In this piece, I’ll talk about the merger of Southwest and Airtran. The merger took place 8 years ago. The reasons are two-fold. One is that I learned about the operating models of airlines in general while the other is that this merger is an example of how cultural and operational factors play an important role that could break deals.
To remain competitive in a cut-throat industry, airlines in the US have had to turn to consolidation or merge and acquisitions (M&A) in recent years (Wharton, 2010). In 2010, Southwest bought Airtran for $1.4 billion (Esterl, 2010), to create a $3 billion airline that would be the 4thlargest carrier in the US. The acquisition of Airtran was, at the time, only the 3rdin Southwest history. It paid $134 million for Morris Air in 1993 and $60.5 million for Muse Air in 1985 (Esterl, 2010). Despite the takeover, not all Airtran’s operation was integrated into Southwest’s immediately. McCartney (2013) reported that only 28% of Airtran’s destinations were moved under Southwest’s operation and that the two continued to function separately until the end of 2014.
Southwest commenced services in 1971 and as of December 31, 2010, the airline operated solely Boeing 737 aircrafts in a point-to-point model to only domestic destinations in the US (Southwest, 2011). The company’s mission statement is “dedication to the highest quality of Customer Service delivered with a sense of warmth, friendliness, individual pride, and Company Spirit” (Southwest). On the other hand, Airtran was, at the time of the acquisition, one of the largest low-cost carriers (LCC) in the country with significant presence at some of the most popular airports in the country such as New York’s LaGuardia Airport and Boston’s Logan International Airport. The airline operated Boeing B717 and B737 to domestic destinations and a few international ones such as San Juan, Puerto Rico; Cancun, Mexico; Montego Bay, Jamaica; Nassau, The Bahamas; and Orangestad, Aruba (Southwest, 2011).
There are two main types of airlines in the US: the point-to-point and hub-and-spoke (Moss, 2010). In the hub-and-spoke system, an airline concentrates its operations at a few first-rate airport locations. The point is to route traffic to ultimate destinations from these key hubs. The system is typically favored by legacy carriers, but comes at the expense of delays due to traffic congestion and other tasks such as baggage handling, gate and slot management.
On the other hand, the point-to-point system refers to the direct traffic from one point to another. It is usually deployed by LCCs for short-haul flights, but tends to be used more for longer flights. The point-to-point system typically involves secondary airports and smaller cities in order to help LCCs avoid head-to-head confrontation with bigger legacy carriers.
Southwest relies on a simple pricing strategy with only one tier and no charges on date changes or bags whereas Airtran offered multiple pricing tiers and additional fees on changes, cancellations and baggage (Wharton, 2010).
Three years after the merger was announced, the pilot issue was resolved (Yamanouchi, 2012) and the majority of Airtran employees accepted jobs at Southwest (Maxon, 2014). In 2014, the last Airtran route was integrated into Southwest’s system and Airtran operated its last flight. Furthermore, Southwest standardized the system for both domestic and international flights, using Amadeus as the technology vendor (Maxon, 2014).
Customer satisfaction, as measured by consumer com- plaints per 100,000 enplanements (Gabreski, 2013)
Southwest prefers to operate only Boeing 737s to keep the operations simple and cost down while Airtran had a fleet of Boeing 717s in addition to 737s. The two airlines adopted two different approaches when it came to distribution. Airtran sold tickets through global distribution networks such as Expedia (Esterl, 2010) while Southwest did it all internally, cutting out the middle man. Wharton (2010) reported that the most contentious issue of the whole merger was the personnel issue. Taking in so many new employees from Airtran might put Southwest at risk of not managing them well enough. Plus, pay and seniority among pilots posed another serious challenge. If the two companies merge, where in the hierarchy would each company’s crews rank?
At the time of the merger, Southwest recorded $12.1 billion in revenue and $460 million in profit (Southwest, 2010), equivalent to 4% of the top line. On the other hand, the figures by Airtran were $2.6 billion and $38.5 million respectively, equivalent to 1.5% of the turnover (Airtran, 2011). Employee-wise, Southwest had almost 35,000 staff on the books (Southwest, 2010) whereas Airtran employed 8,500 people (Airtran, 2011).
The Dallas-based company estimated that the merger would bring in $400 million a year in operating synergies by 2013, yet would cost in the beginning at least $300 in one-time integration costs. MacLennan (2015) reported that Southwest’s shares went up by 230% since the merger’s announcement, compared to a 51% gain for the S&P 500 in the same period. Southwest also noted in the 2013 annual report that the international expansion met the 15% ROIC goal.
First of all, the merger was in line with the mission statement of Southwest. It aims to deliver the highest quality of customer service to customers and obviously new routes brought over from Airtran supported that.
Porter’s Five Forces (Porter, 1979)
If we look at Porter’s strategy framework, the merger made sense. Southwest grew by flying from point to point and using secondary airports. At some point, the strategy would hit a limit and Southwest would have to do something drastic to fuel growth. The purchase of Airtran lessened the competition by eliminating a proven LCC. Regarding the threat of entry barriers, the merger gave Southwest an added fleet of great aircrafts and valuable access to hugely important airport hubs: Atlanta and Ronald Reegan in Washington DC. The former made it more difficult for any new challenger to match the size of Southwest’s fleet while the latter prevented anybody wishing to dominate those two airport hubs. Additionally, growing in size increased the bargain power Southwest has over suppliers, especially fuel suppliers. The increased power could play a significant role in keeping the cost low.
Though the move made sense strategically, it came with a host of risks in terms of operating philosophies, cultures and operations. Southwest had been a quirky airline before the merger. The organization had been very cautious when it came to expansion by acquisitions, a fact proven by its only two M&A moves before Airtran in its history. Southwest didn’t want to risk its closely monitored and managed culture and organization. Merging with a significant airline such as Airtran would be almost guaranteed to disrupt such a closed environment.
Southwest had been a point-to-point carrier for domestic flights with emphasis on customer satisfaction and employees’ well-beings. On the other hand, Airtran believed in the low-cost proposition and adopted the hybrid system for both domestic and international flights.
The merger pushed Southwest to an uncharted territory. They didn’t have experience operating international flights or the hub-and-spoke model. They didn’t have a complex pricing system or much focus on low-costs. Essentially, the table above showed a set of stark differences inherently between Southwest and Airtran. The management of the acquirer had a decision at hand: whether it should continue to operate two separate models or to take risks and choose to stick with one model?
Let’s look at this from another perspective.
Porter’s Generic Competitive Strategies (Porter, 1990)
Following the diagram above, Airtran competed by being a cost leader while Southwest pursued the differentiation path. A full integration meant that Southwest had to choose one final strategy. It didn’t make sense that Southwest acquired Airtran just to eliminate a competitor. The company had had only two deals before Airtran and in the industry that requires quite a high operating capital, spending more than $1.3 billion just to remove some competition without any synergies would be too much an investment, no matter how big Southwest was at the time. Without synergies, the merger wouldn’t have helped either company strategically.
If a full integration was the right direction, the question that remains is: which direction would Southwest choose? Given that Southwest had, at the time, more than 5 times as many employees as Airtran, integrating Airtran into Southwest would be an easier task than the other way around. Plus, Southwest’s operating philosophy was more robust and sustainable than Airtran’s.
VRIO Framework to analyze the sustainability of competitive advantage (Judgev & Thomas, 2002).
Southwest created its own sustained competitive advantage through dedication to employees’ welfare and excellent customer service. It led the industry in customer satisfaction and was profitable for 38 years in a row at the time (Southwest, 2010). It had the brand name as well. The competitive advantage that Southwest built was, in my opinion, very difficult to replicate in such a fierce industry. On the other hand, Airtran’s competitive advantage in my opinion was not as sustained. It could be argued to be a temporary competitive advantage. If other LCCs or legacy airlines had engaged in a price war, I doubt that Airtran would have survived for long. Plus, the constantly rising fuel cost was one of the main drivers of consolidation in this industry in the first place. It made Airtran’s competitive advantage less sustainable.
As a result, it made sense for Southwest to keep its original philosophy and integrate Airtran in its system.
To make the integration work, Southwest had to iron out a few wrinkles as follows:
- The fleet of Boeing 717s
- Difference in distribution system
- Difference in focus on employees and dedication to customer satisfaction
- Difference in reservation systems, especially for international flights
- Difference in pricing models and fees
- Inexperience in handling activities at major airports
- Pay and seniority of Airtran’s pilots and employees
The risks above were the reason why critics and doubters had lukewarm reaction to the merger. They were indeed difficult challenges. Unless handled smoothly, they could impact negatively both the integration and what Southwest originally had. However, the benefits were significant. In Airtran, Southwest found a solution to its quest for growth. It could add more resources and competencies, particularly international flights. In my opinion, the benefits at least justified the risks.
Culturally and operationally speaking, the merger posed an immense risk to Southwest. The two companies were very different and without a well-planned and smoothly-executed integration, it would negatively affect what they already had going on at the time. However, the risk was rightly justified by the potential gains economically and strategically.
In the end, it was wise for Southwest to integrate Airtran into its system due to the reasons articulated above. Years after the merger, the financial performance shown in the “Critical Facts” section was proof of how well Southwest pulled off the integration.
This case taught me the two models in airlines industry and how they differ from each other in terms of operations and culture. Indeed, such a difference highlights an important aspect that management has to consider before any merger.
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