
Source: CIA World Factbook, http://www.cia.gov, accessed June 24, 2006 (with the exception of Export and Import growth rates, which were estimated based on U.S. Bureau of Census data, http://www.census.gov.
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707-414 Two Ways to Fly South: Lan Airlines and Southwest Airlines
24
Endnotes
1 Lan Airlines, 2005 Annual Report, 20-F, http://www.sec.gov, December 31, 2005, pp. 17–20.
2 Lan offered courier, handling, and logistics services to assist companies in the planning, deployment, and shipment of goods.
3 Lan Airlines, 2005 Annual Report, p. 18.
4 Ibid., pp. 17–18.
5 Lan website, http://www.lan.com, accessed June 29, 2006.
6 Delta website, http:// www.delta.com, accessed June 29, 2006.
7 ATM has been adjusted from the company’s stated ATK, which is the number of tons of capacity available for the transportation of revenue load (passengers and/or cargo) multiplied by the kilometers flown. Cost per ATK from: Lan Airlines, 2005 Annual Report, 20-F, p. 22.
8 Lan Airlines, 2005 Annual Report, p. 50.
9 Ibid., p. 37.
10 Ibid.
11 Ibid., p. 48.
12 Ibid., p. 97.
13 Ibid., pp. 26 and F-8.
14 Ibid., pp. 30–32.
15 Lan Airlines, 2005 Annual Report/Memoria Anual, December 31, 2005, p. 27, http://www.lan.com/files/about_us/lanchile/memoria_2005_comercial.pdf, accessed June 30, 2006.
16 Lan Airlines, 2005 Annual Report, pp. 32–33.
17 Passenger planes are used extensively to ship cargo.
18 Lan Airlines, 2005 Annual Report, pp. 27–28.
19 Ibid.
20 Based on observations during flights taken by casewriters.
21 Lan Airlines, Annual Report, 20-F, www.sec.gov, December 31, 2005, p. 65.
22 “Información sobre Viajes, Equipajes,” Lan website, http://www.lan.com, accessed June 26, 2006.
23 Lan Airlines, 2005 Annual Report, pp. 40, 44.
24 Ibid., p. F-31. Do Not
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Two Ways to Fly South: Lan Airlines and Southwest Airlines 707-414
25
25 Ibid., pp. 67–72.
26Ibid., pp. 24–26.
27 Southwest Airlines, 2005 Annual Report, 10-K, http://www.sec.gov, December 31, 2005, p. 1.
28 Adapted from James L. Heskett, “Southwest Airlines 2002: An Industry Under Siege,” HBS No. 803-133 (Boston: Harvard Business School Publishing, 2003); Southwest Airlines website, http://www.southwest.com/about_swa/airborne.html, accessed April 9, 2006.
29 Southwest Airlines, 2005 Annual Report, p. 1.
30 Ibid.
31 Jody Hoffer Gittell, The Southwest Airlines Way (New York: McGraw-Hill, 2003), p. 16.
32 Southwest Airlines, 2005 Annual Report, p. 23.
33 Ibid., p. 41.
34 UAL Corp., 2005 Annual Report, 10-K, http://www.sec.gov, December 31, 2005, Part II, Item 6 (no page number in html document).
35 American Airlines Inc., 2005 Annual Report, 10-K, http://www.sec.gov, December 31, 2005, p. 31.
36 Delta, 2005 Annual Report, 10-K, http://www.sec.gov, December 31, 2005, p. 23.
37 JetBlue Airways Corp., 2005 Annual Report, 10-K, http://www.sec.gov, December 31, 2005, p. 27.
38 AirTran Holdings Inc., 2005 Annual Report, 10-K, http://www.sec.gov, December 31, 2005, p. 23.
39 Frontier Airlines Holdings, 2005 Annual Report, 10-K, http://www.sec.gov, March 31, 2006, p. 29.
40 Southwest Airlines, 2005 Annual Report, p. 29.
41 Ibid., p. 23.
42 Ibid., p. 14.
43 Ibid., pp. 1, 3.
44 Southwest Cargo website, http://www.swacargo.com/cargo/cargosvcs.html, accessed June 26, 2006.
45 Southwest Airlines, 2005 Annual Report, p. 9.
46 Heskett, “Southwest Airlines 2002,” p. 6.
47 Southwest Airlines, 2005 Annual Report, p. 8. Do Not
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707-414 Two Ways to Fly South: Lan Airlines and Southwest Airlines
26
48 “Southwest Airlines and Sabre Airline Solutions Sign a Seven-Year Passenger Reservations Contract,” Business Wire, May 3, 2005.
49 Southwest Airlines website, http://www.southwest.com, accessed April 6, 2006.
50 Southwest Airlines, 2005 Annual Report, p. 2.
51 Ibid., p. 13.
52 James L. Heskett, “Southwest Airlines 2002,” p. 7.
53 Richard McCaffery, “Southwest Airlines' Competitive Edge,” http://www.fool.com/news/foth/2000/foth000928.htm, September 28, 2000, accessed June 29, 2006.
54 Heskett, “Southwest Airlines 2002,” p. 2.
55 As of June 2006, Southwest had announced it would test assigned seats on some routes.
56 Southwest Airlines website, http://www.southwest.com/travel_center/baggage.html, accessed June 26, 2006.
57 Marlene Friesen and Elliot N. Weiss, “Marlene’s Marvelous Adventure: Southwest Airlines,” Darden Business Publishing, University of Virginia, UVA-OM-1152, 2004.
58 Southwest Airlines, 2005 Annual Report, p. 13.
59 Southwest Airlines website, http://www.southwest.com, accessed April 6, 2006.
60 Southwest Airlines, 2005 Annual Report, p. 13.
61 Ibid.
62 Heskett, “Southwest Airlines 2002,” p. 7.
63 Barney Gimbel, “Southwest’s New Flight Plan,” Fortune, May 16, 2005.
64 Southwest Airlines, 2005 Annual Report, p. 13.
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